Marathon Digital Holdings: Massive Hashrate Growth Will Likely Lift The Stock

Summary

• Marathon has an impressive delivery schedule for miners which should propel them to production levels greater than 50 coins per day.
• Marathon has a very good handle on electricity cost which is a key expense driver for any crypto mining company.
• The massive Bitcoin holdings and the positive cycle for Bitcoin make Marathon a compelling opportunity.

Yuuji/E+ via Getty Images

Marathon Digital Holdings, Inc. (NASDAQ:MARA) is a Bitcoin mining company. The company was founded in 2010 and is headquartered in Las Vegas, Nevada. Like most Bitcoin miners, Marathon has found itself in the middle of a hashrate arms race following the mining crackdown by the Chinese government. This has revitalized the industry as roughly 50% of the total Bitcoin network's hashrate has been removed, which greatly increases Marathon's odds of earning tokens. Today, we will look at Marathon's current situation and try to see what investors can expect over the short term from the company.

Source: Marathon Digital Holdings

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 Cheat Sheet

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.

Category Outlook

Bitcoin mining is essentially the solving of cryptographic formulae using electricity and computing power in the hope of earning a token. For this reason, the biggest drivers in profitability are the market price of Bitcoin (BTC-USD), the company's individual hashrate compared to that of the network, and the costs (electricity cost is typically a major driver) the company incurs to earn the token/coin.

Source: Marathon Digital Holdings

It is important to highlight the importance of the company's hashrate versus that of the whole network. Bitcoin mining is a competitive sport. There is a finite amount of Bitcoin that can be in circulation, and having more hashrate means that a firm is more likely to earn a token on average when operating alone and can claim a larger portion of the reward when there is a pooling agreement. To keep ahead of the curb, miners must aggressively invest in the most efficient Bitcoin miners to save costs and improve their relative hash rate. The company has been doing just that with regular purchases from Bitmain, one of the dominant suppliers of industry-leading miners today.

Source: Marathon Digital Holdings

The growth story here has been staggering. The company has increased production by 66% in July with a record yield of 442 coins for the month, bringing its total holdings to 6225.6, which is a massive position. The company now has 30k miners in its fleet and is expected to increase its fleet to 133k by July 2022.

Source: Seeking Alpha

This move is in line with the long-term goal of daily production at 55 to 60 tokens per day by Q1 2022. I am bullish on the company's ability to increase its hash rate. Still, I must emphasize that the price of Bitcoin varies wildly, and it is very difficult to forecast revenue when the price can skip around 10% at a time without any external stimulus.

Source: Marathon Digital Holdings

That said, the company has presented some compelling hypotheticals. Still, again I urge investors not to place too much weight on these figures and focus on the actual price of Bitcoin to formulate their own view on the token.

Source: Marathon Digital Holdings

China Crackdown Should Provide a Short-Term Boost for Marathon

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. Marathon is poised to benefit strongly from this move. They have already done most of the work 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 or other low-cost locations. This should bode well for 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.

Low Cost of Electricity

The company also has a low-cost energy deal with BEOWULF, an energy generation company. They pay an eye-dropping $0.029/kWh and have an average cost of BTC production at $4,541. These numbers are particularly impressive when you consider that another key player in the Bitcoin mining space, Riot Blockchain (RIOT) (discussed here) had direct costs per BTC at $15250 in Q1 2021.

Source: Marathon Digital Holdings

Bitcoin Adoption is Improving

Bitcoin and cryptocurrency, by extension, have been in somewhat of a Goldilocks period lately. If you've been following the news, the largest companies like Google (GOOG), Square (SQ), and PayPal (PYPL) have been allowing Bitcoin transactions in one way or another. This is perhaps the biggest cast for the legitimacy of Bitcoin in the short term. There have also been talks about the repercussions of low rates, unprecedented spending, and seemingly unchecked inflation on the USD, which has only strengthened the case for Bitcoin as it is, in effect, untethered from monetary policy.

Source: Marathon Digital Holdings

As we discussed earlier, Marathon is holding a massive 6225.6 Bitcoin tokens on its balance sheet, which comes with its own set of risks.

Source: theAsianbanker.com

The price of Bitcoin varies wildly, and placing such a large focus on the token could be catastrophic, but Bitcoin is in a positive cycle right now, and this bodes extremely well for Marathon Digital should it persist. In fact, one could argue that it has become quite trendy to hold massive amounts of Bitcoin on one's balance sheet as huge names like Tesla (TSLA) and Square hold significantly more tokens than Marathon. Apart from the actual price of Bitcoin, there are a few key risks that investors should remain abreast of.

Risk of Hikes to the Price of Miners

Marathon Digital 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 Marathon Digital would be left behind. This scenario would likely force Marathon to invest heavily in modernizing its Fleet.

Regulation

While Marathon has a fairly good reputation and with no major issues, it is heavily linked to the fortunes Bitcoin. Bitcoin tends to divide opinions at least at the highest level, which impacts Marathon.

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 any legislative action that significantly damages the price of Bitcoin would directly affect Marathon's bottom line.

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 expect the last Bitcoin to 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

This opportunity is not too complicated. The scarcity issue means that Bitcoin may outlast miners, but this is an extremely long-term issue. The focus right now is the massive hashrate growth, extremely low-cost production, and every indication that the company wants to do more. The most prominent risk here is the price of Bitcoin, which is trending positively at the time of the writing of this article. Marathon Digital Holdings is a Buy and will continue to be a buy as long as Bitcoin trends upward. This is a highly speculative opportunity, so I would encourage strong risk management.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in MARA over 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.