How Investors Should Approach Bitcoin Miners As The Halving Approaches

Overview

Every four years, the Bitcoin halving cuts rewards for mining bitcoin in half. It will happen again in April 2024, when the block subsidy will drop from 6.25 bitcoin (worth $221,000) to 3.125 units ($110,625). Miners will also continue to receive transaction fees paid by network participants, but those are a de minimis part of their compensation. While the practical effect of the halving will be to double production costs for bitcoin miners, bitcoin mining shares may still be a great fit for some crypto portfolios.

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Key Background

The Bitcoin network uses a process known as mining to add transactions to the network. As compensation for expending computing power and incurring energy costs, each block’s miner is currently allowed to create 6.25 new bitcoins. This is the only way that new bitcoins are generated, and halvings serve as a way to slow down the pace of inflation, making existing assets more scarce. The process will continue until the 21 millionth unit is minted in the year 2140.

When bitcoin launched 15 years ago, and bitcoins were worth just a few cents, mining could be done on a basic laptop computer. Today, it is big business where top miners combine to run more than 450 EH/second. In fact some estimates put the annual energy consumption of the bitcoin network on par with a middle income country.

With this arms race comes millions of dollars in annual costs (such as the procurement of specialized hardware, energy bills, and general overhead), so many miners have evolved into multinational corporations with global supply chains. In fact, there are 15 major miners listed on major stock markets such as Nasdaq and the Toronto Stock Exchange with above 0.5 EH/s of realized hashrate in October 2023. Here are the ten largest.

It is also worth noting that the bitcoin halving has historically been an extremely bullish marker for the asset. In the 12 months following the halving in 2016, bitcoin surged by 287%. In the midst of the covid-driven financial boom, bitcoin surged by 542% in the 12 months-post halving. Back when bitcoin was still in its toddler stages, it surged by a staggering 8,256% in the year after its first halving in 2012.

Outlook and Implications

As demonstrated above, miners have had a positive 2023 on the whole. Still, they could face a difficult 12-16 months until the effect of the next halving fully kicks in to compensate for the shrunken rewards, assuming that past performance will repeat itself again. A big reason for this complicated picture is that mining profitability is already at an all-time low based on industry averages, and the halving is going to take place during a period of heightened interest rates for the first time, which can weigh on assets such as bitcoin and gold that do not provide extra yield. Post halving, many bitcoin miners will need to immediately shift into cost-cutting mode in order to ride out the potential trough and catch the next wave. They may also decide to dilute shareholders to raise capital.

On the other hand, there are bullish indicators. Bitcoin has surged by more than 30% since June, when the asset management giant BlackRock filed to list a spot bitcoin ETF, and it is up 120% on the year. As shown in the chart above, miners are some of the largest corporate holders of bitcoin in the world, so if a series of ETFs launch in the U.S., which is expected to occur no later than March 2024, the value of these holdings could soar. The size of this impact will depend on how much capital gets allocated towards these new products.

The price jump in the latter half of 2023 suggests a lot of excitement, but estimates vary widely. For points of reference, the first bitcoin futures ETF in the U.S., the ProShares Bitcoin Strategy ETF (BITO) set a record by bringing in $1 billion in its first 24 hours. In addition, the first gold ETF founded in the early 2000’s, the SPDR Gold Shares (GLD), received $1 billion in its first three days, which was a record then. Spot bitcoin volume sits at around $17 billion per day, so a $1 billion influx would comprise almost 6% of the daily volume. A sudden rise could also liquidate short positions, which could accelerate any upward movement.

Decision Points

It is important for investors to find the right balance in their portfolios for crypto overall, but even when it comes to exposure to bitcoin. Miners tend to provide more beta (return/volatility) than just holding bitcoin outright. In 2023, for example, among the nine leading public bitcoin mining stocks, their value increased by 250% – almost more than three times bitcoin’s price gain. Of course the opposite was true in 2022 when the market declined.

It may not be prudent to keep most bitcoin exposure in mining stocks, but it can be a helpful accelerant during bullish periods. The majority of your exposure to bitcoin could be better apportioned to directly holding the asset or purchasing an exchange-traded product such as a potential spot-ETF, a stock such as MicroStrategy (the world’s largest corporate holder of bitcoin), or a closed-end fund such as the Grayscale bitcoin trust, whose shares currently trade at a discount of 13% to its underlying NAV.

Regarding the specific stocks to own, it is important to consider several factors such as the cost of production, debt on its balance sheet (which could increase the need to sell bitcoin to pay expenses and hurt the long-term exposure of its treasury). Here are some helpful data points to use as a reference, but it is important for any investor to do his or her own research.

• According to one independent analysis comparing the enterprise value of bitcoin mining stocks to their revenue, market leaders Marathon and Riot appear to be slightly overvalued. On the other end, companies such as BitDeer and Stronghold Digital trade at lower ratios. This does not mean that an investor should immediately target the left side of a chart such as this, as there are reasons for blue chip mining firms such as Riot and Marathon to trade at premiums, such as an expectation that they are better positioned to ride out a difficult post-halving period. It is also worth noting that they have by far the two largest bitcoin treasuries of any publicly-traded miner, which could prove to be extremely valuable over the next 12-16 months. Therefore, every aspect of a miner’s business must be taken into account when making investment decisions.

• One company that is getting more attention from the investment community is TeraWulf because of an ultra-cheap nuclear energy contract that it signed in Pennsylvania in March that insulates it from geopolitical driven energy-price increases.
• Although Applied Digital Holdings (APLD: NASDAQ) is not by definition a miner – it is an infrastructure provider that houses and operates miners on behalf of their beneficial owners – it is also on the top of mind of investors because of some nine-figure artificial intelligence customers that it recently signed. A lot of bitcoin miners are making noise about dipping their toes into artificial intelligence, but for most it is just marketing speak.
• Core Scientific may seem appealing to investors given its large hashrate an expected relisting on Nasdaq in January. However, it is important to note that even if the company successfully emerges from Chapter 11 proceedings it will carry a high debt load that will need to be serviced by continuing to sell every bitcoin that it mines. This means that its treasury will remain at 0 for the foreseeable future.

Further Reading