On The Brink with Castle Island - Ethan Vera and Guzman Pintos (Luxor) on Mining Data and Analytics (EP.274)

Episode Date: January 3, 2022

Luxor COO and CPO Ethan Vera and Guzman Pintos join the show to talk about their relaunched data product, Hashrate Index and other trends in mining. In this episode:  The history of the firm Why Luxor created the hashrate index How Luxor gathers data on ASIC pricing and creates their time series charts ASIC pricing dynamics Are sell side analysts correctly pricing ASICs on the balance sheets of public miners? Why different efficiencies of miners have traded differently in the last 2 months How constraints on rack space affect the demand for older ASICs Why so many ASICs can't leave China Is there still residual black market mining in China? Kazakhstan's under-reported mining crackdown Are ASIC development cycles slowing? Are miners still front-running their clients with prop mining? Are Bitcoin miners trying to acquire Bitcoin or do they want to hedge their exposure Are derivatives becoming more popular among miners? The maturation of the Bitcoin mining derivatives market Why prior hashrate derivatives haven't worked Multiple based analysis for public miners Why there is a 'public market arbitrage' for miners Why incentives exist for public miners to be highly acquisitive Do miners care about long term fee budget? Sponsor notes: Compass Mining is the world's first and largest online marketplace for bitcoin mining hardware, hosting, and ASIC reselling. Start mining your own bitcoin by visiting compassmining.io

Hello everyone. Happy New Year. Welcome back to On the Brink. This is the Mining miniseries. Today's episode is brought to you by Compass Mining. More on them later in the episode. Today I sit down with Ethan Vera and Guzman Pinto's co-founders of Luxor, a Bitcoin mining pool. They've just relaunched their hash rate index, which is a great data resource, hashrateindex.com. So we cover a lot of their new fantastic data feeds, including Consolidated ASIC-pric pricing. models. We talk about why different efficiencies of ASICs are doing different things with regards their pricing, why so many ASICs can't leave China, whether Bitcoin miners are hedging their hash rate or if they are simply trying to acquire as much Bitcoin as possible, the history of hash rate

derivatives and why they haven't worked, and whether there's a public market arbitrage for miners. This is chock full of data. Definitely check out the new hash rate index. Let's dive right into it. Brought down by bad mortgage investments, Lehman, which has 25,000 employees will be liquid. The federal government loans American International Group, AIG, $85 billion. This is a different kind of market, and the Fed is asleep. The federal government is stepping it to stabilize Fannie Mae and Freddie Mac, the two mortgage giants that have been threatened by the housing crisis. The Bank of England has pumped 75 billion pounds more into Britain's ailing economy

with a new round of quantitative easing. You print a couple trillion dollars, and all of a sudden, people start to worry. So out of this worry, we have something called the Bitcoin. Bitcoin. All right, so I'm sitting here with... With Ethan Vera and Guzman Pinto's, the co-founders of Luxor, they have released, re-released the hash rate index, a very solid resource regarding all things Bitcoin mining. Highly encourage you to check it out.

Welcome to the show, gentlemen. Welcome to the mining miniseries, the critically acclaimed mining miniseries. It's good to have you on. Thanks, Nick. Thanks for having us. Thanks for having us here. Awesome. So before we jump in to the data, let's talk about Luxor itself. Tell me a little bit about the firm. We started Luxor like about four years ago. At that time, we were kind of like fascinated by the idea of mining pools.

Because mining pools are kind of like combined finance software and consensus mechanism in a blockchain. So for us, like being able to do consensus on like public blockchains, being able to issue coins and then offer services. to miners was kind of like fascinating. From there, we kind of like continue developing new products, expanding into different outcoins. At the very beginning, we started like mining Syak coin and then expanded into different altcoins just due to like balance its constraints,

like running a Bitcoin mining pool requires quite a bit of capital. And then throughout the years, we started like kind of developing this idea of hash rate as a commodity, hash price, So we launched Hachrard Index. Hashred Index, kind of like a community-driven platform that has a bunch of different data points. It's really useful for miners, from the value of Hash Rate to RIC prices, and now like even stock market data for all of the public traded companies, just to kind of like educate and expand on this idea of HashRid as a commodity on something that can be traded. And yeah, that kind of like what gets us here today.

