Riot Blockchain: Massive Hashrate Growth In The Cards But Are We Running Out Of Bitcoin To Mine?
Summary
- Riot is massively ramping up its network hash rate in light of the recent Bitcoin move.
- Sizeable costs associated with Bitcoin production could prove problematic if there was to be an adverse move.
- The issue of Bitcoin caps could prove problematic for Riot in the long term.
Riot Blockchain (NASDAQ:RIOT) is a cryptocurrency mining company that focuses on Bitcoin and, to a much lesser degree Litecoin. They invested heavily in improving their mining capacity or overall hashrate since the public became obsessed with cryptocurrencies when Bitcoin had its first sensational move to $19,000 per coin in December 2017. Its meteoric rise ignited the cryptocurrency industry. Before long, many individuals and companies alike began investing in small computer units that could create Bitcoin, which is appropriately referred to as mining. Riot Blockchain is one of these companies, but there are a few distinctions between them and most of their peers. One of the major distinctions is that Riot is a small company that existed before Bitcoin but quickly pivoted into the space when they saw the opportunity for substantial revenue. Another, much more crucial difference is how aggressively Riot is increasing its mining capacity and the fact that the Chinese government just removed more than 50% of Bitcoin's hashrate with its crackdown.
China Crackdown should provide a short-term boost for Riot.
More than 50% of Bitcoin's hashrate has dropped off the network since May, which has made it 28% less difficult for miners to earn each token. This plays directly into Riot's hands. They have already done most of the legwork in creating a sophisticated mining fleet and have already created a relatively stable operation as hashrate will likely be migrating from China back to the US. This should bode well for investors in domestic Bitcoin mining companies, particularly those with low cost of production along with decent-sized Networks. But the crackdown could do more harm than good if it significantly hurts demand for Bitcoin. But the key point for potential investors in Riot Blockchain should be its attitude towards growth.
Before we get started, there are a few key terms we should go over concerning cryptocurrency. But of course Crypto veterans feel free to skip this section.
Crypto Cheatsheet
Hashrate - the Hashrate is, in effect, a measure of the overall processing power of a Bitcoin network. The mining or 'production' of Bitcoin involves the performance of complex cryptographic algorithms to solve a block, the rewards for which is a unit of cryptocurrency. The hashrate is effectively the amounts of these complex cryptographic calculations the mining Network can perform per second. In general, networks with higher hashrates yield more Bitcoin over a given period of time than lower hashrate Networks. In many cases, higher hashrate networks consume more electricity, but newer, more efficient mining hardware can also provide a higher hashrate per given unit of electricity.
Mining - this is a process of computer hardware performing complex cryptographic calculations for the Bitcoin Network to solve blocks. The reward for solving a block is a unit of cryptocurrency. Miners also improve the overall security of the Bitcoin Network and confirm transactions. Miners earn fees for the transactions they confirm.
Cryptography is a mathematical body of thought that uses mathematical proofs to provide high levels of security. The fruits are used to make it impossible for someone to spend funds from another user's wallet or damage the blockchain without a private key or signature.
Private Key - this is a strip of data that provides proof of an individual's right to spend Bitcoin from a specific wallet by using a cryptographic signature.
Cryptographic Signature - this is the mathematical protocol that allows individuals to prove their entitlement to a particular quantity of Bitcoin. Cryptographic signatures are intended to be untraceable to the individual but easily validated by the network, giving Bitcoin its anonymity.
Pooling - this is the process whereby multiple entities combine their resources to mine Bitcoin together see. This does not necessarily make it a more successful endeavor, as in many cases, there are administrative fees associated with the process. But if you consider that Bitcoin mining has an element of probability to it, it wouldn't take long for you to realize that there may be extended periods for miners where they may be unable to receive a Bitcoin for their efforts. This would create many working cap issues for small to medium-sized companies, so to mitigate against this risk, they pool their resources together and form a larger network, then assign a portion of earnings to each participant based on the hashrate they contribute to the network. This does not excuse miners from the consequences of purchasing subpar mining Hardware that consumes a large amount of electricity to produce a token as the revenue is distributed to the entity less fees. It does not affect the company's individual financial obligations outside of smoothing out Revenue variances month-over-month.
Company Outlook
Source: Riot Blockchain
As a business, Riot Blockchain effectively uses electricity and computing power to create Bitcoins which it sells at advantageous prices where possible. This means that the price of Bitcoin heavily impacts their profitability (as bitcoin is their main revenue source). At the end of Q1 2021, Riot Blockchain was spending approximately $15,250 indirect costs to earn each unit of Bitcoin. Their margin stood at 67.5%, which drove an 88% increase in mining revenue for the company after deducting pooling costs.
Source: Seeking Alpha
The strong revenue growth was due largely to a bombastic move by Bitcoin.
The price of Bitcoin has since declined rapidly and is now navigating through its fair share of headwinds which is not ideal. This makes Riot a highly speculative company with its fortunes heavily linked to bitcoins fortunes in the short term. In the long-term, Riot will likely have to find another revenue source due to limits on the amount of Bitcoin that can be in circulation due to the cryptographic formula use in the blocks. So the possibility exists for Bitcoin to outlast the mining companies, but with that said, it is likely that the last bitcoin won't be mined for at least another 100 years. As things stand, the recent prices have been advantageous for Riot, and another sensational move could put them in a fantastic place financially.
