A introduction to public companies powering the blockchain ecosystem
Bitcoin, Ethereum, blockchain, Web3, and one of my favorite terms: Ponzicoins… fans and critics tend to be pretty passionate about these topics! We’ve experienced close to two years of explosive growth in this space, along with ludicrous volatility in prices, and I don’t foresee the industry’s growth slowing anytime soon (note: growth doesn’t necessarily mean the price goes up).
Is all of this excitement building towards a revolution in the foundations of the web? Perhaps. Honestly, I’m far from an expert in this space - I do enjoy learning about all the new ideas and products being developed with these new blockchain-based tools. This industry could boom and integrate into each of our lives within a few years or it could crash and retain only very niche use cases. That’s part of the fun!
One post can’t possibly cover all relevant angles in a single post. Consider this a surface-level introduction based primarily on public companies, with extra attention to crypto mining.
One of the best ways to quickly learn about an industry or investing niche, as well as identify the key public companies, is through ETFs (exchange traded funds).
For example: want to learn about clean energy companies? With a quick Google search I found SMOG, TAN, ERTH, and CNRG. In addition to having awesome tickers, the websites for these ETFs provide some great information about the industry and how the funds weigh different company characteristics.
After listening to a Bloomberg Trillions podcast about RIGZ, a crypto mining ETF, I decided to do my own research into the public equities behind the blockchain/crypto/Web3 revolution. While I had heard of a few companies in passing, I was pretty amazed at the breadth of services and strategies at play.
The ETFs I focused on:
RIGZ - Viridi Cleaner Energy Crypto-Mining & Semiconductor
GFOF - Grayscale Future of Finance
WGMI - Valkyrie Bitcoin Miners
DAM - VanEck Digital Assets Mining
There’s plenty of overlap in the companies included within each of these funds. I focused on the companies that are mostly/entirely crypto-oriented, and grouped them into three categories: mining, financial infrastructure, exchanges.
I’ll also note that ETFs are a much, much easier way to invest in the crypto industry. You don’t have to pay ~2% transaction fees and more importantly you don’t have to deal with the taxes - which can get really messy.
Here we go…
What is it?
“Solving the proof-of-work puzzle requires miners to exhaust all possible options until a random number — called a nonce in technical jargon — is found that meets the network difficulty target. Rather than guessing numbers manually, miners use special hardware equipment to quickly generate potential solutions.” Source
“Mining is the process by which new units of cryptocurrency are created. Miners use specialized computer chips in conjunction with software to solve complex math problems. In solving the problems, transactions that exist in the current block are verified by multiple participants. As the problems are solved, miners are rewarded with newly issued cryptocurrency.” Source
“Bitcoin mining is an incredibly important part of the integrity of Bitcoin - it is the act of appending new blocks to the Bitcoin blockchain for financial reward (”block reward”).” Source
For simplicity's sake, you can think of crypto miners as the data centers powering various blockchains, much like Amazon Web Services (AWS), Google Cloud, and Microsoft Azure provide the underlying infrastructure for most of the websites we utilize everyday.
Here’s an infographic from a sustainable energy, Bitcoin-focused crypto miner - Iris Energy. They use renewable energy sources to power their computing infrastructure. The computing power they provide to the blockchain contributes to the network’s security and they are periodically rewarded for this in the form of bitcoin. They then sell the bitcoin at market price for cash to fund their operations.
There are layers of complexity beyond what I’ve outlined here. And we’re specifically focused on Bitcoin in this section, which operates via Proof of Work (PoW) consensus mechanism, as opposed to other popular blockchains that use Proof of Stake (PoS), for example. Proof of Work requires computing power (“work”) to validate transactions. Ethereum, the second largest cryptocurrency, is also a Proof of Work blockchain, although the plan is to transition to Proof of Stake in the near future. I’ll include some links at the end for deeper dives.
According to Wes Fulford, CEO of Viridi Funds, there are around 50 public companies involved with crypto mining, with each one providing unique strategies around their balance sheets, vertical integration, use of sustainable energy sources, and more. What may seem like a fairly straightforward industry - turn on some computers and start mining - is actually quite fascinating.
Crypto Mining Economics
According to Hive Blockchain Technologies, there are 5 variables which determine a miner’s profitability:
A mining company’s management team must consider each of these as they craft their strategy.
These companies can build their data centers in cold climates to reduce cooling costs - for example, Hive operates in Canada, Sweden, and Iceland. Iris Energy chooses “regions where we can access abundant and/or under-utilised renewable energy…” Miners can prioritize renewable energy sources and/or prioritize access to cheap energy sources.
Application-specific integrated circuits (ASIC) are used for blockchain mining. Each blockchain’s computational requirements are unique, so these ASICs are designed to mine one specific blockchain rather than being general purpose. The ASICs manufacturers continue delivering faster and more efficient hardware each year. As a result, miners must continually assess their current hardware’s performance and determine optimal upgrade cycles.
The price of cryptocurrencies is obviously outside of the mining companies’ control. At a certain price point, mining a given blockchain is simply not profitable after considering the energy and operational requirements. Bloomberg reported Marathon Digital Holding’s breakeven price for mining Bitcoin at $6,500, for example. If the price drops below $6,500, Marathon would be spending more on operations expenses than they would be earning in Bitcoin.
The blockchain algorithm’s hashing difficulty - the amount of computing power required to solve a block - generally corresponds to the increase/decrease in the number of miners at a given time. For example, if the price of Bitcoin increases, more people will be attracted to mining Bitcoin; however, the hashing difficulty adapts to this increase in miners in order to maintain an equilibrium.
