Crypto Market Commentary
19 January 2020
Doc's Daily Commentary
The 1/16 ReadySetLive with Doc and Mav is listed below.
Hut 8 Mining
The Bitcoin mining industry is hardcore. It is one of the most competitive and ruthless industries that has grown from nothing to a multi-billion dollar market in 10 years. It requires long term thinking, extremely strong stomachs for volatility and a highly professional approach to managing risk.
Today’s review will be for a company I believe to be the most professional miner in the world, Hut 8 Mining. This Canadian company is unique in that they trade on the Toronto Stock Exchange HUT:TSX so are available for retail investors to gain exposure.
Why Mining over Buying Bitcoin?
At its core, mining is a leveraged bet on Bitcoin. It comes down to the belief that the miner can buy bitcoin with a combination of CAPEX and OPEX for cheaper than the price it can be sold on the open market. Miners buy BTC with hardware and power and sell it for a profit in fiat.
Now a miners income is denominated in BTC and their expenses are denominated in fiat currency. Once the mining operation is established, ASICs are purchased and ready to go and power contracts are setup, their costs are now fixed and stable. The outgoing costs in USD are constant.
Miners are in direct competition with a global pool of players for a share in the global hashrate. If a miner has 2% of the global hashrate, over time they will mine 2% of the incoming BTC via block rewards.
The BTC price is volatile. Given that a miner has a fixed outgoing cost in USD, variable income in BTC/USD, the thing that actually changes their profitability is how much of the global hashrate they hold and what the long term average price of BTC is.
To add increased complexity, the global hashrate is also volatile and variable!
So how on earth does investing in mining make sense vs just investing in BTC and eliminating all this volatility from your portfolio?
It comes down to the staying power of the miner. Given the dog eat dog world of mining, only the strong survive. If we assume that at least a few miners are profitable in the market (else nobody would mine) then the trick is finding miners who reliably capture consistent and GROWING share of the global hashrate.
The miners who survive are those who are mining BTC cheaper than the open market demand. This is why a strong miner is a leveraged bet on BTC. If they produce BTC below its market cost, they can HODL more. If they do so over a long time, their reserves can become very large.
How badly would you like to HODL a huge stack of BTC?
HUT 8 Mining
I have listened to a few podcasts now which cover Hut 8 Mining. I have also been following the company on the sidelines for a while now and see a number of high profile Bitcoin analysts speak very highly of them. A recent podcast link is below.
Where Hut 8 differs from its competition is that their whole premise is to be a publicly traded investment vehicle for people to gain exposure to Bitcoin. Their business model is not like most miners which is to mine and sell immediately to realise maximum fiat gains. The Hut 8 business model is to sell only what is required to operate and HODL the rest.
They aim to be a miner cross Bitcoin ETF. Pretty neat idea right. As of Q3 2019, Hut 8 has mined over 12,000 BTC and HODLed ~3,500 BTC, around 30% of their stock.
Another key differentiator of Hut 8 is their deployment of hardware. Rather that most miners filling a room with pre-built ASICs with all the casings, fans and ‘wrapping’ as produced by the likes of Bitmain, Hut 8 is in a partnership with BitFury to build custom facilities.
The commonly understood ASIC looks like that below and is a plug and play system. The reality is that this is a chip with a whole lot of extra ‘stuff’ around it and is a neat little package for a retail miner. Selling this ‘stuff’ is good for Bitmain. However these prebuilt systems are basically disposable.
Once they become non-competitive, as chips develop and advance, and a whole new miner with a whole new set of ‘stuff’ needs to be purchased. Basically, the Bitmain units are designed as isolated individual units rather than a holistic design for a larger scale facility.
Sounds like planned obsolescence Apple products right, line up for the next iPhone anyone…
Hut 8 is different. The company is half owned by ASIC manufacturer BitFury. Together, they have developed a proprietary system called the BlockBox. These are fitted out shipping containers that are customized with air conditioning and filled with motherboards hosting ASIC chips. It is literally a shipping container sized version of Bitmain’s ASIC. Each BlockBox provides around 12PetaHash/second and cost around $1M each. At current global hashrate of 120ExaHash, each BlockBox is equivalent to around 0.01% of the global rate per box.
