What Bitcoin Miners Can Learn from Portfolio Management | AIM Summit London 2023
In a talk at the AIM Summit 2023 in London, Fred Thiel discusses the valuable lessons Bitcoin miners can glean from portfolio management techniques. While initial expectations often anticipate soaring Bitcoin values and steady profits, the reality is marked by extreme volatility and fluctuating energy costs. Bitcoin mining operates in alternating cycles of profitability and break-even due to the dynamic nature of energy expenses and shifts in the global hash rate. To navigate these challenges, miners must adopt adaptable business models and secure appropriate financing strategies. This involves a blend of approaches, including balancing self-hosted and third-party hosting, leveraging renewable energy credits, maintaining a reserve of Bitcoin, and implementing hedging strategies to ensure sustainability across varying market conditions.
Transcripts are autogenerated. May contain typos.
foreign so I'm going to talk a little bit about what Bitcoin miners can learn from portfolio management and I would assume the majority of the people in the room here are not Bitcoin miners but you are typically investors portfolio managers and so you understand the theory of portfolio management um and what I'm going to try to kind of in very simple terms explain is how Bitcoin miners can apply that same type of thinking to their operations Safe Harbor statement obviously we're a public company so
um forward-looking statements etc etc etc um so most people have expectations on Bitcoin mining that oh bitcoin's going to go to the moon it's going to be worth a million dollars very soon we're going to hold 100 of our Bitcoin we have really cheap electricity we have abundant capacity and we have Limitless access to Capital that was 2021.
when Bitcoin was going to the Moon everybody held all the Bitcoin they produced electricity was still fairly cheap there was abundant capacity and there was tons of capital and lots of capital was raised lots of Bitcoin mining companies went public raised a lot of money the reality is there's a lot of volatility this is an industry um where 50 of the time your borderline Break Even or not making money and fifty percent of the time you're printing money and you think the world's never going to end for you
um in the good years your price of electricity which is your single biggest input cost doesn't even matter because your margins are so high that if you're paying two cents three cents four cents five cents ability doesn't matter in bad times it kills you and there's margin compression 2022 was one of these years where we went from an industry which in 2021 at its peak at 80 90 margins everybody was very profitable you really couldn't go wrong then the tide went out and a lot of people were left without any swim trunks
on and you had Energy prices because of the Ukraine conflict that were doubling tripling quadrupling in some cases and the price of Bitcoin fell by 75 percent all of which created a perfect storm you had bankruptcies one of the largest miners publicly traded minors in the U.S core scientific amongst them third bankruptcy um you know they were operated in a model where essentially they gave their customers fixed cost on hosting and they had variable input cost on their power and when your energy cost goes way above
what you're billing your customers you run into problems then there are also operational challenges with energy um getting permission to connect your miners dealing with regulators um as well as just systems quality issues ETC and then they're macro factors um you know today you heard three very esteemed economists talking about their outlook on the macro World well Bitcoin is very much driven by the macro environment the value of the US dollar drives Bitcoin interest rates which Drive the US dollar drives the price of Bitcoin
risk on risk off attitudes Drive the price of Bitcoin Bitcoin mining as a business though is also very much impacted by energy costs um as I previously mentioned but also by something called the global hash rate the Bitcoin Network for those of you who don't know Awards minors a fixed number of Bitcoin per day it's a zero-sum game doesn't matter how much I mine or how much somebody else Minds that same number of Bitcoin will be produced every day and there's a concept called the difficulty rate which is essentially a
calculus that the Bitcoin network does automatically which says I will produce a block every 10 minutes and no matter how many people are mining I'm going to make sure that nobody is so good that they can solve a block so that the block rate goes faster than 10 minutes and so it automatically adjusts every two weeks and I'm simplifying this a little bit but essentially what happens is in the good times people say wow this is great I'm going to go buy lots more minors I'm going to mine more Bitcoin and I'm going
to take market share well when everybody does that the global pool of people doing this might be applying twice as much compute power as they did the prior year but they're still the same number of Bitcoin being awarded and so you're having to deploy twice as much Capital pay twice as much for energy to get to the same spot and then every four years you have this thing called a having where the number of Bitcoin awarded to miners drops by 50 percent and you know today we're at roughly 19.
