The Lesser-Known Risks of Crypto Mining Stocks

When it comes to mining Bitcoin, crypto mining stocks immediately come to mind given how often they appear on headlines. Droves of miners operate behind the scenes to confirm transactions that have pushed Bitcoin to nearly $900 billion in value (as of mid-September). They are an essential piece of blockchain consensus, creating new bitcoins from scratch by solving complex cryptographic puzzles and verifying transactions on the blockchain. 

Commodities like oil and gold have upstream and downstream components, which start at the beginning of the extraction process and end downstream with refined products. Trading and investing in Bitcoin mining companies is similar to investing in upstream commodity markets. 

The companies behind Bitcoin mining stocks either offer crypto mining hardware, or mine the cryptocurrencies themselves.

Investors trade crypto mining stocks to take advantage of the high volatility and growth in the sector while harnessing the leverage available. However, the unusually high volatility is a double-edged sword, because the bottom can fall out on these stocks far more quickly than with any digital coin. 

We’ll take you through the lesser-known risks of crypto mining stocks so that seasoned investors can make an informed decision.

Why Buy Cryptocurrency Mining Stocks? 

Investors buy the best Bitcoin mining stocks because as digital assets like Bitcoin and Ether rise in value, cryptocurrency mining stocks also climb. Investors capitalize on leveraged stock market trades without actually owning any cryptocurrency. 

Bullish surges and leaps in Bitcoin and other cryptocurrency prices, as well as increased demand and distribution, mean that stocks associated with cryptocurrencies also start attracting attention. You can compare trading crypto mining stocks to trading gold shares. There’s no actual gold ownership, but the value of large gold mining enterprises reliably moves in line with the price of gold. Similarly, crypto mining stocks tend to fluctuate relative to the value of crypto assets. 

One reason to invest in crypto mining stocks is that most retirement accounts won’t allow adding cryptocurrencies to your retirement portfolio. A way around this is to buy Bitcoin mining stocks. That way, you expose your portfolio to the potentially massive upside of investing in cryptocurrency, albeit indirectly.

Leeor Shimron, a member of the Business Development & Strategic Partnerships Team at Kraken, refers to Bitcoin mining shares as a “high beta play” due to the way public mining companies rose 5,000% on average during the last bull run, when Bitcoin climbed 900%. His analysis reveals that Bitcoin mining stocks rose 2.5% for every 1% increase in BTC’s value. In certain cases, crypto mining stocks can outperform the underlying cryptocurrency mined. 

Historically, mining pools in China have controlled the majority of Bitcoin’s hash rate. China manufactures most of the world’s mining equipment, and mining farms have used cheap electricity prices there to build up a large presence. Due to the recent ban on cryptocurrency mining in China, numerous opportunities for miners in North America and the rest of the world to make huge profits have opened up. At the same time, companies are mining more bitcoins than ever, since it’s now easier, due to the downward difficulty adjustment resulting from the expulsion of Bitcoin miners from China. 

Investors holding a significant stock market portfolio who qualify for margin trading effectively trade cryptocurrency mining stocks as a leveraged bet on the underlying cryptocurrency’s rise in value. While the logic behind this strategy works, many investors don’t realize how volatile mining stocks can be. A managed corporate crypto mining pool can shut down overnight if its holding company decides the expense is no longer worth it. They can decide to simply liquidate all assets, and move on to another investment. Or — in the case of Chinese miners — regulatory action can lead to a crackdown. Buying Bitcoin mining stocks comes with significant risk.

Cryptocurrency popularity is accelerating and, with it, the demand for mining. According to an Industry Research report, “the size of global cryptocurrency mining activities is projected to reach [$258 billion] by 2026, from [$102 billion] in 2020, at a CAGR of 16.8% during 2021–2023.” In addition, the total value of all crypto surpassed $1 trillion in early 2021. 

What Are the Risks Of Crypto Mining Stocks?

Investors are attracted by returns. Crypto mining giants Marathon Digital Holdings (MARA) and Riot Blockchain (RIOT) are two clear examples of how Bitcoin mining stocks can outperform the growth of Bitcoin itself. In 2021, Marathon stocks have climbed 165%, and Riot has grown by 65%, whereas Bitcoin has only been up by about 30% in the same space of time. Even though MARA has plans to deploy over 75,000 more miners by the end of the year, with 15,200 more coming in January 2022, the company is not yet profitable. 

