The Breakdown - Where Bitcoin Mining Goes From Here

Episode Date: January 8, 2023

On this Long Reads Sunday, NLW reads: The worst of Bitcoin mining in 2022 by Zack Voell  What Will It Take for Bitcoin Mining Companies to Survive in 2023? By George Kaloudis  Bitcoin Mining: A Positive or Negative Indicator for the Future of Crypto? By Daniel Kuhn  Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW   - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with today’s editing by Michele Musso and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Image credit: Yuichiro Chino/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8. 

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is produced and distributed by CoinDess. What's going on, guys? It is Sunday, January 8th, and that means it's time for Long Reads Sunday, the 1st of 2023. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper in the conversation, come join us. on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod.

All right, friendos, well, today we are doing a three-part read from the world of Bitcoin mining. As we discussed a bit in yesterday's weekly recap, Bitcoin miners have had a rough go of it. We've seen major players like Compute North and more recently Core Scientific, the largest miner in the world, go into bankruptcy, and others like Argo have only survived because of 11th hour bailouts. The sands are shifting underneath the entire industry, and today we are reading not one, not two, but three pieces discussing exactly that. We're starting appropriately with a piece called the worst of Bitcoin mining in 2022, which was written by Zach Vol and published on the Compass Mining blog. Zach writes, even the most casual observer knows that crypto had a bad year.

The reason for the industries tumult could fill an entire article of their own, but the Bitcoin mining sector had a particularly rough year, and this article is dedicated to cataloging all of the bad things that miners suffered. From bankruptcies and resignations, to D-listings and lawsuits Bitcoin miners saw at all. So here's a recap of the worst events from Bitcoin mining in 2022. Bankruptcies. Bitcoin mining companies that filed for bankruptcy or were significantly affected by counterparties filing for bankruptcy was a common theme in 2022. Compute North filed for bankruptcy in September 22. According to filings, the company owed as much as $500 million to at least 200 creditors. In February, seven months before bankruptcy, the company raised $385 million.

$4. Scientific, the largest publicly traded Bitcoin mining company, also filed for bankruptcy a few days before Christmas. The company warned a potential bankruptcy in October 2022 as its stock price plummeted. Core plans to continue mining through its bankruptcy proceedings. Celsius, a prominent crypto lending platform, also saw its sizable mining unit go bankrupt just months after the team announced its plans to go public. Celsius told bankruptcy court that continuing to mine was key to its restructuring plans. but the mining unit burned $40 million during the first two weeks of bankruptcy. BlockFi was another prominent crypto lending service that maintained a sizable mining unit and has filed for bankruptcy. To date, no reports have indicated that BlockFi's mining assets

which are hosted by Blockstream have been interrupted or taken offline. Marathon is another high-profile publicly traded Bitcoin mining company, but they have not filed for bankruptcy. They're on this list because of their exposure to bankrupt firms, however, to illustrate the mild contagion of mining bankruptcies. Bloomberg reported that Marathon disclosed over $80 million of exposure to now bankrupted Compute North, not fun. Argo has also not filed for bankruptcy, became dangerously close in 2022. The company even accidentally posted fully prepared bankruptcy filings on its website, which had a catastrophic effect on the company's share price. A $100 million deal with Galaxy Digital's mining team helped Argo avoid bankruptcy, however. Section 2,

executive resignations. 2020 also saw some notable shuffling among the ranks of mining executives in both private and publicly traded companies. This list is not exhaustive, but here are a few key resignations. Dave Perrell, who was the CEO of Compute North and remained on its board, resigned in September before the company filed for bankruptcy. Jeffrey Kurt, who led Greenridge Generation since 2021, abruptly resigned in early October 2022. Whitney Gibbs, who co-founded Compass Mining, also abruptly resigned amid, quote, setbacks and disappointments in July 2022.

