Iris Energy: Transaction Fees Change Everything

Summary

• Recent developments in the Bitcoin community have resulted in elevated transaction fees and greater miner rewards.
• Iris Energy has scaled to 5.5 EH/s and is guiding for 6.5 EH/s this year. The company has the cash needed for the ASICs.
• The company has market-leading mining efficiency numbers and no debt.
• Looking for more investing ideas like this one? Get them exclusively at BlockChain Reaction. Learn More »

Adrian Vidal

In my previous Iris Energy (NASDAQ:IREN) article for Seeking Alpha, I mentioned my belief that the company should consider flipping its treasury approach from a 100% production seller to some sort of hybrid model. This belief stems from the fact that Bitcoin supply emissions have been the largest driver of miner revenue by far. Thus, with a block reward halving happening overnight in a little under a year, all BTC miners theoretically benefit from holding BTC on the balance sheet to benefit from the theoretical increase in the coin's price.

LookIntoBitcoin

Bitcoin has a history of increasing in price following halving events. This is a somewhat critical part of the coin's construction because without higher coin prices, the miners who process transactions and secure the network see revenue decline in perpetuity if fresh supply at a constant USD-denomination is the only source of income. This is theoretically while input costs remain unchanged. It's not a great recipe for success long term but there is a recent catalyst that might minimize the impact from declining block reward emissions.

Maybe HODLing Won't Be Necessary

In a previous article covering Bitfarms (BITF), I explained some of the recent developments regarding the Ordinals NFT protocol and the impact that NFTs on the block space have had on Bitcoin transaction fees. I won't re-write that section again here but the main takeaway is that Ordinals lead to more transaction fees for miners and the inscriptions from that protocol have continued to make new highs in recent weeks:

Ordinals Mints (Dune Analytics/dgtl_assets)

I detailed why I felt Ordinals had the potential to lead to a fee war within the Bitcoin community back in early February, and that assessment is closer to coming to fruition. Regardless of whether everyone within the Bitcoin community likes Ordinals or not, the potential stickiness of transaction fees is a significant fundamental development for the miners. Despite short-lived spikes to fees over the years, the industry has been almost entirely reliant on fresh BTC supply emissions from the block reward. We can see the impact from the transaction fee increases in May in the chart below:

IntoTheBlock

Between January and April, the share of Bitcoin miner rewards coming from transaction fees averaged about 2.4%. Through the first half of May, that average has spiked to over 17%. While there are a couple clear outlier days on May 8th and May 9th that are helping to boost this surge in transaction fee share, even when we take those two days out of the average we still get a transaction fee share of total rewards of roughly 14% for the month of May.

I have to be clear that I'm not saying that Ordinals or BRC-20 tokens will be what causes transaction fees to continue higher. But I will go as far as saying something likely needs to be adjusted to the model for miners to remain profitable long term. This is an idea that has been explored previously by analysts who are much smarter than me. In my personal view, the simplest approach might be the one that aligns with the free market mentality that I believe most bitcoiners possess; market participants simply have to start paying a more realistic fee for the service they're using.

Surviving Crypto Winter

Things looked pretty bad for the Bitcoin mining industry in Q4-22 and Iris Energy was no exception. After scaling from under 1 EH/s in March 2022 to nearly 4 EH/s by October, the crypto market moved against the sector and Iris had to forfeit machines held through special purposes vehicles. This led to a dramatic month over month fall in BTC production for Iris from October to November of last year:

IREN vs BITF (Company Disclosures)

While it was unfortunate the company missed out on 5 months of BTC mining revenue at a time when the coin was staging a recovery, Iris structured it's machine collateralization in a way that allowed the company to live another day and try again. At the end of April the company had 4.0 operating EH/s. As of May 10th, Iris has 5.5 EH/s. In my view, this scaling of capacity in such a short amount of time is impressive and encouraging.

