Bit Digital: Another Victim of Hosted Mining? (NASDAQ:BTBT)

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Bitcoin (BTC-USD) mining is a tough business right now. In addition to the shrinking margins that continue to plague the entire space, there are additional risks that can be added to a company’s operations depending on how it is modeled at the infrastructure level. Some choose the asset-light approach taken by a company like Marathon Digital (MARA), while others are vertically integrated like Riot Blockchain (RIOT).

Asset-light refers to using hosting partners for mining services instead of handling the mining operation directly on the own-and-operate sites. While I think asset reduction probably makes a lot of sense when times are good, when times are bad, too many third parties theoretically add an element of risk that vertically integrated organizations don’t have to deal with. digital bits (NASDAQ: BTBT) seems to be learning that the hard way.

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With a market capitalization of $90 million, Bit Digital is one of the smallest publicly traded Bitcoin mining companies. The company uses the asset-light approach to Bitcoin mining and has a geographic presence in North America that includes New York, Texas, Georgia, and Nebraska.

During the month of August, Bit Digital generated 145.3 BTC from its operations and claimed a crypto treasury balance of 919.2 BTC and 3,684 ETH; those crypto stacks have a current market value of $17.5 million in Bitcoin and $4.8 million in Ethereum. The company also owns 38,594 Bitcoin miners, of which only 29% have been deployed with Bit Digital’s hosting clients.

Third Party Issues

Late last week, the company revealed that Blockfusion, one of Bit Digital’s hosting partners in New York, received a cease and desist from the city of Niagara Falls. This cease and desist is tied to zoning requirements:

the Notice orders the cease and desist of any cryptocurrency mining or related operations at the facility until Blockfusion complies with Section 1303.2.8 of the City of Niagara Falls Zoning Ordinance

According to Blockfusion, the order went into effect on October 1 and an application to renew the old permit could take months:

Blockfusion has also reported that it is preparing applications for new permits based on the Ordinance’s new standards and that permits may take several months to process. Bit Digital management continues to monitor the situation.

Given New York State’s potentially adversarial approach to Bitcoin mining, it would be prudent to assume that implementation of Blockfusion could take a considerable amount of time. The problem for Bit Digital currently is that 17% of their active mining fleet is hosted on Blockfusion. This is a production that can be difficult to migrate to another hosting site because Blockfusion is not the only provider facing problems.

An even bigger client for Bit Digital is Compute North. Compute North recently filed for Chapter 11 bankruptcy:

The bankruptcy is perhaps the biggest bitcoin mining news to emerge in the 2022 bear market. Compute North provides hosting services worth $700 million worth of equipment for some 84 mining entities, including publicly traded companies like Marathon Digital Holdings.

While Compute North has claimed that the bankruptcy filing will not immediately affect operations, the reality is that there is now a risk to the company’s previous deals. In theory, this could be an opportunity for some of the biggest players in the Bitcoin mining space. But, in my opinion, any potential modification of the previous agreements can have a great impact on Bit Digital specifically. In Bit Digital’s Q2 filing, the company stated that 20 MW of its current hosting comes from Compute North with a total of 48 MW coming from the hosting provider in the future:

As of June 30, 2022, Compute North provided approximately 20 MW of capacity for our miners. Our expected overall future hosting capacity with Compute North is approximately 48 MW.

Given Bit Digital’s current fleet figure of 42 MW and the 123 MW capacity figure that the announced purchases should ultimately provide, Bit Digital relies heavily on Compute North for its current and future mining operation.

MW projection

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Just under half of Bit Digital’s current fleet is powered by a company that just went bankrupt and an additional 17% of Bit Digital’s non-computing capacity is now offline with no real ETA to come back online. . It should probably go without saying, but this is not an advantageous position to be in and the asset-light model is being seriously tested as the mining industry grapples with the double whammy of higher energy costs and lower Bitcoin prices. For asset-light miners, we’re likely to see more of those energy costs passed on to host users than in previous Compute North deals.

Extensive BTC mining challenges

The sustainability of profitable Bitcoin mining is entirely dependent on higher BTC prices in perpetuity. The main reason for this is the block reward. With the block reward projected to halve in 2024, miners need higher Bitcoin prices to continue operating at a profit if the mining cost remains the same or even increases with higher electricity costs.

mining benefit

BitInfoCharts

As it stands, miner profitability is already at a 24-month low and that figure could possibly trend even lower if the price of Bitcoin continues to decline while the hash rate rises.

New sources of income

To the company’s credit, Bit Digital seems to be aware that alternative revenue streams are needed in an industry that is currently dealing with change. For example, Bit Digital did not mine Ethereum (ETH-USD) in the month of August and stated in its September investor presentation that it intends to start staking Ethereum for more stable rewards.

ETH Slide

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But if Bit Digital is going to switch to a model where a large percentage of its revenue comes from Ethereum staking, it will probably have to increase the ETH in its treasury to generate significant returns as a new revenue segment. I believe there are other publicly traded companies that are in a better position to benefit from Ethereum’s move to proof-of-stake consensus and I shared one such insight with BlockChain Reaction subscribers in September.

Summary

The good news for Bit Digital investors is that the company does not have a lot of debt and has plenty of cash on the balance sheet to change its model should it decide to do so.

active

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The company owns thousands of mining machines that have not yet been powered up. Those are assets that could be liquidated or moved to a facility that can handle the capacity if the opportunity to do so exists. As I understand it, the goal of the asset-light model is to be agile and have options. This would seem to be the time when Bit Digital should exercise whatever options it has on its assets and deals. I don’t think Bit Digital is a “sale” here. But I can’t call it a “buy” either. I’d like to see clear guidance from the company in its September production update in the coming days. If the price of Bitcoin goes up, there are other publicly traded miners who will benefit more from that increase.

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