Bitcoin miners made a big mistake during COVID

It’s been a tough year for Bitcoin miners.

2022 brought the nasty cocktail of rising costs and falling revenues. The former was mainly affected by high electricity costs, while the latter came out of the plummeting Bitcoin price, which has fallen from a peak of close to $69,000 to $17,000.

This has put a squeeze on miners. It also has the hash rate. The hash rate is the computing power that contributes to the Bitcoin network. It increases as the difficulty of mining increases. In other words, more miners mean more competition and greater computing power required to earn revenue. And the hash rate continues to rise, jumping along to all-time highs.

Overleveraged mining companies feel pain when the market turns

As the pandemic bull market exploded upward, the gains for Bitcoin miners were staggering. Many loaded up with debt to finance new equipment and increase the hash rate – part of the reason the chart above shows such a steep increase.

Unfortunately, those investments didn’t pay off as Bitcoin plummeted as the world transitioned to a high interest rate environment, sending risk assets south across the board.

Many miners have gone under as a result, with the high-profile case of Core Scientific filing for Chapter 11 bankruptcy protection just a few weeks ago.

The move to upload the investments was a rash in retrospect. Many mining companies simply assumed that Bitcoin had put its days of violent withdrawals behind it. But the crypto has lost three-quarters of its value since its all-time high in November 2021.

Many mining companies, such as Core Scientific, did not have this in their range of outcomes. Ultimately, it cost them, as their bloated debt balances weighed heavily as the Bitcoin price continued to fall.

Miners showed poor resource management during COVID

Miners’ dependence on the ultra-volatile Bitcoin price is evident. Their revenue is denominated in crypto, and the collapse over the past year is a big reason why they have struggled. However, it is interesting to see that so many companies speculated more on the price than they had to.

There is nothing to prevent mining companies from diversifying their interests by monetizing the Bitcoin they receive for their mining activity. However, the chart below highlights the diamond hands approach that mining companies took with respect to their reserves.

When the price of Bitcoin increased during COVID, the companies did not sell – demonstrated by their reserves in BTC remaining relatively stagnant, but rising drastically in dollar terms.

If we zoom out to a longer time period, and look at 2018-2022, it is even clearer how aggressive the mining companies were – there was no change in their mantra of holding bitcoin, even as the market cap of Bitcoin rose above $1 trillion.

Final thoughts

It is of course easy to be an armchair analyst here and waltz in with the benefit of hindsight. No one knew that Bitcoin would plunge so sharply in such a short time. But at the same time, we all knew there was one possibility.

Despite claims by ardent supporters that it can act as an inflation hedge, the reality is that it trades as a high-risk asset, and it has fallen back many times in history. Completely ignoring the possibility that it could simply do what it has always done—that is, rise and fall violently—was ultimately the hubris that killed many of these miners.

Again, this should not be read as a foregone conclusion. Bitcoin could have gone to $200,000 and the core of the problem would have remained: this was an overly aggressive move in terms of risk management.

For many of these miners putting their business at risk by handing over and refusing to sell reserves to fiat was a reckless decision. Sure, it could have worked in terms of fat profits. But it would still have been a big gamble given the historical volatility of Bitcoin. That much is obvious right now.

Regardless, miners face a battle on many fronts, with high electricity costs and markets in disarray. They will hope 2023 brings better luck.