3 million Bitcoin mined and there will only ever be 21 million Bitcoin and so every four years the number of Bitcoin miners get drops if the price of Bitcoin goes up by two every four years most people would think oh well that's fine as it typically has the problem is this difficulty rate and Global hash rate as more people mine Bitcoin it gets harder and harder to do it and so even though the price could double every four years in reality it has to more than treble nearly quadruple because people keep buying more Miners and do more Mining
and it continues to grow and in the past two and a half years we have more than doubled the mining capacity in the network which means that even though the award rate of Bitcoin hasn't dropped by 50 percent effectively if you didn't buy any more miners since nine since 2021 you would be producing half as many Bitcoin today as you were in 2021 so it is a very challenging business but when it's done properly with good risk mitigation it can be extremely successful so how can minors bridge the gap between
the expectation of this business where you're going to get rich Bitcoin is going to go to the Moon you're going to hold all your Bitcoin and it's super profitable with high energy costs a very volatile price of the asset that you uh are mining and this constant increase in difficulty so Markowitz developed a concept of modern portfolio Theory essentially instead of looking at individual assets and basing your investment on kind of individual assets look at portfolio Theory and instead allocate based on risk-adjusted returns
so that you no matter what the environment you're in get a good return then I'm overly simplifying it and I'm sure that if Larry Summers were in the room listening he would take me to the bench and say listen you got to take my class at Harvard um but diversification of Investments can reduce risk and especially the total risk and again remember Bitcoin is profitable two years out of every cycle and it's not profitable or it's break even two years out of every cycle so you have to optimize your business model
such that you can operate Come Rain or Come Shine and you have to optimize your Capital stack such that you have the right financing at the right times and you're not sitting upside down with high interest rate debt when the market crashes which is what happened to a number of miners last year so asset class returns can increase as their risk increases but you have to be careful and so if we look at kind of Ray dalio's perception on this you know conventional portfolio risk can be very focused on equities or a single asset class but if
you have an all-weather risk portfolio you're spreading that risk and you know or private investors the 60 40 kind of concept of allocating between equities and bonds was kind of The View on portfolio risk diversification for institutional investors it's obviously much more complex but essentially the goal here is if you're going to be a Bitcoin miner and you want to operate using portfolio Theory you need to have a diversified business model that allows you to operate when times are lean very efficiently but also allows you to grow
very quickly when times are generous and at the same time have a way to carry a lot of value on your balance sheet so you're able to finance your growth when times are good so how do minors use this framework to build their mining portfolios so if you think about how miners operate they're typically two flavors you are either building and operating your own mining operation you contract directly with the power company you lease land you buy land you build the infrastructure and then you operate it yourself or you use
third-party hosting where you contract with a data center operator essentially and they build it they operate it the only thing you do is buy the actual mining rigs deliver them to that operator and then they run them for you for typically a fixed fee or a fixed operating overhead cost and then pass through on the power um the third party hosted model works great when times are good and you need to move quickly provided there's capacity meaning that there's availability of space because you can just buy miners
give them to an operator they plug them in they operate them and you only allocate Capital to buying miners which is where your biggest return is because if you are if you look at a typical Bitcoin mining operation about 30 to 40 percent of the capital goes into the infrastructure right it's Transformers it's containers it's buildings it's everything you need other than the mining rigs themselves and then the balance is the mining rigs and if you can spend all your capital on the mining rigs your return is going to
be much greater than if you're having to spend 30 or 40 percent of it on infrastructure because you have more cash to invest in mining rigs that was the model Marathon used in 2021 and 2022 very much a third party hosting model but the problem is there's risks with that what happens if you're third party hosting partner goes bankrupt arested for example compute North went bankrupt what happens if power prices go out of control and your partner hasn't hedged for it properly so in lean times it's much better to be
