Bit Digital: Bitcoin Halving Could Make Mining More Difficult

Summary Bit Digital Inc. is an institutional crypto miner with over 45,000 specialized computers mining Bitcoin. Despite a strong rally in Bitcoin prices, Bit Digital delivered disappointing financial results in 2023 as increasing Bitcoin network difficulty reduced production. The upcoming Bitcoin halving event will make mining even more difficult, and the introduction of spot Bitcoin ETFs has reduced demand for miners like Bit Digital. I wrote an initial article on Bit Digital Inc. ( BTBT ) in November, noting that the company's crypto mining business has poor fundamentals as it is on a steep 'capital spending' treadmill. However, BTBT does have an interesting nascent business providing artificial intelligence ("AI") workloads for generative AI applications. Since my article, BTBT has been essentially flat, despite a 90% increase in Bitcoin prices (Figure 1). Figure 1 - BTBT vs. Bitcoin (Seeking Alpha) In my opinion, Bit Digital's poor performance reflects the challenges facing Bitcoin miners as they must contend with ever increasing difficulty in mining Bitcoins and little barriers to entry. Furthermore, mining equipment quickly becomes obsolete, so mining companies like Bit Digital have to constantly spend capital to refresh their mining fleet. Bit Digital Overview First, for those not familiar with the company, Bit Digital is an institutional scale crypto miner with a fleet of more than 45,000 specialized computers with a combined hashrate of over 3.7 EH/s (Figure 2). Figure 2 - Bit Digital Overview (BTBT investor presentation) Bitcoin Mining Is A Tough Business Recently, Bit Digital reported earnings result for Q4 2023, with full year revenues of $44.9 million, a 39% increase YoY. However, the company still suffered a $0.16 loss for the full year, despite a strong rally in bitcoin prices in 2023 (Figure 3). Figure 3 - Bit Digital Financial Summary (BTBT 20F report) Interestingly, Bit Digital generated a corporate loss despite cost of revenue of mining Bitcoins of just $19,610 in fiscal 2023 (Figure 4). Except for a brief period at the end of 2022, Bitcoin prices have stayed above Bit Digital's 'cost of production. So it is disappointing to see BTBT fail to generate corporate profits. Figure 4 - Bit Digital cost of production (BTBT 20F report) My main takeaway from analyzing Bit Digital's financial performance is that Bitcoin mining is a race to the bottom with no winners. Consider the fact that in 2022 and 2023, BTBT spent over $100 million in capital expenditures (including purchases made with digital currency) to acquire new equipment in order to 'grow' its Bitcoin mining business, increasing capacity from 1.6 EH/s to 3.7 EH/s currently (Figure 5). Figure 5 - Bit Digital Cash Flow Statement (BTBT 20F report) However, in terms of production, Bit Digital actually generated only 1,507 bitcoins in 2023, 27% less than 2,065 bitcoins mined in 2021! The main culprit behind Bit Digital's reduced mining efficiency is the Bitcoin network difficulty, which has roughly quadrupled in the past 2 years (Figure 6). Figure 6 - Bitcoin network difficulty (blockchain.com) Bitcoin Halving Will Make Mining Twice As Hard To add to Bit Digital's misery, the upcoming bitcoin halving event expected in the coming weeks will likely make mining Bitcoin exponentially more difficult and production for miners like Bit Digital will likely further decline. Offsetting this increase in difficulty is a likely increase in Bitcoin prices. Historically, Bitcoin prices tend to rally significantly around halving events, as their scarcity increases (Figure 7). Figure 7 - Bitcoin prices tend to rally around halving events (techopedia.com) However, net-net, I do not believe the business of Bitcoin mining generates any real value, except during brief periods of strong rallies in Bitcoin prices. Bitcoin ETFs Reduce Demand For Miners Savvy investors seem to agree with my assessment on the miners, as the introduction of spot Bitcoin ETFs in January 2024 have removed market demand for the Bitcoin miners like BTBT. Since January 11th, BTBT has declined by over 30% while Bitcoin has rallied by 59% and spot Bitcoin ETFs like the iShares Bitcoin Trust ( IBIT ) have rallied 48% (Figure 8) Figure 8 - BTBT vs. Bitcoin and IBIT (Seeking Alpha) AI Business Began Generating Revenues In January Even the company itself seems to be hedging its bets by diversifying into other business segments. As I wrote in my last report, Bit Digital launched Bit Digital AI in October, a business providing computing servers to support generative AI workloads. Management believes its core competency of operating servers efficiently will allow it to excel at providing AI workloads. Bit Digital AI signed an initial agreement with an anchor customer to provide the customer with access to a minimum of 1,024 Nvidia GPUs. The agreement was subsequently expanded in January to include an aggregate of 2,048 GPUs worth more than $50 million in annualized revenue to Bit Digital, with potential expansion to 4,096 GPUs over time. To help finance the growth of the AI business, Bit Digital has executed a sale-leaseback agreement with a third party on 96 AI servers (representing 768 GPUs) for a period of 3 years with the total lease rate representing a percentage of the contracted rate for those GPUs. However, it must be noted that Bit Digital is a relative minnow in the AI space, competing against cloud giants like Amazon's AWS and Microsoft's Azure, in addition to cash rich new entrants like CoreWeave (Figure 9). Figure 9 - GPU rentals is fast becoming a commodity business (cloud-gpus.com) In my opinion, the economics of renting out GPUs remain unclear and appear to be yet another capital intensive race to the bottom, similar to the Bitcoin mining business. Although Bit Digital expects to generate $50 million in annualized revenue from its anchor client, I advise investors against placing too much value on this nascent business without more details on the costs of financing and operating these servers. Conclusion Bit Digital recently reported full year earnings for 2023, with revenues of $45 million but EPS of -$0.16. Despite the company spending over $100 million in capex in the past 2 years, Bit Digital actually produced less Bitcoins in 2023 compared to 2021, as Bitcoin's difficulty roughly quadrupled. With an upcoming halving event, mining Bitcoins is likely to get even more challenging for miners like Bit Digital. While higher Bitcoin prices will offset difficulty in the short-run, the long-term business fundamentals of mining Bitcoins remain poor. With the introduction of spot Bitcoin ETFs, savvy investors have switched away from owning the miners into owning Bitcoins directly through the ETFs. Although Bit Digital's recent foray into AI workloads look promising, I would caution investors against placing too much value on this business until we see more concrete economics. I continue to rate BTBT a hold for now.