What was the inspiration for creating the index? Did you feel that the data environment in mining was kind of weak and ought to be kind of remedied? Yeah. So kind of like when we created the Hatchet Index was like two and a half years ago. It was kind of like a night time weekend's project for the entire like Luxor team. There were like no public resources available on, for example, what's the current value of Hachshrate? Like miners were just like trusting Mining pools to like pay them early

on the expected value of their compute power. There also wasn't like any resources on the cost of these ASIC machines, right? Like Bitcoin miners, how much they're worth. Most of the purchases were happening on like one off OTC trades over telegram between

miners and like Chinese brokers and whatnot. So trying to, so Hashid Index was also a way to shed some light into the industry, try to bring new data points, new insights, and maybe more transparency into the ASIC mining space. But right now, where 2020 and 2021 has been professionalized a lot. There's a lot of new public-grated miners. But like two and a half, three years ago, that was not the case.

Most of the miners were much smaller internal size. There were very few that were actually publicly traded. So yeah, kind of we're in a completely different ecosystem. Yeah, how should index work kind of like an answer to that? Some of the data I think is really informative is your like rig index data. And, you know, first of all, just gathering data on ASIC pricing is a huge contribution in its own right. Because to my knowledge, there isn't a good consolidated source of that data anywhere. But then also this abstraction you use where, you know, for your main index, you actually

divide the ASICs into different types such that as the generations of ASICs fade in and out, you actually have kind of consistent kind of time series trends showing the different sort of genres of ASIC. So just tell me a little bit about how you constructed that index. and also just how you gather the ASIC pricing data in the first place. Gathering ASIC prices, it's definitely hard because, as I mentioned before, most of these ASIC traits are happening behind the scenes in like one-to-one telegram channels, right? So what we've been doing over the last three years is try to scrape the web to get as many data points as we possibly can.

Also, complementing a data set with some like brokers data. We have like partnered with that essentially supply us with like firsthand information about all of the deals they've done, both in the east and the west, so China and the US, try to, with intention to put together this index. And then we've split the prices into what we call efficiency tiers. And we have kind of like old, mid and new gen ASEX. Why we split into efficiency tiers? is because at the end of the day, the efficiency of a machine is what determines its profitability

and it's breaking point. What's their, like, for example, turnoff point based on your local electricity power rate and what's like current hash price. So those A6 will trade a dollar per share very similarly because their margins are pretty similar as well. So yeah, in that index, you can see how we split into like old, made a new gen ASEX.

We've been gathering these prices. I think since like early 2018, so this is going to be our fourth year in which we have computed the index. And yeah, and why it's useful for miners, I guess, there's multiple reasons. Some of the insights that we have gathered

and put together the last few months, it's, for instance, there's a lot of talk in, like, probably minding companies how much their bitcoin is worth. in terms of how much they hold in their balance sheet. But they, not too many, like, analysts are, like, talking about how much their ASICs are worth. So, for example, if you look at, like, I don't know, Marathon or Hat 8, they have, like, hundreds of thousands of ASICs, either currently running or in, like, future orders.

And sometimes those ASICs at current market prices are worth more than what they are, like, holding in BTC. And also these ASIC prices are extremely volatile. So you can see how their, potentially their market capital, their stock price, can also change based on the fluctuation on their underlying ASIC prices. So that's kind of like one insight that we've been essentially leveraging the rate index for. But there's like many other things that you could use that index for as well. And does the sell side take ASIC pricing into account? Or is it still, are they still kind of developing these techniques? So I think in terms of cell side research coverage, they are starting to hone in on some of these ASIC pricing, especially when it comes to new purchases.

For example, with Marathon's latest purchase, the dollar per tarahash was a huge point for cell side analyst to cover. But they haven't really started to look at the existing fleet of miners like Guzman was mentioning. So Marathon has a historical order of new generation equipment at under $20 a tarahash last year in 2020. that mining equipment is now worth about five times what it was worth. And so we suspect that will be a focal point for cell site analysts to come. And we've started to give them a lot of research and data to help them out in their reports. And so we worked with a lot of people on both cell side as well as like the Twitter analyst to help them build reports and analysis into these companies.