self-hosted where you can control everything but in generous times you want to be able to grow as quickly as you can and maximize the return on assets when you grow with third-party hosting you can be very lean you know a marathon the end of last year had 7x a hash capacity so say two to three percent of the global hash rate and we had sub 25 employees where most of our peers had 100 employees or similar sizes the self-hosted model requires more op-x you have to have more employees on site operating it um so it means more of a fixed cost but
again in lean times you have the ability to more control what you're doing you can focus on efficiency versus effectiveness self-hosted model though has challenges from a geographic flexibility perspective typically it makes sense to concentrate your resources in one location so that you can have the lowest amount of Opex per megawatt of power so you want to have big sites where you can have a medium-sized team and if you're going to build another site build it within driving distance of the first site
ideally problem is that creates concentration risk because what happens if the community where you're operating decides they're going to change the rules on Bitcoin mining what happens if the electrical utility changes something so you don't have Geographic diversity necessarily in a self-hosted model unless you specifically plan for it with the third party hosted model it's very easy I'll work with a partner in Texas I can work with a partner in North Dakota I can work with a partner somewhere else
your return on assets in the self-hosted model can be much greater because you're stripping out the margin that the hosting partner would normally have earned um and in the third party hosted model you're obviously paying somebody to take all that infrastructure risk that you didn't want to take and as I mentioned earlier regarding bankruptcies the jurisdictional and Regulatory risks are much greater with third party hosted than they necessarily are with self-hosted because in the self-hosted you typically have
agreements with the power companies the local communities whereas you have to trust your third party hosted partner that they've done it properly so third party hosted has advantages from a capex perspective but it doesn't quite have the same advantages from a return uh on assets so what's the ideal model well the ideal model is a diversified portfolio so if you think about a traditional Investment Portfolio you may have fixed income typically bonds equities or having Alpha stocks alternative assets real estate for example private
Equity you may have Commodities as a way to hedge inflation and then you would hold cash well as a minor you can follow a very similar model you can do some self-hosted which gives you operational efficiencies you can have some third party hosted which gives you the ability to grow rapidly the right times you can have what are called Rec producing sites wrecks are renewable energy credits so this is a concept where if you think about energy being your single biggest input cost is a minor imagine you are cited at a location
which is a renewable energy generating site imagine if you're capturing methane flare gas from an oil field that methane FL that methane is 80 times more damaging to the environment than carbon dioxide you can get renewable energy credits or even better rins which have a higher valuation which can be easily traded in the market that can subsidize your electrical costs and lower your energy cost almost zero in some cases so that's a way to hedge your costs then you can hold your Bitcoin like owning gold for example
so that you have ample reserves on your balance sheet now some people would think holding Bitcoin in your balance sheet is risky because when the price of Bitcoin drops it loses value but when the price of Bitcoin goes up it gains in value what's the benefit of that well if when you're going to grow you initiate that growth primarily during upticks in the market well then your balance sheet keeps going up in value because of the Bitcoin you're holding and though it's counterintuitive it typically takes anywhere from
9 to 18 months to grow in a self-hosted environment whereas it can take six months to grow in a third-party hosted environment so the time value of growth benefits third party hosting if the Market's in a growth cycle and so that's why you want to have this evenly balanced kind of certain amount of self-hosted for efficiency a certain amount of third party hosted for rapid growth and you want to keep a balance sheet full of Bitcoin as much as possible and then cash obviously to operate the challenge is in today's
environment compared to 2021 you have to be able to do this without carrying a lot of debt and you have to have access to Capital markets for growth capital and what that means is that if you look at the universe of minors out there scale becomes hugely beneficial if you don't have scale you don't have optionality because if you don't have scale the capital markets are more limited you definitely don't have access to debt markets you don't get preferential pricing on the equipment it's a lot harder for you to negotiate