Emiliano Gradsky, who co-founded BitFarms in 2017, announced his resignation three days before the end of 2022. Section 3, delisting notices. As crypto markets crash, stock prices of crypto mining companies also crater. Most stock markets have priced thresholds that companies need to keep their stock prices above, otherwise delisting is a possibility. A large number of public mining companies relative to all public mining companies have received notices of possible delisting in the past year. In August 2022, Bitmining sought to reassure its investors after receiving a notice from the New York Stock Exchange about potential delisting due to minimum price standards. The company's chairman said in a statement at that time that, quote, it should not be concerning that our stock is currently

trading at these levels, noting it tumultuous market environment. The same month, Mawson received a notice of potential delisting based on its noncompliance with minimum bid price rules. In October 22, digit hosts received the same notice of potential de-listing as reported by the block. The NASDAQ listed companies was given 180 days to regain compliance with listing rules concerning minimum share prices. Green Ridge Generation also received a notice of potential de-listing in the middle of December 2022. Per standard listing requirements, the notice stated that, quote, the company failed to maintain a minimum closing bid price of $1 per share for the prior 30 consecutive trading day period. BitFarms received a similar notice one day

after Green Ridge for the same reasons of failing to maintain a minimum closing bid price of at least $1 per share. In a press release, BitFarm said it plans to, quote, continually monitor the bid price and evaluate other options to regain compliance. Canaan, a NASDAQ listed mining hardware manufacturer, also received notice of potential delisting, but this time share prices were not relevant. Instead, the securities and exchange commission flagged Canaan for potential delisting because it used an auditor whose work can't be inspected by the U.S. audit regulator. Section 4. Mining lawsuits. When the market sours, lawsuits are abundant. The Bitcoin mining sector is no exception. Again, this list is not exhaustive, but simply

note some higher profile lawsuits from the past year. Aquare faces a lawsuit claiming breach of contract, negligence, deceptive trade practices, and fraud, which seeks at least $250,000 of damages. Iris Energy faced a class action lawsuit over the production of its mining equipment which was withdrawn one day after the suit was filed. Tennessee's Washington County sued Bright Ridge, a local mining utility, in an attempt to force their operations to shut down, which the county claims violate zoning rules. Riots sued Northern Data over improper data disclosures

relative to the acquisitions of Riot's flagship mining facility in Texas. Winstone, Riot's flagship mining subsidiary counter sued Japan's CMO internet in a four-year ongoing dispute and seeks $15 million of damages. Core Scientific was sued for allegedly failing to disclose a series of adverse financial circumstances to shareholders and knowingly providing false information. Final section, a new chapter begins. 2022 was a horrible year for Bitcoin mining. Through it all, the Bitcoin network continued producing

new blocks and overall hash rate steadily grew. But the overall landscape was grim, that the worst is behind miners seems likely, but it is certainly not guaranteed. Market conditions could continue to worsen and things could continue souring. But one thing is sure, whoever survives this market will be battle-hardened miners like no other. All right, thank you, Zach, for that sobering piece. Next, we move to George Kulutas, who writes, what will it take for Bitcoin mining companies to survive in 2023? Obviously, a good compliment to what we just heard from Zach.

George writes, It was a perfect storm for Bitcoin mining companies in 2022. Interest rate hikes increased the cost of capital. Mining Bitcoin became less profitable as hash rate stubbornly trudged upward, while Bitcoin's price tumbled, and mining companies' treasury management strategies failed them. The result of the tempest shows up in the stock prices of the five biggest public miners by hash rate.

In 2022, core scientific, riot blockchain, Bitfarms, Iris Energy, and Clean Spark traded down 99%, 85%, 91%, 92% and 79% respectively. Ouch. No, this doesn't mean that Bitcoin is dead or that Bitcoin is destined for zero dollars. It doesn't even necessarily mean that the public mining companies will disappear. What it definitely does mean is that we're due for and are in the midst of a bit of restructuring and strategy rationalization that will leave the mining industry better than it was before. What was wrong before?