It takes time to set up a mining operation. If the price of Bitcoin rises quickly, the established miners will enjoy higher profit margins in the meantime, before more mining competition joins and drives the hashing difficulty up.
This adaptive feature is a creative way to address supply vs demand.
Some mining companies choose to lease their ASICs rather than purchase them. There’s no need for large capital outlays and it provides increased flexibility as they monitor market dynamics. Other mining companies actually outsource all of the ASICs procurement and maintenance - they purely focus on capital allocation decisions.
These decisions affect whether your hardware is a fixed or variable expense.
Balance Sheets of Miners
Bitcoin is often called ‘digital gold’. Building on this description, when we look at the majority of gold mining companies, they seek to convert their gold to cash quickly. The production cycle keeps humming and gold is sold at market price at the time it is ‘produced’. Given that their revenue is already reliant on gold’s price at the time of sale, keeping gold on their balance sheet ramps up the volatility since they’re making a bet on the direction of gold. For longevity, they want to avoid this.
There are two camps within crypto mining.
The first approach seeks to replicate the gold miners - Bitcoin is sold at market price as soon as it’s acquired. These miners, such as Iris, tend to be more resilient in a bear market where the price of Bitcoin is falling. They don’t hold Bitcoin on their balance sheet, so the drop in Bitcoin’s price only affects current and future output.
The second camp, with companies such as Marathon, Hut8, and Bitfarms, intentionally hold Bitcoin on their balance sheets as a directional bet on the price of Bitcoin continuing to increase moving forward - in their perspective, why sell an asset you expect to exponentially grow in value? These miners are thus ‘momentum’ plays in the Bitcoin space - the price of Bitcoin directly affects both their current and future output, as well as the Bitcoin on their balance sheet. In January 2022, Hut8 reported holding 5,826 self-mined Bitcoin, equivalent to $233M at $40k/Bitcoin.
Earning rewards for mining is all about probabilities. You only get rewarded when you solve a block - it’s all or nothing. The result is earnings which can fluctuate wildly.
One way to eliminate some of this uncertainty is to join a mining pool. Think of this similar to an office pool for a lottery. You and your coworkers each contribute some money to the pool, you collectively buy some lottery tickets, and if you win the reward is split amongst the pool based on the percentage you contributed. It’s a way to increase your odds of winning, while lowering the potential reward. These mining pools smooth out the revenue for mining companies.
There are also mining pool arrangements which pay miners based on the ‘expected earnings’ their mining should generate. For example, based on the current price of Bitcoin, hashing difficulty, etc. I might expect to earn $100 per day. To ensure a steady cash flow for my company, I might choose to simply take $98 from another entity and let them capture any earnings I generate from mining, which are expected to be $100 but could be lower or higher.
More about Mining
Web3 Breakdowns podcast: An Overview of Crypto Mining
Cambridge FAQ on Bitcoin mining: Article
Mining luck and pools: Article
Real-time mining stats: Dashboard
Meb Faber Show": Interview with Wes Fulford, RIGZ
Many crypto ETFs include Silvergate Capital, which is a traditional bank built for a digital currency world. Among their range of services, they:
Provide financial infrastructure and banking services for companies building in the fintech space. This includes significant compliance and regulatory assistance.
Operate the Silvergate Exchange Network, which facilitates US dollar transactions between digital currency exchanges (ie Coinbase) and institutional investors (hedge funds, private equity, etc)
Silvergate Capital’s focus on catering to the digital currency industry makes them an attractive entry point for large institutions seeking exposure to this space without the hassle of internally addressing all the compliance and technological hurdles. These institutional investors can rely on Silvergate Capital for their crypto asset management.
Additionally, as an experienced provider of infrastructure for many fintech and crypto-focused companies, they are well positioned to capitalize on future growth in crypto by solving these headaches for their clients.
While there aren’t many public asset managers focused on the crypto space, they’re worth mentioning due to the crucial role they will likely play in onboarding large institutions. Galaxy Digital, based in Canada, is primarily a crypto asset manager with $2.4B in assets under management, but also runs its own mining operations, venture capital fund, and blockchain projects. As a result, they provide broad exposure to various sub-industries in the crypto space.
Exchanges are the entry point for converting fiat currency (i.e. US dollars) into various cryptocurrencies, as well as for trading between cryptocurrencies.
Decentralized exchanges (DEX) such as SushiSwap and Uniswap are simply algorithm-driven marketplaces that facilitate these trades. All you need is your crypto wallet address. This allows for trading between two parties without a third party to facilitate.
While one of the core benefits of blockchain technology is its decentralization, many centralized exchanges (CEX) have also gained in popularity due to ease of use and more familiar interfaces for beginners. Of the top 10 exchanges by volume on CoinMarketCap, only Coinbase is a publicly listed company in the US, with a market cap of over $36B as of 3/10/2022 (it reached $70B in late 2021). However, many other fintech companies have begun offering centralized exchanges as well, including Block (formerly Square), PayPal, Robinhood, and others.
Their primary revenue source is the transaction fees generated by users buying and selling crypto. On that note, Coinbase’s transaction fees range from 0.5%-4.5% - that’s a lot! There aren’t many good options for pure crypto exposure via your brokerage currently (at least not in the US), which is another reason I think it’s worthwhile to consider the public equity and ETF options mentioned in this post.
For more about Exchanges: Article
Welcome to crypto! It’s not for the faint of heart and it’s far from a guarantee that it will meet the enormous expectations placed on it by enthusiasts. None of this post is intended to be investment advice.
Thanks for reading! Now we end with a few fun memes…