It's funny that we're in a new world where, you know, sell side, you know, at Wall Street institutions or like on an even footing with like smart people on Twitter. You know, there's a lot of porosity between the two. So I want to ask you guys something specific with this rig price index. So you got to divide into three bands in terms of efficiency. Since early November, the least efficient cohort has actually sold off, I would say pretty materially in dollar terms and then the medium one has has rallied and the the most efficient cohort has been roughly flat so you know you're seeing different like quite different behavior based on the efficiency tier of the A6 in the last two

months so I don't know if you guys have explanations for that what what would actually explain those disparate reactions over the last kind of 60 days. Yeah, so I think this is the type of interesting analysis we hope people get into with this data is looking at these types of events and trying to figure out how they can predict the future more. In regards to this specific one, I think there's probably a few reasons that result in this outcome, but the main one I look at is infrastructure-constrained environment. And so right now, we're in an environment, where there's still not a lot of rack space for miners to plug in their machines.

And so the default for them is still to plug in the most efficient machines as possible, given the ASICs that are out there. And so you'll start to see discrepancies between the changes and prices of low generation machines to the new generation. And so I think if you look at the constraints in the environment, then you can start to draw some hypotheses on what's, causing those fluctuations and prices. So what characterizes the environment right now?

I mean, obviously the big discussion point has been like this quote-unquote hash rate migration. In our prior conversation, you guys were telling me that maybe it's been slightly overplayed the extent to which some of these machines are actually extractable from China. So maybe tell me a little bit about that. Yeah, so in May of 2021, China ban mining, as we all know, the hash rate dropped by over 50% based on some measures. And so about 80x a hash worth of computers and A6 needed to move abroad to find new homes. The first ones that found new homes were the new generation equipment and then slow trickle in of mid-generation and old-generation equipment to follow that. We suspect that a lot of those machines will never leave China for one main reason,

which is they have a high failure rate on shipping. And so if you ship out, say, a Bidmain 17 series, there's a high likelihood that that machine fails in transit, and it's not worth shipping out. In addition, we don't think there's going to be a lot of miners that can run the 17 series abroad as efficiently. So a lot of those miners will just stay in China and potentially be buried there one day. And so we suspect somewhere between 20 to 30 X a hash of mid to old generation equipment still in China. And some portion of that will remain there. And other analysts on this show have suggested they think maybe up to 20% of the Bitcoin hash rate is still residual Chinese mining that's effectively operating in a black market.

market context. Do you guys align with that? I mean, according to the Cambridge data, which obviously we know is not perfect, you know, China has basically zero percent market share, but some others have suggested it might be, it might be non-zero. What's your sort of current view on that? I understand why Cambridge says it's zero because the Chinese mining pool is reported that they have zero Chinese clients, which is in accordance with the laws there. And so they can't report that they're taking hash rate from China. We know that to be different. We know of miners that are still operating there.

I don't know the exact number, but the way I'd estimate it is by looking at the Chinese ban in May of this year and then looking at how fast hash rate came back online versus shipping timelines. It's clear that at least 10 to 15 X a hash came back online from China. There's just no way that A6 could move that quickly abroad and find new rack space. So I would put like a rough estimation at like 50s. to 30 X-a-Hash still operating in China. I think 20% is probably high,

but I'm around that number in my estimation as well. And the migration to Kazakhstan was also hit a roadblock recently, right? Because Kazakhstan started to regulate mining more aggressively. Am I right about that? You are. Kazakhstan seems like another version of China where unless you have boots on the ground or, you know, people that you really trust there,

it's hard to determine what's true and false there. So it's hard to sit here in the West and understand fully what's going on in Kazakhstan. But from the information that we're getting, that's true. There's been a lot of power of curtailment and hard time for miners to build out there in the recent months. So I want to scroll down to the historical ASIC chart. You guys have a scatter plot here, which is really, really fascinating. So it goes all the way back to 2015 and you start with the S3 and now you have the most, you know, recent machines, the S-19s and the what's minor machines. And you're showing

the development in, I guess this is tarahash per second, right? As these new machines come out and you can also segment it by manufacturer, which is, so I guess, you know, there's been a lot of hype around manufacturers hitting like these frontiers, you know, like thresholds of what we can realistically do in terms of manufacturing processes, like getting down to five nanometers, and which is, I guess, as good as it gets with current technology. And there's a lot of discussion around like slowing development cycle for A6. Looking at the chart, it kind of looks like we haven't really tapped out in terms of efficiency growth. Where do you guys see it? Like, do you view, do you think it's a real phenomenon that, you know, maybe the ASIC release cycle is going to

slow down to a much slower cadence structurally as we kind of hit that five nanometer threshold and find it largely impossible to sort of progress beyond that? Or do you think we're going to continue to see growth and efficiency here? A few things there. So, The first one, it's, I guess, props to Karim, help me. He was kind of the thought, like, he essentially put together the feedback for us to build this chart. So Hashreden, that's kind of like easy thoughts is we are taking community feedback all the time to add new metrics, new charts, new insights.