with partners and you just don't have the balance sheet to do it and so as you look at mining in the future here over these next Cycles and we're about to go into a having cycle in May of next year again really only the strong will survive and I think you're going to see a consolidation of kind of the biggest players not necessarily through M A but simply through attrition of the smaller players and I think what we're going to continue to see here is the miners that have access to Capital that have good
liquidity that have low debt on their balance sheet and that have the ability to grow are going to continually grow and take a greater and greater share of the global hash rate and the smaller miners will not so in summary kind of adjusting your Capital allocation based on what's happening in the market when times are lean you want to have a lot of self-hosting when times are rich you want to use third-party hosting as an advantageous model but you need to be careful to have a proper balance of the two and you want to hold your Bitcoin
through the right times and at times sell your Bitcoin today for example Marathon will sell Bitcoin to cover operating costs because the weighted cost of capital is very high today where in 2021 it was very easy for us to raise money in equity markets or debt was very inexpensive it made no sense for us to sell our Bitcoin when Bitcoin was going up today though Bitcoin has gone up nicely this year debt is very expensive and Equity is highly dilutive and so instead we will sell part of the Bitcoin we produce to
cover our operating expenses and hold the rest where prior to you know the end of last year we held every single Bitcoin we produced which is one of the reasons why of publicly traded companies in the US were the second largest holder of Bitcoin and it provides us a lot of strength in our balance sheet today so you need to be Diversified and you need to have scale and I think that's if you look at the mining space those are the miners that are going to have the best chance to be successful not just through this cycle
but also to the next cycle and the cycle after that so any questions yes wondering how you deal with your banking relationships there's been a lot of talk about choke point two uh with the US beginning to cut off um you know crypto businesses to the banking network but also with the bankruptcies of signature and silver gain so how do you approach that and are you finding it an issue with your business um so banking for crypto related companies is a challenge we banked with both silvergate and signature um with silvergate we had credit lines
where we pledged our Bitcoin and had and borrowed money against it for a revolver and a Term Loan luckily we paid those off at the end of last year in early first quarter this year um so we were already disengaged from silvergate when their problems happened but in the case of signature we had a nine-figure amount on deposit with them that luckily we were able to move but where before we would have two or three banking relationships today we have nearly 10.
you have to have diversity um and the other thing you know I think that the economists may have spoken about today is instead of holding cash in current accounts we now have a portfolio of short-term treasuries um other bonds things like that where we're keeping minimal amounts of cash actually in the bank itself but rather using instruments that are essentially liquid with low risk as well as Bitcoin in our balance sheet great thank you um first question is when Moon the the second question is a serious one
um once you've mined the Bitcoin do you diversify that into any other assets like ethereum for example and are you potentially interested in looking at um you know earning yield on those those assets you know ethereum and D5 Etc uh we don't uh so from a perspective of digital assets we only hold Bitcoin um there's risk with ethereum with staking and now being de-staked regulatory risk uh just it adds additional volatility I can hold Bitcoin and I can sell calls uh call options for example that are out of
the money on my Bitcoin generate more yield than I can by lending it out to people so um that's just more of a hedging strategy but we don't hold anything but Bitcoin we don't mind anything other than Bitcoin either oh sorry oh I don't control the microphone so go ahead so um with hash rate becoming less and less profitable and more commoditized does marathon also plan to use other Financial hatching strategies than just like holding and selling um so as I said you know we can sell calls on bitcoin
we can do callers where you have puts the problem is that typically the economics on those don't really make sense for us it's really all about putting our Capital to work uh with minors and just continuing to invest and grow to either maintain or grow our share of the global hash rate okay I think we are done with questions but I can stand on the side and answer any questions anybody has okay thank you very much [Applause]
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