Why Bitcoin Mining Shares Plunged on Tuesday

What happened

The news couldn’t be much worse Bitcoin (BTC -8.86%) and cryptocurrencies today. Inflation in the US came in higher than expected at 0.1% last month, with core inflation up 0.6%. This was despite investors believing that inflation may be easing, which could have opened the door for the Federal Reserve to slow the pace of rate hikes.

Shares of Bitcoin-related stocks were trading near their daily lows at 3:00 PM ET. Riot Blockchain (RIOT -9.92%) was down a whopping 9.8%, Bit farms (BITF -11.35%) had fallen 10.6%, Marathon Digital (MARA -11.16%) fell 10.9%, HIVE Blockchain Technologies (HIV -11.13%) fell 11.3%, and Cabin 8 Mining (COTTAGE -15.42%) fell a whopping 14.6%.

So what

Bitcoin is down 9.9% as I write to $20,245, which seems bad, but the cryptocurrency is still up 7.4% in the last week. However, when Bitcoin falls rapidly, it can often cause Bitcoin mining and related stocks to fall dramatically as well. This happens for two reasons.

First, Bitcoin miners generate Bitcoin as income, so when the value of Bitcoin falls, their income effectively does too. Second, these companies often have significant Bitcoin reserves on their balance sheets, so a drop in Bitcoin actually means a loss of value on their balance sheet as well.

While all this is happening, Ethereum (ETH -5.95%) is moving rapidly towards The Merge over the next day or so, which will give the cryptocurrency significant advantages over Bitcoin. The Ethereum blockchain will not be as energy intensive as Bitcoins and has the smart contract capability that Bitcoin cannot compete with. There are many investors who believe this will shift value from Bitcoin to Ethereum.

We’ve already seen miners on Ethereum’s proof-of-work blockchain suffer because they have no work to do after The Merge’s transition to proof-of-stake. That’s the macro trend for all cryptocurrencies, and Bitcoin has no answer to lower energy usage right now.

What now

Bitcoin, in particular, was supposed to be a hedge against inflation. But that hasn’t been the case for at least a year now, and the cryptocurrency trades more like a speculative asset than an inflation hedge.

What I would be concerned about for Bitcoin miners is a continued decline in Bitcoin’s price after The Merge. Ethereum is a compelling alternative with much more functionality as a form of payment and innovation than Bitcoin. And with a focus on energy use and environmental impact across the tech industry, the more than 99% reduction in energy use after The Merge will be compelling.

I don’t think Bitcoin miners have a good business model in today’s market and that’s what keeps me away from these stocks. They mainly play arbitrage against the price of Bitcoin and the cost of mining a Bitcoin. If that arbitrage goes to zero, the whole business model quickly falls apart and a once solid balance sheet can become a liability.