Riot is Bringing The Bucket and Not The Thimble
Riot Blockchain has been investing heavily in Bitcoin miners. As of December 31st, 2020, the company had increased its hashrate by 461% over the rate in December 2019. The company has even more aggressive plans for 2021, and if you are a big believer in Bitcoin, there is a lot to be excited about.
Source: Riot Blockchain
As of March 31, 2021, Riot had deployed a total of 13,746 miners in its fleet. The company has since committed to a purchase order for 42,000 Antminers, bringing its network hashrate to approximately 7.7 EH/s. This is outstanding news as while the hashrate from China migrates to new ecosystems; Riot will be capitalizing.
Source: Riot Blockchain
Riot does, however, have significant costs associated with the mining of Bitcoin. According to the company, the direct costs for Q1 FY21 stood at $15,250. The company can also hold Bitcoin where appropriate and hold out advantageous prices for the business. However, this is highly speculative and carries with it its own degree of risk.
Key Risks
The biggest risk associated with Riot Blockchain has to do with what has historically been its biggest opportunity: Bitcoin's price. Because of the nature of its business, Riot's market share and profitability are heavily influenced by the price of Bitcoin. In some circles, Riot is even referred to as a proxy for Bitcoin. While Bitcoin has generally moved up strongly since it captured widespread popularity, if an external stimulus like regulation was to impact the price of Bitcoin in a negative way significantly, this would almost certainly significantly damage Riot Blockchain's market cap and likely their earnings if it were to persist. Riot can be viewed as a small company that only produces a handful of products that happen to be priced in a very unpredictable way. Their main products are Bitcoin and Bitcoin-related services, suggesting a lack of diversification, which would prohibit me from calling this company investment-grade. There's money to be made on the speculative side and either direction. Still, it seems as though the short-term risks, outside of regulation, and the actual price of Bitcoin seem relatively muted, and the more critical risks are skewed to the medium or long-term.
Regulation
While Riot generally does business well and stays out of any real trouble, it is heavily linked to bitcoin. Bitcoin tends to divide opinions at least at the highest level, which impacts RIOT.
Politicians have recently begun taking aim at Bitcoin regarding its energy consumption and its role in enabling cybercriminals to receive payments discretely. Elizabeth Warren recently spoke out on Bitcoin's role in illicit activities.
"Online theft, drug trafficking, ransom attacks, and other illegal activity have all been made easier with crypto. Experts estimate that last year more than $412 million was paid to criminals in ransom through cryptocurrencies,"
These are worrying statements as of any legislative action that significantly damages the price of Bitcoin would directly affect Riot's bottom line.
Risk of Hikes to the Price of Miners
Riot Blockchain does not currently manufacture its own mining fleet. They're purchased from Bitmain Technologies Limited. There is nothing proprietary about their mining fleet, which opens the door for risks associated with competition, redundancy, and pricing power. Bitmain Technologies Limited has already increased the cost of its miners due to relatively heavy demand. They seem to hold much of the pricing power. The crypto mining industry is also rapidly innovating the mining hardware used to earn Bitcoin. It is possible that if there were significant updates to mining equipment over a short period of time that Riot Blockchain would be left behind. This scenario would likely require Riot to invest heavily in modernizing its Fleet, which could be problematic when you consider that the direct costs alone associated with the mining of Bitcoin, its major Revenue driver, stood at $15,250 at the end of Q1 2021.
The Scarcity of Bitcoin
there can only ever be 21 million units of Bitcoin in circulation. This figure does not include the Bitcoin lost, or the Bitcoin lost through death without inheritance or loss of security keys. At the time of creating this article, we stand at approximately 18.75 million units of Bitcoin in circulation, which implies that the scarcity factor could become more problematic in the future. As more and more Bitcoin is mined, companies must increase their network hashrate proportionally to maintain stable hashrate and Bitcoin production by extension. This also involves increasing electrical costs for each coin earned which can eat into margins in the extreme case. At the rate prior to the China crackdown, we could expect that the last Bitcoin would be mined in the year 2140, with the reward expected to halve every 4 years. This implies that Bitcoin will most likely outlast mining companies, which of course, shortens the lifespan an investor can realistically expect from a Bitcoin mining company. It is important to emphasize that the recent developments with China were not taken into account due to the expectation that the disruption in hashrate will be transitionary. That is, I would expect that existing miners would either purchase more capacity to meet the shortfall in supply or that the capacity that existed in China would migrate elsewhere.
Conclusion
The most prominent risk right now for Riot Blockchain is the price of Bitcoin. They have a working, promising business model, but unfortunately, there are key factors out of their control that can heavily impact their business. I believe the other risks that could devastate Riot are primarily long-term problems, but this is a new frontier, and anything could happen. It is hard to see Riot finding long-term strength without a massive move in bitcoin. One has to wonder if it would just be better to buy bitcoin instead of the miners at this point (if they were bullish on the currency). I would be more likely to buy than short Riot at these levels, but I believe the best play is to simply Avoid.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.