Finding a needle in a cryptostack

A hard to ignore asset class

Investors looking for exposure to digital assets without necessarily initiating a crypto position may, for example, invest in crypto exchanges, banks, or miners. However, it is the latter that solely provides the most correlated exposure to the value of Bitcoin. The only caveat is that finding a miner that will keep up with the growing global mining rate of Bitcoin and remain profitable is like finding a needle in a haystack.

Atypical sources of value

The value of a crypto mining company comes mainly from two sources: the amount of crypto holdings on its balance sheet and earnings capacity based on its efficiency. The first depends on the mined cryptocurrency and its price. The second is a mathematical output determined by the company’s and network’s hash rates. Hash rate measures computational power per second.

A higher hash rate means more calculations can be performed, increasing the probability of mining a crypto block and earning the reward. Theoretically, the value differential between two companies with similar mining capacity would further come from the operational and financial costs. However, we find that the energy source, type of financing, additional revenue streams and quality of mining rigs may significantly influence the company’s value proposition.

Energy source matters!

Mining companies running on fully sustainable resources have significant advantages. Renewable energy is a natural hedge against rising energy prices. Running carbon-neutral mining operations also opens the doors to institutional investors, who are becoming heavily ESG-focused. Some companies even go beyond carbon neutrality, directly targeting zero-emission sources.

Quality of mining rigs – a key to cost control and higher efficiency

Since the total cost of running a crypto mining facility has three main components – the cost of electricity, SG&A¹, and depreciation – investing in more efficient, easier-to-operate machines with longer lifespans is critical for effective cost management and operational profitability. For instance, investing in the best available mining equipment (like the Antminers S19XP) may improve cost efficiency beyond the industry average. If operated in a well-managed and temperature-controlled facility, it may last 50% longer.

However, the 5-7 years promised lifespan also comes with months of lead time due to chip shortages and supply-chain bottlenecks.

“Mine and hold” strategy

Each mined Bitcoin may be sold, leveraged, or kept on the company’s account. Keeping Bitcoin on the balance sheet is a natural hedge against speculatively priced mining equipment.

Financial discipline

Given that Bitcoin mining requires a continuous upgrade of the mining fleet, miners’ financing and corporate structure remain essential factors to consider. Miners must aggressively invest in their mining fleet to outgrow the market. Investors appreciate miners with stronger financial discipline and the ability to mine Bitcoins in-house.

Additional sources of value

Some miners are purely focused on mining, others like Riot Blockchain and Core Scientific also provide hosting infrastructure. It isn’t easy to separate the costs relating to hosting from those linked to mining. Valuation metrics may indicate a company as expensive in terms of “high cost per mined Bitcoin”. Still, by scaling down its hosting business, its mining activities could end up being more valuable. Moreover, infrastructure that can be owned or outsourced also impacts valuation. Owning or outsourcing comes with value trade-offs– who is the company outsourcing to, what type of energy is he company using, how much does it contribute to global emissions and how much control does the company have over its outsourcing costs?

Looking through a clearer lens

We have developed a simple tool to explore the current industry landscape by mapping miners on three metrics adapted from the well-established industry ratios:

• “Price over the expected hash rate in twelve months” shows how much investors pay today per unit of the expected hash rate. The higher the y-axis, the more expensive the company’s expected mining rate is.

• The “premium” the company is currently trading at versus its Bitcoin holdings and mining capacity. The former is usually valued at market price. The latter is a function of Bitcoin price, the total cost of mining a Bitcoin, additional expected mined Bitcoin in the next twelve months, and the efficiency of the mining fleet.

• The “market share” the company expects to control in twelve months in proportion to the global network.

Such a tool makes understanding value drivers and spotting outliers much easier. In our investment universe, this would correspond to Hut 8 Mining and BIT Mining. While having reasonable mining costs, they do not plan to significantly increase their hash rates in the next twelve months, leading to their higher price to (lower) expected future hash rate.

What you need to remember

Financial tools and metrics, while helping to identify the outliers, hardly distinguish the major players, as they fail to show the complete picture. They do not consider the atypical sources of value such as energy source, hosting capabilities, cooling efficiency, and other revenue streams like hosting. Looking only at financial metrics may prevent investors from choosing the most attractive riskreward investment. The atypical accounting nature of mining operations skews most financial metrics and obscures potentially exciting investments. Only by analysing all the unorthodox factors we have covered in the article may investors have the full picture of whether a miner has real potential.

To conclude, crypto miners are not the only way to have exposure to crypto assets. Our approach to managing our portfolios aims at increasing the potential risk-reward by diversifying crypto exposure across the entire value chain, from miners to financial institutions.

 ¹Sales, General and Administration

Mark Temnikov, Portfolio Manager and Financial Analyst, AtonRâ Partners SA