So if anyone listening to the podcast wants to see some, like, cool analysis, like please reach out and we will be more than happy to build it. And then in regards to your question, I don't think like A6 improvement is like ever going to slow that. I mean, we've seen since in like 2015, A6 efficiency keeps decreasing. We've been through like three or four generations of A6 already. Each generation like lasting couple years tops. And now like a few months ago, Bidman just announced like a new miner. the S-19 XP, which is already 20 to 25% more energy efficient

than the current latest generation hardware. This new ASIC won't ship until Q3 and Q4 next year. But I mean, they're probably already like testing and running in their own facilities, right? So that hardware is already available. They're most likely developing what's the next generation after that. Eastern, I think yesterday, you put together some like predictions for next year, and you were estimating that being made next year might announce, like even at 20 joules per hash miner,

which would be like another 20 to 25% more energy efficient than the new S-19 XP that's still to be released. So I think manufacturers, especially with the AIC prices that we are seeing right now, they are incentivized to go to the fundaries and pay more for chips, completely more than, for example, what, like, technology cell phone manufacturers would do. So I think that essentially, in the next few years, more ASEC manufacturers are going to get more allocation of, like, three and five nanometer chips, allowing them to produce more and more ASEX, and hopefully with, like, lower efficiencies.

You know how in the days of your manufacturers used to do proprietary mining and effectively front-run their clients because the key determinant of success in mining was just having access to the latest and greatest. That's not really the case today, I presume. We used to call that they pre-R-O-I that for you. They'd ship it to your ready ROIed. I mean, obviously that's kind of predatory. I think a bad business practice. Do we suspect that that still occurs today? Not on large scale.

Yeah. So we used to run a collocation back in 2018. Some of those boxes coming from the manufacturers directly, you could tell that those machines have been operating for longer than an R&D test. They'd collected a lot of dust. There was like moss in them. And so it was clear that those machines were running for, you know, month, two months, which is unnecessary for testing a new unit.

We don't see that right now, at least with the top tier manufacturers being Bitmain of MicrovT or Kanon. So I think between the three of them, there's not a lot of mining going on before they ship the machine. But I do believe a lot of them have their own mining farms. Canaan has, I believe, 1.7X has written out mining farm. I'm sure Bitmain has quite a bit themselves as well. So I think those predatory practices are almost gone in the A6 mining space, but I'm sure they exist in some of the tier two and tier three mining companies.

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Obviously, I think that was the biggest trend maybe of 2021 was just the enormous amount of public market capital allocated to mining, in particular in the U.S., also Canada. Mostly in the West, I would say. It's interesting how, you know, the U.S., I believe, has something like 40% of the world's public equity capitalization, but 20 to 25% of GDP. So it punches way above its weight in terms of just like public equity markets. And this is a total digression, but a lot of that has to do with the fact that we have a common law system

and just a very favorable sort of governance regime in terms of raising capital. And the weird thing is that that results in miners being able to raise. And I think that's part of what is driving this westward move in terms of mining and lots of miners sending up in Canada in the U.S. So I don't know what the number raised this year from public miners was, but it was very material. And we were talking about this before the show. You've got miners that treat their business and public markets, their capital raising. strategy as a way to accumulate as much Bitcoin as possible. And there have been a lot of well-hyped Bitcoin purchases from miners, so not just acquiring it through mining, but also just buying it.

And you see miners doing this business model where they issue stock and finance their operations that way. And so they treat the stock vehicle as a way to just accumulate Bitcoin. And then I don't know what the end goal would be exactly, but basically get their hands on as much Bitcoin as possible. And then on the other side of that, you have some firms, you know, I was talking to a couple of recently. Some will say, no, actually, we're just a cash in, cash out business, which is like mining any other commodity. And we don't want to hold the underlying. We just want to lock in our price and earn a competitive margin. and become a mature sort of maybe dividend-paying stock and a utility type thing.