For the last few years, some miners have held on to the Bitcoin they mined, opting instead to finance operations with debt and other capital. This works really well when two things hold true. One, the price of Bitcoin is increasing, so the amount of people looking to get involved in Bitcoin for the sake of not missing out is high. Two, the cost of capital is cheap, so the amount of people looking to get involved in Bitcoin for the sake of yield is high. And these two things were true for the last couple of years.

So we had this really weird situation where Bitcoin mining companies, who are in the business of mining Bitcoin, weren't explicitly making money by mining Bitcoin. Instead, they were making money by financing the mining of Bitcoin. This is a bit of an oversimplification, but really just a bit. In our theoretical world, a Bitcoin mining business makes money like this. The business has Bitcoin mining machines which mine Bitcoin, and the business in turn exchanges a portion of that mine to pay for the expenses needed to run the business. In our wacky world, a Bitcoin mining business makes money like this. The business has Bitcoin mining machines, which mine Bitcoin and the business in turn takes capital from the debtor equity money.

markets to pay for the expenses needed to run the business. I'm not saying companies do this exactly, but there are mining companies like Marathon Digital that have stuffed all the Bitcoin in his mind in the last 26 months on its balance sheet, rather than selling any of it to pay for operations. Bluntly, this doesn't make a shred of sense to me. I stand by the idea that businesses should drive to function as a going concern in the long run, without a dependence on the capital markets, and make more money than it costs to make that money. Otherwise, that business shouldn't exist. So when our wacky world moves to a place where, one, the price of Bitcoin is decreasing, two, cost of capital is increasing, and three Bitcoin mining is getting more competitive, you might be in

for a world of hurt. Well, all those things happened in 2022, so cue the recent news of a core scientific bankruptcy, a fulsome restructuring, and a capital infusion to save Argo from bankruptcy and the resignation of BitFarm's CEO. So what's better now? What now? We know the public mining companies are struggling, but amid all of the pessimisms there's, of course, reason for optimism. see, in theory, mining companies will mine when it's profitable and won't mine when it's not profitable. The mining machine these companies run can be shut off and turned on easily. But in practice, miners aren't shutting down and ramping up their operations based on everyday price movements of Bitcoin or electricity. Instead, miners mined consistently through market vacillations.

And because of that, there's a need to practice some sort of treasury management strategy that extends beyond hold all the mined Bitcoin. The strategy would involve some sort of consistent exchange of a portion of mined Bitcoin to fund operations, because eventually the price of Bitcoin might start going down, or the price of electricity might start going up, or both. Public market investors value both the predictability of cash flows and upside valuation potential. Public Bitcoin mining companies have the ladder and spades, but the former is sorely missing. Proper treasury management solution should anticipate and mitigate the unevenness of profitability associated with the markets that govern the Bitcoin mining industry.

This strategy wouldn't allow a mining business to hold on to as much Bitcoin as possible to sell at an elevated value during a bull market, but it would allow the mining business to more easily handle market stress. Besides, miners aren't in the business of timing markets. They're in the business of mining. So whatever happens now at the very least, we should expect the mining companies that survive this perfect storm and market downturn will make some sort of change. I think big public mining companies will revisit their hold-all-the-mine Bitcoin strategy, and that should better equip them to thrive well into the future. Assuming, of course, the miners learn anything from this. Okay, so far as you've seen, we've got Zach talking about just how bad

22 was. We have George offering a reason why it got so bad and a potential path forward. And now let's turn to Daniel Kuhn, another Coin desk writer, who published an opinion piece called Bitcoin Mining, a positive or negative indicator for the future of crypto. In a piece last week titled Crypto will be fine, former coindesker Brady Dale noted that even though crypto took a beating throughout 2022, some indicators remain bullish. Notably, Bitcoin's hash rate, which is how much computational power is directed towards securing the network, held steadfast. Dale wrote, if the industry were dying, these miners should be winding down. According to blockchain.com data, Bitcoin's hash rate hit an all-time high in November.