RIOT, on the other hand, reported a considerable gross margin of 67.6% during the first quarter of 2021. Despite massive investments and a fairly steady rate of return at the moment, there’s no guarantee that mining companies will continue to meet their profitability projections. Miners purchase expensive hardware, acquiring the world’s highest-powered semiconductor chips based on the expectation that prices are going to follow a particular trend over the next three to five years. During this period, energy prices can fluctuate, and buying new mining equipment will grow more expensive. If this offsets projected returns, crypto mining stocks could collapse. 

Trading Bitcoin and Ether mining stocks is a risky endeavor. Without assessing the risks of crypto mining stocks, many investors find themselves taking on far too much volatility while entering trades, without a clear assessment of where the market may be moving. 

Here’s a breakdown of a few risks to be aware of. 

High Upfront Cost Can Result in Operational Inefficiencies

In the “early” days of Bitcoin, it was possible to create or “mine” bitcoins on a home computer. Since then, the race to mine bitcoins has led miners to use increasingly sophisticated and expensive hardware. Prices on specialized mining hardware have surged as miners compete with gamers for equipment. Miners have also pooled resources and created mining companies to get the most out of their mining production.

Bitcoin mining companies need to make massive investments into high-end processors and semiconductors to mine cryptocurrencies. This high upfront cost is worsening with the global semiconductor shortage that’s driving mining hardware prices up. With a lack of hardware, mining wouldn’t be as efficient. At the present moment, mining companies are acquiring graphics cards well before gamers do. Between these two markets a massive shortage is arising.

The cryptocurrency boom has already hiked up semiconductor production to the point where there are now more powerful GPUs than ever. Unfortunately, the global scarcity of semiconductors has driven the costs even higher. Now, even mid-range cards are out of reach for the average gamer. Should hardware shortages continue to wreak havoc on the industry, causing mining hardware prices to skyrocket, mining could quickly end up at the point where it’s simply not worth it as an investment anymore. 

Huge Energy Consumption And Carbon Footprint from Mining

To keep operating costs low, cryptocurrency mining companies need to find cheap energy sources. These tend to be fossil fuels and natural gas, which can cause plenty of greenhouse gas emissions and lead to huge carbon taxes down the road. Carbon taxes already play a major role in curbing the effects of global warming, and are set to increase as natural resources diminish. Only time will tell whether crypto mining companies will be able to sustain the massive fees imposed.

With carbon emissions of over 77.54 megatons of CO2, which is currently comparable to that of New Zealand, and electronic waste equivalent to that of the Netherlands, critics are coming down hard on the resource consumption of cryptocurrencies. After all, the mining carbon footprint for one Bitcoin is 191 tons of carbon dioxide, whereas the equivalent mining value in gold only equates to 13 tons. 

Before the crackdown on crypto, China hosted 65% of all the miners in the world. One of the reasons for this was China’s low-cost renewable energy, specifically hydroelectric energy. Hydroelectric dams produce excess energy in the rainy season, which drives down energy costs significantly. After the rains, the miners have reverted to coal or whatever source of energy that’s cheapest. 

Non-PoW (proof of work) coins currently comprise 43% of all cryptocurrencies by total market capitalization. There’s a movement away from consensus algorithms with huge energy consumption and large carbon footprints, which could theoretically decrease the popularity of Bitcoin and begin a vicious cycle in which prices drop and miners make even less profit. 

Introduction of New Blockchain Technologies May Affect Mining

While the current consensus algorithm of Bitcoin is unlikely to change in order to lower energy and carbon emissions, other cryptocurrencies are addressing the issue. Ether mining stocks currently hinge on power-hungry consensus algorithms, but Ethereum 2.0 will soon transition from proof of work to proof of stake (PoS). Crossing over to PoS could make ETH 2.0 considerably more efficient than it currently is.

With PoS, gone is the need for mining equipment that requires massive computational power. A combination of shard chains and PoS can lower the carbon footprint of Ether to a fraction of its current resource draw. As currencies like Ether evolve, mining could become redundant for many coins and tokens. The effect on mining share prices would be devastating, and no one truly knows the time frame of adoption and rollout with any degree of certainty.

The Volatility of Mined Cryptocurrency

Sudden crashes in the coins that are being mined can cause big swings in overall revenue, which can ultimately determine whether a crypto mining company can stay afloat in the long run. This makes mining companies even more vulnerable, especially in light of potential government restrictions and clampdowns. Should cryptocurrency markets stay bearish for too long, crypto mining companies could quickly decide to shift their investment elsewhere and cut their losses, instead of struggling to keep up with costs and regulations. 

