Want a wilder ride than bitcoin? Try bitcoin mining stocks

There are few investments globally that have matched either bitcoin’s total uplift in percentage terms or the uneven nature of its ascent during the past six months.

But one category of investment has ballooned to an even greater extent during that time: the shares of the companies mining bitcoin.

The price of one bitcoin has skyrocketed from around $8,000 in mid-September to its recent high point of more than $60,000. The chart below highlights the explosive performance of six prominent mining stocks — Canaan, Riot Blockchain, Marathon Patent Group, Ebang, Hive and Hut 8 Mining — in that same period.

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With the exception of Ebang, the increase in these companies’ value has far outstripped that of bitcoin in percentage terms — and Ebang has still added $600 million to its market cap. 

But the lurches in bitcoin's price are also reflected in the performance of mining stocks. The value of Canaan, as a case in point, rose some 19 times from around $300 million in mid-September to an all-time high of $5.7 billion on March 11. In the past week, however, it has fallen sharply back to $4.5 billion.

How are investors valuing these stocks? Perhaps the more important question is this: how should they be valuing them?

While it may help to compare them with stocks in companies that mine natural resources like gold, ultimately it's about how one projects the future value of bitcoin.

Picks, shovels and 'torque'

The way shares in listed crypto miners have behaved comes as no surprise to market veterans.

Ethan Vera, co-founder of Luxor Tech, a wholesale buyer of crypto-mining computational power or “hashrate,” says the pattern is similar to the relationship between gold and gold-mining equities in wider commodities markets.

“Public equities are kind of like a levered play on bitcoin,” he said. “It provides some underlying torque to the commodity itself, which is pretty standard across commodities industries. Of course, when it goes down the same thing happens.”

One of the reasons for this added “torque,” Vera explained, is that miners are making a bigger bet on cryptocurrencies than those who simply buy them — as institutional investors and corporates are doing with greater frequency. 

Besides holding crypto directly, miners are also investing heavily in the infrastructure that will produce crypto in the future.

“It’s like being able to purchase stock in a central bank, right? They’re the ones that are producing the currency,” said Brad Nagela, newly-hired global head of options trading at crypto market maker B2C2. So during a  bull market crypto mining stocks are “very, very popular,” he said.  

But there is no perfect analog for what a crypto mining firm does. For example, consider hardware costs. A big part of miners’ capital expenditure goes towards purchasing the latest and greatest in mining equipment. 

In normal times and in more traditional industries, companies expect the value of their machinery to depreciate over time, primarily due to wear and tear. In bitcoin mining, the major factor to consider is the price of bitcoin.

During a bull run, cutting-edge ASIC (application-specific integrated circuit) mining machines can grow scarce and skyrocket in value — amplifying the torque that investors are after when they buy mining stocks.

Companies sitting on both bitcoin and the limited means to acquire more of it have the potential to “outrun bitcoin investors in bull runs,” said Vera. That explains why in November 2020, just as bitcoin’s latest boom was picking up pace, bulk pre-orders for the most powerful bitcoin mining hardware from major manufacturers were queued up until May 2021.

The fact that both mining machines and colocation services — typically offered by data centers capable of powering the machines — are becoming increasingly expensive only adds to the unique nature of the exposure public mining stocks can offer investors.

Merrick Okamoto, chairman and CEO of Marathon Patent Group, a Nasdaq-listed crypto mining company, pointed to “locking up” the ASIC supply chain as a key differentiator for his company.

“Have you noticed that since we announced we purchased 100,000 S-19s from Bitmain there have been no other major announcements of bulk purchase orders? Why do you think that is?” Okamoto said in an email to The Block.  

“It’s because our management team lived through the 2017 bitcoin rally and saw what happened to the prices and the supply of ASIC miners from Bitmain,” he said. “The prices went from $700 per unit to over $9,000. And the supply chain dried up with delays in deliveries for 8 to 12 months.”

Marathon bought $265 million worth of Bitmain ASIC miners last summer. The firm’s market capitalization is currently around $3.6 billion, up from around $64 million in mid-September 2020.

Power plays

As to how investors go about picking which mining stocks to buy, there are few considerations more pertinent than computing power.

“All bitcoin mining is at the end of the day is a bunch of data centers and power pointed at bitcoin,” said Jaime Leverton, CEO of Toronto-based Hut 8 Mining, which is valued at around $920 million today — up from $74 million in mid-September. Leverton said that Hut 8 possesses 109 megawatts in power capacity.

A mining firm’s power capacity seems to matter more to investors than the amount of actual bitcoin the firm holds. 

Both Hut 8 and Argo Blockchain, a London-listed mining company that has also seen its valuation skyrocket over the past six months, strategically hold bitcoin on their balance sheets.

During an interview in late February, Leverton said Hut 8 held over 3,000 BTC on its balance sheet, all of which had been mined by the company itself. That equates to about $165 million at today’s prices.

Around the same time, Argo’s CEO Peter Wall told The Block his company — which is currently valued at around $1.3 billion — held only 501 bitcoins on its balance sheet.

Investors, apparently unfazed by the discrepancy, are attracted to bitcoin mining stocks because of their desire to skate where the puck is going — similar to why people invest in companies like Tesla, said Wall.

Leverton said investors in Hut 8 are buying “the forward projections of the incremental bitcoin being created” as well as the actual bitcoin already the company holds. So the quantity — and quality — of miners a company has on hand is a crucial distinguishing factor.

Okamoto said Marathon currently owns 2,560 miners hosted with Compute North, a crypto-focused colocation center. In October 2020, the company signed a joint venture with Beowulf Energy to secure exclusive access to a 105-megawatt bitcoin mining data center in rural Montana, and the firm is working to “aggressively” build its mining operation there.

The full details of this expansion effort truly capture the spirit of mining in a goldrush.

“Pads are being poured and mining containers are being installed daily," said Okamoto. Thousands of Bitmain S19s — purchased as part of the $265 million order — "are being deployed as we speak" at the new location in Hardin, Montana, he said.

“We should have over 10,600 miners operating at Hardin within 45 days as well as the 2,650 miners at Compute North, which will produce approximately 1.2 exahash.” (At publication time, the 7-day moving average for the bitcoin network's total hash rate is around 157 exahashes per second.) 

But that infrastructure will quickly lose value if bitcoin's price crashes. Investors might then experience the stock's torque — except on the way down. The scale of the operations assembled by the likes of Marathon should therefore be seen as a massive bet against that happening.

Investors must first decide whether to bet on bitcoin itself. After that, buying a mining stock might be just a matter of mathematics.

Okamoto referred to an online bitcoin mining profit calculator, which suggests that if all Marathon’s miners were installed today, the company would be generating $1.2 billion in gross profit each year (with the price of bitcoin at roughly its current level).

“Therefore, if our current market capitalization is $3.2 billion, investors have to make their own decision what multiple they should pay for a company that ‘could’ produce over $1 billion in gross profit,” he wrote.

To his credit, Okamoto seems to appreciate the operative word in that calculation.