Bitcoin mining stocks underperforming due to extreme volatility.

Key Takeaways

  • Bitcoin mining stocks have traded with significantly more volatility than Bitcoin itself
  • Mining stocks have underperformed, as rising energy costs and increased competition has cut into profits
  • Miners also overleveraged during the pandemic, purchasing new equipment with debt and holding onto Bitcoin stashes as prices fell
  • Fees on the network rose with the Ordinals protocol and thus provided miners relief, but have since fallen back to normal levels

For those remotely interested in the world of cryptocurrency, it’s no secret that Bitcoin is incredibly volatile. At one point in March 2020, it was worth $4,600. By November 2021, at the peak of the bull market pandemic, it hit $68,000. A year later, it fell back down to $15,500, and currently hovers around $27,000.

But there’s something even more volatile than Bitcoin itself: Bitcoin mining stocks.

First, a quick explanation for those unfamiliar with Bitcoin mining. Miners validate transactions on the Bitcoin blockchain, acting as “volunteers” because there is no central authority to maintain the blockchain. However, they get paid for their work, receiving revenue in the form of Bitcoin. This revenue stream comes from two streams: the block reward subsidy (which halves every four years) and transaction fees.

The bottom line is that miners pay a cost to maintain the blockchain (in the form of energy/electricity) and receive revenue in return (in the form of Bitcoin).

Mining share price performance

Here are two things that have been consistently true about the performance of Bitcoin mining stocks. First, they are highly correlated with the price of Bitcoin itself. Second, they have shown far greater volatility than Bitcoin.

The Valkyrie Bitcoin Miners ETF, launched in February 2022, is a good way to demonstrate the performance of mining stocks. It allocates at least 80% of its holdings to companies that derive at least 50% of their revenue or profit from Bitcoin mining operations.

Since its launch, it has significantly underperformed Bitcoin, down 59% compared to Bitcoin’s 37% loss during the same period. However, it has outperformed Bitcoin this year, up 142% compared to Bitcoin’s 62% rise.

Why have mining stocks suffered?

Mining stocks almost trade like a leveraged bet on Bitcoin. Their entire business depends on the popularity of Bitcoin because their revenue is literally denominated in it, and the more people use Bitcoin, the more transactions there are to validate and the more lucrative mining is.

As a result, mining stocks have struggled immensely during the bear market. Despite rebounding this year as crypto markets have turned more optimistic in line with the macro climate and expectations around the future path of interest rates, mining stocks are still far below the prices at which they traded 18 months ago.

One reason for this is resource management. Bitcoin miners get paid in Bitcoin, but they can sell their holdings if they wish. As prices surged during the pandemic, on-chain data shows that miners largely held onto their stash, rather than selling. This means they did not monetize their Bitcoin as prices appreciated. The more Bitcoin miners hold, the more volatile their stocks will be.

Looking back, it appears that miners made a mistake by not diversifying their holdings, betting heavily on Bitcoin’s price holding up despite the violent fall. This has proven to be a bad bet.

Bitcoin hash rate is at all-time highs

Miners didn’t sell much Bitcoin as its price rose and instead invested in more equipment as mining revenues surged in line with the rocketing prices during COVID. Unfortunately, many miners also turned to debt to finance new equipment, which was selling for bloated prices as more and more miners entered the market.

Since then, the price of this equipment has fallen, just like the Bitcoin price. The chart below shows the growth in hash rate on the network, a measure of the total computing power mining Bitcoin, which has risen incessantly.

While greater hash power is excellent for Bitcoin overall and vital for the security of the network, it makes things more challenging for miners. More hash power means more competition.

Because of the incentives laid out in Satoshi Nakamoto’s Bitcoin whitepaper, this means a difficulty adjustment will kick in, making it harder to mine Bitcoins when more miners are on the network. This is necessary to keep Bitcoin on track to hit its final supply of 21 million bitcoins in 2140. Otherwise, an increase in miners would validate transactions quicker and hence release more Bitcoin into circulation.

This sounds complicated, and it is. But the bottom line is that more hash power on the network requires more energy to mine Bitcoin, which is eating into the bottom line of miners.

What happened to energy costs over the last year? Surging inflation and the war in Ukraine have sent electricity prices aggressively upward. The chart below shows the movement in the US, the most popular mining destination.

This means that miners are getting double squeezed – on the revenue side, falling Bitcoin prices are reducing their revenue, while on the cost side, the price of energy has also risen. Higher costs and falling revenue are not good, and the share prices are falling.

Are Bitcoin mining fees rising?

Recently, there has been an increase in transaction fees on the Bitcoin network, attributed to increased activity as a result of the Bitcoin Ordinals protocol. However, this spike in fees proved to be brief. The percentage of miner revenue derived from fees has fallen right back down to earth.

While the Ordinals protocol was certainly a bonus for miners, its effect has worn off, and it appears unlikely to disrupt the age-old pattern: as the price of Bitcoin rises in bull markets, more people use the Bitcoin network, meaning more transaction fees. In bear markets, the opposite happens. The percentage of miner revenue derived from fees tracks the Bitcoin price quite well.

Final thoughts

To sum up this mining report, miners will always suffer when the price of Bitcoin falls and outperform when it rises. This is because more people use Bitcoin when prices are rising, meaning more transactions and more revenue.

In the last year, miners have been fighting a battle on the cost front, with inflation and an energy crisis pumping up the cost of electricity, even if the worst of that may be in the rearview mirror. Additionally, many miners overleveraged themselves by purchasing more equipment at heightened prices on debt. Not to mention the decision of many miners to hold their revenue in Bitcoin rather than monetize into fiat.

Competition is now also fierce, input costs are rising incessantly, and the hash rate on the network is near all-time highs. In short, the days of college students mining on laptops are long gone.

All these factors have contributed to what has been an extremely challenging environment for miners over the past year. It also explains why mining stocks are even more volatile than one of the most volatile mainstream financial assets: Bitcoin itself.

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