Investors should only invest in what they understand. If you invest in something you don’t fully comprehend, that’s more akin to speculating. Most people dabbling in cryptocurrency haven’t a clue about the intrinsic value of what they’re buying. For evidence of that, look no further than Dogecoin (DOGE), a cryptocurrency that started off as a joke, and one that now has a market cap of $27.6 billion. Not convinced? How about Shiba Inu Coin (SHIB) which describes itself as follows:
Shiba Inu (SHIB) is a token that aspires to be an Ethereum-based alternative to Dogecoin (DOGE), the popular memecoin. Unlike Bitcoin, which is designed to be scarce, SHIB is intentionally abundant — with a circulating supply of one quadrillion.
So, one cryptocurrency that started out as a joke now has another cryptocurrency mimicking it run by people who think that cutting up a pizza into one million slices means you can feed one million people. If you think that sounds stupid, just read their elevator pitch:
The white paper is something you’d expect to read in The Onion. It starts with proposing “a cryptocurrency that’s 100% run by its community,” and closes with “our roadmap will remain top secret to ensure our continued advantage in this highly competitive space.” Juche ideology is more compelling than this tripe, yet it’s been ascribed a $2.9 billion valuation as institutions make it available alongside all the other 5,000 cryptocurrencies out there. Coinbase recently announced the availability of Shiba Inu coin, something that seems entirely irresponsible. Neither of these coins have any intrinsic value whatsoever. The only thing propping these tokens up is greater fool theory and a whole bunch of cryptocurrency miners.
About Cryptocurrency Mining
Not all cryptocurrencies need to be mined, but the most popular cryptocurrencies – Bitcoin and Ethereum – do. Today we’ll be talking about arguably the most popular cryptocurrency thus far – Bitcoin.
In order to create a Bitcoin, a computer needs to solve a complex series of algorithms. In the early days, you might have been able to download some bitcoin mining software on your home computer and mined some bitcoin, but not now. As time goes on, the complexity of these algorithms increases, so that more powerful equipment is needed to solve them. An increasing number of bitcoin miners trying to do the same thing means it takes longer to mine bitcoin. That’s because the barrier to entry is quite small. To mine bitcoin, you just need:
The more difficult the problems become to solve, the more powerful equipment you’ll need, the more electricity you’ll consume. As time goes on, the bitcoin becomes more difficult to mine while the rewards simultaneously decrease – every four years, the number of bitcoins provided to the miner that successfully solves the problem gets cut in half.
There are only 21 million bitcoins that can be mined in total. Of these, around 18 million have already been mined. For the 3 million bitcoins remaining to be mined, the rewards decrease over time while the need for resources increases over time. You would need to emphatically believe that bitcoin can only increase in value over time for this investment thesis to make sense. One company that believes the “eternal bitcoin price appreciation” thesis is Hut 8 Mining (HUT), a $1.378 billion cryptocurrency mining company.
About Hut 8 Mining Stock
Founded in 2011, Canada’s own Hut 8 Mining is a publicly traded cryptocurrency mining company – one of the largest – that owns numerous crypto mining data centers which utilize fixed-rate electricity contracts to mine bitcoin. It’s a simple business on the tin. The costs – electricity and data centers – need to be less than the revenues they receive from the bitcoin they mine, otherwise they don’t have a business.
If you’re in the business of mining bitcoin, then your revenue equates to the amount of bitcoin you managed to produce. For the first half of 2021, Hut 8 Mining managed to mine $48.93 million worth of bitcoin at a cost of $28.77 million. That bitcoin can either be held on their balance sheet or converted to cash. About $1 million was converted to cash, while the remainder remains on their balance sheet.
Right now, Hut 8 Mining is holding about $62.62 million in bitcoin while opting to fund their operations by selling more shares. In the first six months of this year, shares outstanding increased +47%, a dilution that shareholders who focus solely on price will fail to realize.