That means that the global Bitcoin hashrate is equivalent to around 12,000 shipping containers filled to the brim with high end, state-of-art ASIC chips…Incredible.
Where the advantage comes is that when chips become outdated, one does not need to pay for all the ‘stuff’ and instead just swaps in and out the new chips. These containers are customized to provide the ideal climate for hardware longevity and does not need to accommodate the unnecessary fans on a Bitmain unit designed for an individual chip.
As an additional advantage, these containers are easily moved and shipped which helps with facility mobility in the event a new power source or efficiency is found elsewhere.
At the end of the day, from all I have seen and heard about Hut 8, they are an extremely professional outfit. They are a far reach from the miners operating out of dusty basements and not treating their hardware with the longevity it deserves.
Hut 8 is primarily located in Canada with two main mining facilities in Alberta and another in Drumheller. Canada is an ideal jurisdiction and climate for mining as it is a stable government, generally progressive and its cold. The cold temperature drastically reduces the demand on air conditioning and cooling requirements.
The combination of stable jurisdiction and cool climate offset the cheaper power but higher risk government structures in say Venezuela, China or eastern Europe. The power sources for the facilities are primarily natural gas as this is a main export from the region.
Impact of the halving
The reason why Hut 8 may represent a sound opportunity is that the halving is coming. Now this event essentially doubles the cost of production for miners. Sounds bearish right?
It is for weaker miners. For strong miners, it is a bull case.
If we believe that the demand for BTC is constant or increasing, then price increase is the only market variable that can move as supply reduces. Given the above it seems Hut 8 is well equipped for survival. Thus we can assess the current cost to mine against the market pricing for BTC to see what a doubling in production costs would do for protitability.
Current cost to mine is around $4250, an increase due to Hut 8 deploying and investing in upgraded capacity and chips in 2019. Based on the podcast I likened above, Hut 8 seem to have around 2% of the global hashrate.
Now assuming they are a strong miner (which I believe they are), the halving is about to wipe out maybe 20-40% of their competition. If price remains flat (say at $9000), that means that Hut 8 is mining at cost (doubling currenct cost 4250 x2 = $8500) but their share of hashrate may increase to 3% or even 4%. That means that their profit actually remains exactly the same.
Then we factor in the likely increase in BTC price. This will keep more competition online but also allow for Hut 8 room to continue expanding. You can see how intense this game of chess cross chicken bitcoin mining is.
The investment case
If we now review the Hut 8 share price, it is pretty hard not to see the correlation to the BTC price. I also see that Hut 8 has taken more of a beating than the BTC price, likely a symptom of the traditional market needing to adjust to the new paradigm of ‘that is Bitcoin?’.
Miners take on more heat in a bear market. But they outperform BTC in a bull market.
If we believe that Hut 8 is a strong miner and BTC is likely to appreciate after the halving due to demand, then Hut 8 is primed to capture a larger profitability than they have today. Basically, Hut 8 will make equal profit to today if price doubles (to $17,000) or they double their share of hashrate to 4% due to competitors failing.
If more than one of those conditions are met, Hut 8 will greatly outperform the market. Couple that with their strategy of HODLing and only selling what is required, and there is a sound investment case. A leveraged bet on BTC by taking on the risk of a mining operation.
Clearly, mining is risky business. Volatility and bear markets are destructive and valuing a company is a different type of due diligence when compared to evaluating Bitcoin itself. That said, I have been an advocate for looking for gold miners who have sound operations and strong correlation to the Gold price. Price often contains all the information you need.
The Bitcoin price and the business operations are the primary risks that I can see. HODLing mined BTC is both risky but also potentially high reward and shows that Hut 8 is confident in price appreciation long term.
Hut 8 is a unique opportunity for equity in a leveraged stake on Bitcoin’s success. They are one of the most professional outfits in the industry and I sense are one of the strongest miners. Crrying 2% of global hash is no small feat, that is a massive stake in the network. Many big names in the industry speak very highly of their operation and from what I have seen, they seem to have a sound and unique approach.
Many risks of unstable governments and adverse policy is minimized being based in Canada. The primary risks here is BTC price appreciation. However with the introduction of options contracts and futures, miners are better equipped than ever before to deal with these risks and hedge properly.
Hopefully this very high level overview presents a good springboard for further research and due diligence on Hut 8 mining.
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