Last year created an unprecedented risk event for the Bitcoin community. While we have seen this level of spot price volatility before, leverage within the mining community has reached all-time highs. This compounded the effects of debt exposure with falling spot prices, rising energy prices and falling collateral values. Cash mismanagement has been rampant in 2022 and has led to a problem that financial hedges can solve and/or prevent.
The strategy that many miners have used to manage cash so far has been relatively simple: buy and hold bitcoins. In other words, hope and pray. With price models often assuming an average growth of around 2% per month and a floor price close to the current average cost of production between $18,000 and $22,000. Obviously, these assumptions did not turn out to be true.
Nathan Cox is Chief Investment Officer at Two Prime, which offers structured products and derivative strategies for digital assets and risk management.
Machine financing in 2021 was rolled out at record prices, when large orders arrived with long delays and profit margins were high. As these orders were executed and hash power continued to grow, the hash price tested new all-time lows in 2022 and has already begun to test the sustainability of this long-leveraged strategy. A close look at the documents filed by public miners with the United States Securities and Exchange Commission shows that many companies are in dire straits.
Now miners face a tough reality, can operational budgets survive a prolonged crypto winter?
The answer will not be the same everywhere, and we have already seen several victims of the new bear regime. Our concern is that bitcoin miners have become overexposed and now face potential liquidation if bitcoin prices remain depressed for an extended period.
So how do miners navigate this financial and operational minefield?
Miners must incorporate sophisticated financial strategies, in line with the energy and commodities companies that came before them. If bitcoin is indeed a commodity, it’s time for industry leaders to start treating it as such by managing financial exposure with financial strategies.
For years, the oil and gas industry has used sophisticated risk management strategies and gold mining companies have used Target Repayment Futures (TARF), a structured financial contract that helps hedge risk.
Miners should also look to reduce downside risk, replace upside beta, and generate a return on their digital assets. These strategies have proven successful in traditional commodity markets and have enabled major energy companies to steadily expand their businesses for decades. Miners recognize this need, although it may be too late for some.
With the current macroeconomic environment, rising interest rates, shrinking liquidity and diminishing risk assets, it is time for the digital asset industry to take the necessary steps to deal with this volatility and integrate tools that will create sustainability and certainty. This is appropriate behavior for any trustee running a bitcoin mining company.
The digital asset industry has suffered major setbacks due to leveraged borrowing without capital controls and risk management, and it’s time to reconsider the industry’s long-term growth strategy. The solutions exist today to prevent further losses or liquidations, and we hope that miners will have the constitution to evolve into a better future.