Just as rapidly as currencies like Dogecoin have gained more than 6,000% since the start of the year, they can also plummet in value. Bitcoin skyrocketed from a high of $60,000 in April 2021 to under $30,000 in July. While it’s steadily retraced to just over $45,000 by mid-September, an excessive fall in value could forecast doom for many crypto mining companies, forcing undercapitalized miners to abandon operations.

Share Dilution

Unlike investment in Bitcoin, for example, your holding in a crypto mining company can be reduced when the company issues additional shares out of the blue. This process is known as share dilution, and happens when mining companies try to raise funds for expansion. When a company dilutes its shares by issuing additional ones, the value of existing investors’ shares and their proportional ownership of the company are reduced.

Centralization

Crypto mining companies operate similarly to traditional ones, with ownership structures and centralized management. Unlike with cryptocurrencies, there is no path to truly decentralizing management of operations. This leads to the consolidation of power — along with the potential for abuse.

Bankruptcy

Since it’s traditionally structured, a crypto mining company can declare bankruptcy when it runs out of funds. This requires liquidation of any assets, with any remaining value going to creditors first. Shareholders have the lowest priority in the capital structure, meaning that they’re the last to get any money back from the liquidation of a company. This makes holding crypto mining stock potentially more risky than holding a cryptocurrency that benefits from collective belief in an asset.

Uncertain Market Conditions 

Trading cryptocurrency mining stocks isn’t easy, especially when one begins to invest in small-cap stocks. Stocks like CleanSpark, SOS and Ebang are easily influenced by the hype and market movements of groups of traders. With the right timing, early investors made fantastic returns in just a few short months, but opportunities like this are few and far between. Risky, early-stage investment saw quick returns, but those who didn’t realize when to sell off and move on would have done far better in a market they understood.

The difficulty of scaling and the rising cost of hardware — combined with rising regulation — create uncertain market conditions. Miners invest in ASIC rigs and other high-end mining equipment, relying on an estimated revenue rate based on their Petahash per second (PH/s) or Exahash per second (EH/s). Not all companies can keep up with the immediate costs, and while their computational power may be there, changes within the crypto space can lead to expenses smaller companies can’t afford.

Dangers of a New Industry

The cryptocurrency mining industry is still relatively new. You have far more people owning crypto than mining crypto, and little is known about the future of related industries. Conventional stocks are connected to companies and movements which have been charted and studied relative to competitors for years. However, cryptocurrency’s future is uncertain, which is largely responsible for the prevailing volatility. A lack of basic comparative measures between new mining companies makes gauging investment viability extremely difficult.

There’s very little to go on when analyzing the viability of new miners, other than the basic hash rate offered and the share price. Before China’s crackdown on cryptocurrency, which banned initial coin offerings and cryptocurrency mining, the country was a haven for startups. Companies like Bit Digital, Inc. are now forced to find new locations for over 20,000 computers. If local regulation and tariff structures around the world change too much in the coming years, miners may be forced to shut down operations completely. 

Unstable Share Prices

Cryptocurrency mining companies have fixed costs which allow for fairly reliable revenue projections. DMG Blockchain Solutions CEO Sheldon Bennett explains that in the $16 billion dollar Bitcoin mining market, around $5 billion is spent annually in mining costs for Bitcoin mining companies, which leaves the miners taking roughly $11 billion in profit. This doesn’t mean, however, that the share price of mining companies will remain stable.

The recent ban on cryptocurrency mining in China uprooted countless mining companies, creating an unexpected and unforeseen expense. We have yet to see the effect of moving thousands of mining machines to new countries — and even after crypto mining share prices adjust, they’ll take time to find their new place amid the new infrastructure. New regulations and changes within the industry create unstable share prices that are hard to predict.

The Bottom Line

Crypto mining stocks offer investors a leveraged bet against the price of Bitcoin. However, Bitcoin mining involves a significant amount of risk, both financial and regulatory. High up-front costs that crypto mining companies have to pay for specialized equipment expose them to operational inefficiencies, and huge energy consumption and carbon footprint draw significant negative attention. The inherently volatile nature of crypto is often magnified in crypto mining stocks. 

Many seasoned investors still prefer Bitcoin and Ether as long-term investments. The U.S. investment sector is eagerly awaiting any ETF approval by the SEC. The United States’ last application was filed by VanEck ETFs in March of 2021. Whether they’ll end up approved or not remains unknown, but investors are confident that it’s just a matter of time before a Bitcoin ETF will be approved. Until then, investing in Bitcoin and other cryptocurrencies is a far more stable strategy than unpredictable, high-volatility cryptocurrency mining shares.