So tell me about what you're seeing in terms of how miners position themselves along that axis in terms of Bitcoin accumulation vehicles versus just profitable companies that happen to mine Bitcoin and what the breakout is that you've seen among those public miners. Yeah, so I think you hit a key point here, which is miners will need to, to differentiate themselves and increasingly, you know, competitive public markets. And so everyone is taking their stances here. In terms of how they position, I would say the majority of miners right now, 90% plus are positioning as proxies to Bitcoin. Mostly because of the bull run that's happened in Bitcoin here, as well as the lack of a Bitcoin spot ETF.

And so the trade of still being a proxy to Bitcoin in public markets is a good one, one that, you know, micro strategy is done quite well, whereas the small minority of miners right now are playing the Fiat in, Fiat out game. So I think that would shift depending on market conditions. If we were to head into bear markets, I think more miners would head from the Bitcoin proxy camp to the Fiat in Fiat out camp. But for now, it's a very distinct split, I guess, of the majority over in the Bitcoin camp. I would say, though, like with traditional commodity markets, like a gold company, The majority of gold producers do not hold a lot of gold on their balance sheet. They are that kind of fiat in, fiat out.

Let's get a good return here. Let's produce the commodity at a discount to spot and let's earn a return. And that's kind of a very traditional commodity market. But where Bitcoin mining is different is that where Bitcoin is not a pure commodity in the sense of like a gold, a silver, and oil. It's also a technology advancement. And so in some ways, the public miners want upside. exposure to that technology and appreciation of the value of the Bitcoin network. So what and we need to talk about this as well with hash rate derivatives. So in in the gold

instance, I'm less familiar with the market. Do you know if gold miners take advantage of derivatives to lock in a certain price? Is that something that they actually do? They do. Yeah. One of the common derivatives financial instruments, gold miners will use is an offtake agreement. And so basically selling forward their production ahead of actually creating a new site. And so they can lock in the value of their future production right away. We think that's an incredibly interesting play for Bitcoin miners with a hash rate offtake agreement where they could sell forward the first year and a half of their hash rate produced from a certain site and lock in that return.

And then after that, everything's gravy. So we think a lot of those innovative derivatives, the traditional commodity markets will end up in Bitcoin mining. So this is a critical point because I think part of the unwillingness to, or the, you know, the derivative market in Bitcoin mining has not really blossomed yet, although there have been many attempts to create these instruments. And I think part of the explanation for it, feel free to correct me on this, would just simply be that miners wanted to get max long Bitcoin. And they had no interest in hedging their hash rate or selling Ford. But as maybe we go to more, and this is where I think this is going, is as we go to more of the gold mining model as the industry matures and we go to fiat in, fiat out, then miners maybe start to become more interested in selling the, Ford's. Is that sort of like a plausible hypothesis? I believe so. Yeah. If you look back to March of 2020, a lot of miners were hedging forward

their hash rate if they could. Companies like Grid, Harry Sudok and Bid Uda were kind of pioneering some of these early hash rate OTC contracts. And so they were really popular in those types of markets. The bull market of 2021 has changed a lot of views on that, as you alluded to. but I think as the industry matures and stabilizes, we'll head back to a dynamic where miners will want to take advantage of hash rate derivatives to either use it as a fundraising tool in the case of an offtake agreement or a hedging tool in the case of a futures deal. But have there been any instruments that have really gained traction and also who would be the buyer of these instruments?

There's been various iterations of derivatives in the hash rate space. The first were OTC contracts, either through cloud mining platforms or like BidHuda OTC desk. Then there were a number of hash rate derivatives, sorry, hash rate tokens that came out earlier this year from Binance and Poulin and also the one from Blockstream that gave investors exposure to hash rate through a token system. And that was quite popular amongst buyers. you saw hundreds of millions of dollars pour into the three of those combined. And so there was really a large universe of people that wanted access to hash rate and purchase hash rate forward. I don't think that's the final iteration of these instruments.

I think it's just a step along the way. And in the next three years, we'll see more and more iteration on these derivatives and a more robust structure that make it easy for the miners to trade and investors to get a hold of. And this is a market that you guys are also looking to get into. We sound like a broken record here, but yeah, our plan is to launch some hash rate derivatives in 2022. We think it's really important for miners to hedge out some of their risk, and we want to give investors the opportunity to gain hash rate behind their desk. They don't need to go build a mining farm. They can go and trade hash rate futures.