Bitcoin's hash rate rose steadily over the past 12 months, even as the network's token, Bitcoin lost over two-thirds of its value. For many, that's a sign of faith in the long-term success of the network. Of course, there's more to the story than a single statistic. As Compass mining, Zach Vol, another ex-coindexter, detailed in a Monday report, which is the one we just read, the Bitcoin mining industries took a series of severe beatings in 2022. In his catalogue of all the bad things that miners suffered, Vol found that at least four executives of major mining firms resigned over the last year, six lawsuits were filed against mining companies for reasons stretching from breach of contract to zoning rule violations,

and stocks were publicly traded mining companies were in the doldrums. Additionally, two mining companies, core scientific and compute North, filed for bankruptcy while Celsius Network and BlockFi, two bankrupt crypto lending firms with sizable mining wings, are likely going to have to restructure their operations. Another two mining companies' Marathon Digital and Argo blockchain are also at risk of filing for bankruptcy. The situations vary by firm, but the main causes of the issue stem from Bitcoins to press price and often poor treasury management. My colleague George Kulutis simplified the picture by saying that over the last few years, many mining companies pursued accelerated growth strategies financed by debt and other investments

while often choosing to hold onto their mined coins. Quote, many miners acted too deterministically, end quote, projecting Bitcoin would hit $100,000. $1, Jury Bolivich, head of mining at the crypto mining and staking firm Foundry, which is owned by CoinDisc parent company Digital Currency Group, told CoinDesk. The situation worked well when Bitcoin's price was rising and the cost of financing expansion was cheap, two things thrown off course amid macroeconomic uncertainty and rising interest rates. Already outside firms have been stepping into backstop losses and inject much-needed capital into the lagging professional mining sector.

Galaxy Digital struck a $100 million deal with Argo, Crypto Exchange Finance has spun of a fund for distressed miners. and on Tuesday, investment giant BlackRock committed 17 million to bankrupt Bitcoin miner core scientific. Although the mining sector is in a precarious position, fueled in part by state-of-the-art mining equipment that was ordered and deployed during the heady days of 2021, when Bitcoin hit a high of nearly 69,000, the industry likely isn't going to be wiped off the map. Battle-tested firms have better treasury management, and new financing options are coming

online. Like derivatives options from 2 Prime that could allow miners to hedge their mining risks in a way that other commodities markets like oil do. More capitulation and bankruptcies could come, and unprofitable miners may be taken offline. But considering the global sprawl of the mining industry, the sector's committed activist investors and supporters and the growing importance of mining within the hydrocarbon

and wider energy sector, mining will remain. And the business might be better for its recent troubles. All right, guys, back to NLW. I think just trying to wrap this up in a nice little bow. At the end of the day, what happened with miners was in retrospect a pretty clear story. Money was cheap and easy and demand to give capital to the sector was high in 2020 and 2021. Miners took advantage of that and took on debt in a way that they hadn't previously.

When prices fell precipitously in 2022 amidst a overall global shift away from risk assets to say nothing of internal crypto industry turmoil, and that smashed headlong into rising energy prices, all of a sudden that debt financing was hugely problematic, and the Bitcoin collateral on the balance sheets wasn't enough to pay it back. Simple as that. It's important in these moments to separate, quote, the mining industry from individual mining companies within it. The visual analogy that I've always loved for Bitcoin mining is water flowing over rough terrain

or rough topography. It just kind of flows into the gaps. It's entirely possible that in two years, the global composition of miners looks very, very different from the people doing the mining now. But it seems very unlikely to me that in general, bankruptcy is in corporate turmoil right now, do anything other than get debt and leverage out of the Bitcoin mining ecosystem. That's not to say at all that I'm rooting for any of these miners to fail. I want these companies to be strong, solvent, and focused on the long term.

So to all those Bitcoin miners that are still out there working, I appreciate your efforts and good luck. Anyways, guys, hopefully this set of articles was useful and interesting to you. As always, I appreciate you spending some time with me on your weekend. Until tomorrow, be safe and take care of each other. Peace.