Iris Energy

Iris is expecting to bring on another 1 EH/s of operating capacity, most of which is at the company's Childress site. Iris projects this will require an additional $35 million in capex to scale. On the last quarterly conference call CEO Daniel Roberts mentioned the machines required to bring on that additional EH/s have yet to be purchased and the company is being patient with those buys:

In terms of anticipated CapEx, we haven't procured miners at this stage. We will look to do that. Over time, we don't see the urgency. We can give some guidance on what that might cost. There have been some recent market benchmarks that people can refer to. We're looking to procure the BITMAIN S-19 XP mines as a priority.

Hashrateindex

Fortunately, ASIC prices are still cheaper than at any point in the last year and Iris has the cash to pull off this additional EH/s scaling without taking on debt. Finally, the company has proven to be in a class of its own when it comes to maximizing efficiency:

Miner YTD Metrics	BTC Production	Avg BTC per EH/s
Iris Energy	820	94.3
CleanSpark (CLSK)	2,395	90.1
HIVE Blockchain (HIVE)	1,065	90.0
Bitfarms	1,676	87.5
Bit Digital (BTBT)	447	87.4

Click to enlarge

Sources: Company disclosures

Year to date, Iris Energy has proven to be the most efficient miner in the space based on average BTC mined per EH/s. I expect that to continue given the company's intention to buy S19 XPs.

Risks

To date, Iris Energy has not been a profitable business. As currently constructed, the company is highly reliant on the price of Bitcoin and consumer demand for BTC. Bitcoin has had quite a bit thrown at it in the last 12 months and it seems clear that US-based regulators are in the "fight them" phase of the crypto story. This could theoretically diminish demand for BTC and that could negatively impact Iris Energy's stock.

Investor Takeaways

Crypto Winter has been devastating for many of the Bitcoin miners in the public equity markets. We've seen several examples of solvency issues, bankruptcies, and drastic reductions in production. Despite the hiccup in Q4, Iris Energy structured its obligations in an advantageous way and seems to have come out on the other side as one of the top companies in the industry again.

For me the combination of exahash growth and mining efficiency make IREN a buy for Bitcoin miner stock holders. While I've previously been slightly skeptical of Iris Energy's BTC treasury management approach, if there is long term stickiness to BTC transaction fees, securing the network can theoretically be a profitable business even when the reward from fresh supply issuance is halved next year. I've again taken a small long and will look to add on any weakness in the near future.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of IREN, BITF, BTBT, CLSK either through stock ownership, options, or other derivatives. 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.

I'm not an investment advisor.

Comments

[jholmes23]

All makes sense. Got burnt bad in the last cycle on miner stocks. Never again

[globalmacro]

Good article, thanks. I think Iris Energy is a great story in the making.

[parity]

@Mike Fay Question, to get the transaction fee, is that proportionally dependent on how much hash is provided in the network?

[Mike Fay]

@parity as I understand it yes. Though I'm not 100% certain of that

[parity]

@Mike Fay That ASIC price index chart is the best. I think if one layered on a BTC price on the right hand side, it would be obvious to see that Bitcoin mining is a horrible biz in a high admin cost situation (cough cough, publicly traded company with a lot of mgmt costs). The old miners value never come back as Bitmain etc come out with better miners every 2 yrs and hash keeps on going up. Depreciation is a real cost here and if you look at net profits, these public companies are not profitable. All the bulls are focused on adj EBITDA and that is just the wrong economic metric.

[wwwestman]

@parity Where is the horrible part?? With IREN we're talking about a 200m mcap company with roughly 100m in annualized forward-looking earnings with a 30K avg BTC price. 0 Debt and 50m cash with assets in place they have proven they can operate efficiently

[bazooooka]

@wwwestman how do those revenues look if hash difficulty doubles and BTC stays range bound for a year or so?

[mizzou20]

@bazooooka Get real. With the Bitcoin halving in about 10 months, the BTC price will increase. Next year, the odds favor a BTC price in the $80-100K plus area. Miners with reliable, low to average cost power costs will win and those with high and unreliable power will suffer. IREN has no debt, a low 55 million share count, experienced management, four owned facilities, and can self finance (expansions).