So we're really excited about this market. What would you do different with your product as compared to prior hash rate derivatives? Like going back into one of the main reasons that none of the previous iteration of hash rate products, like, succeeded. I think it's the technology it's not there yet. Like some of these products are kind of like good iterations, but none of the products kind of like are a perfect hedge for like hash price, the expected value of that hash rate. And hash rate is something that mining pulls understand really, really well. Because on the end, we are paying miners on the like expected value on a real time basis. So I think our.

way of approaching this product is by like it's kind of like a bottom up approach where we have the technology component like ready to go being able to proxy hash rate if we want to do like physically delivered or like settled

hash rate futures that's something that only like a mining pool can like actually do on a large scale without like going OTC so kind of like integrating with the mining pool with like hash rate futures I think that's where the real product market fed is going to be moving forward.

So returning to public markets briefly, you guys have a great panel on your hash rate index pertaining to mining companies. You have some interesting comparables, some interesting metrics that you built here, market cap over hash rate. Talk me through how you might seek to compare public miners, especially on a multiple spaces. and whether the community of analysts has done a good job of that historically or where they can improve. Yeah.

Right now, I would say the majority of public market analysts on the sell side are covering three different metrics. One is hash rate trading multiples. So something that we have displayed there on hash rate index, which is hash rate from the company divided or market cap divided by hash rate. The second would be BTC production. So at the end of every month, you'll see the public miners get power ranked by the amount of Bitcoin they produce throughout the month. And then the third is cost to mine one Bitcoin. And so all those metrics right now, I think, could use some tweaking. They don't fully cover exactly what you'd want to look at in the miner.

And so, for example, with a hash rate to market cap metric, you're not acknowledging the efficiency of their equipment. you're not looking at the operating cost of their equipment's running at. And so what you really want to do is drive down further into the PNL. And so I would love to see in 2022 more people looking at something like an EV to EBTA metric that looks more like a proxy to cash flow. So that takes into consideration the equipment that they're running as well as the operating environment of that equipment. And then also on the front of like cost to mine one Bitcoin. would love to see more standardization there.

Kareem and Brandon came onto your show was a couple of weeks ago and did a really good job presenting their model. So we'd recommend everyone check that out and see more standardization there because right now everyone has their own different metric and it's not an apples to apples comparison. And then finally on BTC production, I think that's also an interesting one because Bitcoin is one of the only industries where you could actually check out these mining companies live production rate. you don't need to wait for them to report it themselves. We're operating on a public blockchain. For companies like Marathon that run their own pool, it's quite easy.

You can track their pool and how much they earn. But even for companies like, say, riot or hive, you could check out which mining pool pays them out and match it up with previous months' production. And you can map out their addresses. So you could get a live update to how much these companies are earning every day. So I think there's a lot of metrics that we'd like to see come into the space in terms of sell side coverage, and we're going to try and help promote and pioneer some of those.

That's fascinating. So kind of a real-time financials, sort of like the equivalent of, you know, looking at satellite images of parking lots to ascertain like sales volume for retailers and things like that. I love that idea. I hope some of these, a lot of alpha in this conversation right now.

One question I have is like, I'm looking at the correlations between the prices of these miners on your dashboard. And they honestly is a cohort. Like there's certainly like quite correlated Bitcoin for the most part. But they, their performance is like quite disparate over the last few months. But I would kind of expect that miners ought to be correlated in terms of. their performance. So what would normally, what would be the major variables that explain that sort of disparate performance? I believe most of these companies aren't very differentiated when it

comes to their actual operations. The majority of them still buy machines, plug them in as their operating model. But where they do differentiate is on how they raise capital. And so a lot of miners recently have been penalized based on expectations of future dilution. of the stock. And so companies like Argo blockchain is probably a good example of that. You know, they have a large Texas facility that's coming online next year.

And I think the market is predicting some dilution ahead of them. And that's why there's weakness in that stock versus something like Marathon, which is kind of already raised and ordered machines. And now the market is predicting that they don't need to raise any more capital. So the differentiation I think that we saw

in divergent in these stock prices in 2021 were largely a part of how they play the capital markets. And the companies that have gone aggressive this year one, that may not always be the case, but companies like Marathon and Riot and Bid Farms and HUDAid, I think, are the winners this year, just given how aggressive they've gone with future hash rate orders and the markets reacted well to it. So that makes sense. So one thing that we talked about beforehand was this sort of public market arbitrage, the fact that you can tack on value to your stock causing what I think might be a bit of a perverse behavior or at least

very risk seeking. So explain that to me and the implications of that. There's a discrepancy right now between the capital intensity of building a Bitcoin mining operation and the valuation that it accrues in the public markets. And so for an example, Marathon right now has about three X a hash of current hash rate, yet they trade at over $3 billion market cap. And so if you take that as a market cap to hash rate valuation, that's over $1,000 per tarah hash worth. They can go and acquire that for $100 a tarahash. And so there's a 10x premium on every dollar they put in.