In the face of such heavy dilution, shares have soared leading many investors to confuse price action with the quality of the underlying business. If a stock increases +1,000%, that’s a good thing, right? Not for risk averse investors who believe in the efficient market hypothesis and see price volatility as a bad thing. When a stock price increase sharply for no good reason, it’s rarely because “investors are only now coming to realize the incredible value on offer.” Just look at how Hut 8 Mining has performed over the past year:
- Hut 8 Mining 1-Year Return: +1,184%
- Bitcoin 1-Year Return: +300%
- Nasdaq 1-Year Return: +41%
Remember, this is a company that’s increased their outstanding shares over that same time frame by at least 47%. While Hut 8 Mining did spend $1.425 million on “Investor relations and regulatory” over the last quarter (let’s hope that’s mostly on the regulatory part), there’s a much bigger reason the thesis is attracting so much interest. At least some of the excitement around bitcoin mining stocks is coming from across the pond in China
The Chinese Crypto Mining Exodus
One reason the bitcoin mining thesis has recently become more appealing is because of China’s ban on bitcoin mining. At one point in time, the majority of bitcoin mining was happening in China because they have some of the world’s cheapest electricity. Now China’s top regulators have banned crypto trading and mining (they’re now targeting illegal crypto mining). This means the total addressable market for crytpo just fell by 20%, and it also means that crypto mining becomes a whole lot easier for people who miners who reside in countries where it’s legal.
The profitability of bitcoin miners comes down to three variables:
- The cost and amount of electricity needed to run the servers
- The speed which you can mine (increases as number of other miners decreases)
- The price at which you can sell bitcoin
With fewer Chinese miners to compete with, Hut 8 Mining can produce more bitcoins using the same resources. As long as the price of bitcoin doesn’t fall, their operation should become more profitable now that China is out of the game. Bear in mind that many of these Chinese miners are just relocating to places like Texas, one of the cheapest places to buy electricity in the United States. This also represents a double-edged sword. If one country successfully banned bitcoin mining, others can too. It’s just another regulatory risk that affects cryptocurrency, something that itself has a great deal of regulatory risk.
Should You Buy Hut 8 Mining Stock?
Every pundit on this planet tells you what great stock to buy, but they won’t be around to tell you what to do if the stock doubles, triples, or drops -80%. That’s what volatile stocks do. When you invest in a stock, the most important aspect of wealth preservation is understanding the risks you’re taking on. In the case of Hut 8 Mining stock, you’re taking on a huge amount of risk coming from all directions.
We’re talked before about how irresponsible it is for companies to keep bitcoin on their balance sheets. As investors, we’re not paying company executives like Elon Musk or Michael Saylor to speculate on the price of bitcoin, we’re paying them to run their companies. Hut 8 Mining has decided to hold nearly $62.62 million in bitcoin. Well, they don’t actually hold that bitcoin. Another company called BitGo Trust Company does, something they rightfully note as a credit risk. The other credit risk they cite is the several thousand bitcoin (about $85 million in today’s prices) they’ve loaned out to several parties that pay them 4% in exchange. Is that counterparty risk really worth 4%?
In our recent article on A Complete Guide to Investing in Blockchain Stocks, we talked about how a bitcoin miner’s success is directly tied to the price of bitcoin. If you’re looking for exposure to bitcoin, just buy bitcoin. Why take on the operational risk associated with a bitcoin mining company? Imagine a business where you need to increase your headcount consistently over time because the workload is constantly increasing, all while the price of what you’re selling gets halved every four years. That’s the sort of business you’re investing in with blockchain mining. Add to that equation the volatility of Bitcoin and this becomes a business we wouldn’t touch with a ten-foot pole.
Cryptocurrencies are a manifestation of blockchain technology that’s still being figured out by entrepreneurs, investors, and regulators alike. There’s potential to be had in whatever endpoint blockchain technology reaches where it becomes a solution to a problem instead of a solution looking for a problem.
The world of cryptocurrency is incredibly risky. Even the “safest cryptocurrency,” Bitcoin, is a volatile mechanism that’s so bulky people actually transact off the blockchain now, something that seems to defeat the purpose. Most people can’t explain bitcoin properly, and even fewer can explain the complex processes behind mining bitcoin. If you don’t understand a thesis, you shouldn’t invest in it. And even if you do understand bitcoin mining, HUT stock seems like a very risky way to get exposure to the infallible growth of bitcoin.
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