They get $10 in public market value for their spot hash rate. It also works on the futures. So for example, Riot, I believe has over 9x a hash on futures orders, but they're trading a $3 billion stock too. And so that's roughly, you know, $333 per tarahash. And so even on futures order, you can still get that premium. And so that's why we've seen a lot of companies raised to the public markets. There's going to be probably a dozen or so new names entering the space in Q1 next year.

And people really want to gain that arbitrage of dollars in versus value in the public markets. And so, I mean, this isn't the first time I've heard this. I mean, it's a feature of other industries. Kind of recalls certain historical bubbles as well. But, you know, the logical conclusion of this behavior is like, you know, you're compensated with, you know, options and share-based compensation. So as an executive and, you know, improving the valuation of your company, you know, financially accretive to you. So then you get kind of a principal agent problem where your incentive is not to like most prudently manage the, you know, the business for shareholders, but it's actually to most aggressively pile on hash rate because you're getting this enormous premium. And so as you say, there's an arbitrage or a premium there because you're getting a huge public markets premium for every incremental unit of hash rate you add. So isn't the conclusion of that that miners are going to be like too pro-cyclical and and be sort of too aggressive in stacking on hash rate and, and, you know, might be incurring too much risk in sort of like this market cycle? Is that like a reasonable conclusion to draw from that? I think that's reasonable.

Miners right now are aggressively expanding sometimes without even space to host those machines. sometimes in very high operating costs, you know, above five, six cents a kilowatt hour. And so I think a lot of these companies are taking large risks that will pay off if we continue to have a bull run here. But if the market has a downturn, I think a lot of these companies are going to face financial troubles and are going to be, you know, large points in history that we remember is taking way too much risk in a bull market. One of the weird things is that miners can get sort of bailed out by a political risk event. elsewhere. So like the Chinese ban like that's you know there's like two ways to make money I guess as a minor like the price of Bitcoin can go up or like difficulty and hash rate can go down.

And so you can also sort of get bailed out in a certain way if a large jurisdiction bans mining. So that's something I always think about is like you can just get lucky if like some some some country somewhere decides to outright ban mining or make difficult for the of the miners there. In August 2020, I think many of these companies were a few months away from closing doors. If you look at their financials in Q3 2020, it was grim. And so they got bailed out by the price of Bitcoin. But I mean, they placed the right bet, so I can't fault them for that.

I do think this is this trend is actually going to get worse because the next cycle, I believe, will have more MNA activity where if you think about it, if a miner has say one X a hash and valued at $1 billion, they should be buying companies that are having one X a hash and valued at half a billion because that's going to be accretive to them on a hash rate basis and likely a P-E basis as well. And so I think in an environment where it's hard to get the machines themselves, which we'll probably see at the end of 2022, you'll start to see public market acquisitions. For example, companies that are very undervalued, like a company like Argo, I'm sure,

is a huge acquisition target for any company that's valued. at three times their amount on a hash rate basis. So the more aggressive companies will consolidate get bigger and get more aggressive heading into the next cycle. So is that a trend which you think would lead to more concentration in the mining industry? And is that something to sort of be concerned about in terms of like if it turns into a sort of highly concentrated space?

It's hard to say if it's going to get more concentrated, just given we didn't know how concentrated it was in China. Right. So very well could have been more concentrated back then. But yeah, I do think it will continue to get consolidated at the mining co level. There's too many public miners out there that aren't differentiated. You know, there's going to be like 30 large miners plus by next year and all telling the same story.

So it makes sense that quite a few of them merge. Yeah. Also, like M&A, it's a really good way for all these publicly traded mining companies to, like, meet their hash rate targets. because all of these hash rate targets are like extremely aggressive. And given all of the supply chain constraints, manufacture ability to produce new miners, new gen miners being like essentially sold out everywhere, even like in China.

Like meeting this hashirate targets is going to be extremely hard for all of these biolids mining companies. And something that we've been seeing as well, it's, and I think it's going to be a trend onto the next year, you know, Bitcoin miners are going to start looking into Alcoid miners and report their hash rate as Bitcoin equivalent. So they're most likely going to be mining,

I don't know, Equahash coins or like Iherium and report Bitcoin equivalent hash rate in order for them to meet their hash rate targets. MNAs are also another way to meet that target because they can acquire a couple exahash that are really plugged in and running right away just through the GANA process rather than procuring those machines,

sourcing them into the US, finding rack space and also like managing the hash with which is extremely difficult to do so. And that also might affect their financial performance in the future if they are not able to build those targets that they've been promising to investors. So yeah, I think that's also like another trend from the next year. So I've had you guys on for a bit here. And I want to end with another question relating to the data. So you have some good network data here.

You know, I love network data, of course. And, you know, one of the most concerning charts in Bitcoin, I think, is the percentage of block reward that is fee-based, right? And, you know, it kind of like fluctuates around zero most of the time. And then in bull markets, it goes up to, you know, 10 to 30 percent. And right now it's back to almost zero, which is highly disconcerting to me, frankly. because, you know, at maturity, in theory, the fees will be the subsidy for the miners, and they will account for all the revenue. So two questions, I guess, like how concerned about this are you?

And then what do public miners say about this? Because their long-term discounted cash flows are going to be a function of issuance, of course, but also fees. And after the next having the fees are going to be yet. again more material. So what are the miners themselves messaging about this? This one is kind of like a really hard to say. As you just mentioned, there's kind of like a three very distinct fee like kind of like super cycles or the history of Bitcoin through for like like the 2013, 2014, 2018 and now 2021. I think long term what we are all hoping, to have like a sustainable view market is to get like more Bitcoin adoption.

Even right now, if you look at number of transactions per second in the network, we are still not reaching like 2018 levels. So right now Bitcoin has less transactions than 2017, 2019. So we are we still have like a very long way to go to sustain more activity in the Bitcoin network that will hopefully help kind of. of like subsidize all the security that miners are bringing on the table into the Bitcoin ecosystem. So I think that's a lot of work to be done there, scaling Bitcoin, like using layer twos as well, bringing more like on-chain activity. And hopefully that will drive like a more

healthy fee balance over the next few halvings. I think over the short term, let's say one, two halvings from now, that's not a concern because most of like miners' revenue comes from Bitcoin price and they block subsidy itself. But yeah. Do the miners talk about this or is it a time horizon thing where they don't necessarily care about what happens 10, 15 years out? We talked with miners on it when they're pitching to investors because that's when it comes up. But really from like their day-to-day operations, they only start caring about having like six months before. And so we're still kind of, you know, halfway through this having cycle where,

it hasn't come up on miners, you know, mind right now. They're still focused on getting infrastructure and machines. So I suspect by kind of late next year, everyone will start thinking about it again, heading into the next having. But I would add to this is a lot of people position this as like existential to Bitcoin, which doesn't really make sense to me. It's like the fees aren't high that Bitcoin network will fail. That's not the case.

I think there's a high correlation between how much people are willing to spend on security in terms of basics versus how much. they're getting rewarded for securing the network. And even if you go back to 2011 when the price of Bitcoin was low, there's still people willing to plug in GPUs in mine. And so in a case where transaction fees don't take off and we don't see Bitcoin price take off, it's not like the network's going to fail.

It's just there's going to be less investment into it. I already think Bitcoin is by far the most secure decentralized network out there. And so if there is kind of less capital investment and Bitmain print, say, 50,000 machines instead of 100,000 a year, then I don't think it's a big deal. So from an industry perspective, it's really not a big deal. The industry will adapt and Bitcoin will continue to get secured by the miners on the network. Well, Sud.

So where would you direct listeners to follow your work? Obviously, I'm going to link the Hashrid Index, but any other places you recommend. So yeah, check out Hashrate Index. Guzman already kind of mentioned it's community driven. So hit us up with any feedback there. We love building a new analysis. And then you can follow us on Twitter, hash rate index, as well as on at Luxor, at Luxor Tech Team. We provide kind of daily updates there as well.

We also have our newsletter link there where we send out twice a week updates to hash rate index, different analysis that you can use gathering with the data. So, yeah, hit us up there. Thanks for having us on the podcast. This has been really informative. Thanks again, guys. Thanks a long, Nick. You know,