Bitcoin mining is capital intensive in the sense that it costs a lot of money to set up the farm, buy the machine, buy the land, service the lot, buy the transformers and install it.
Then we have the OPex which is also costly with the two primary accounts here being the electricity cost and employee cost. We can add in any rent that the plant may have in here as well.
We saw Core Scientific declare bankruptcy in 2022 when it was the biggest public miner in terms of hashrate. When core Scientific started in 2021, capital markets were adamant to allocate to the most expansive bitcoin miners. Its strategy was to keep the bitcoin received and finance the OPex of the farms. Instead of diluting shareholders via equity and share issuance, they decided to get loans. Their debt-to-equity ratio in April 2022 was around 0.58 while Marathon, BitFarm were around 0.25 and Riot along with CleanSpark were around 0.06.
A 0.58 debt-to-equity ratio is not uncommon in most industries but Bitcoin mining is different as the main revenue source is volatile in nature and cyclical as well. When the bear market came, all public miner share prices decreased and Core Scientific saw its ratio increase at a rapid pace as equity was decreasing. In July, its ratio was at 2.9 and in November, right in the bear market it was at 24.2.
The way the debt was setup was also a contributor as the ASICs were used as collateral for the loans, as the ASICS value decreased in the bear market, their balance sheet started to look even worse in the eyes of shareholders.
This covers the balance sheet solidity aspect; Now let’s look into the liquidity/cash on hands that Core Scientific had in order to pay the OPex. As noted above, their strategy consisted of holding Bitcoin for as long as possible and only selling it as a last resort. Its total liquid asset consisted of $365M in Bitcoin (9,618 BTC at a price of $40k) and $50M in Cash. Then May 2022 came and Core scientific saw its treasury value evaporate, hence it started dumping the BTC on the market to salvage some value.
The rest is history, Core Scientific was not able to produce enough Bitcoin to service its debt which was $10M higher than its operating cash flow of $7M.
So what can we learn from this experience so that existing miners both public and private do not fall into the same issues?
The easy reply to the Core Scientific case would be: don’t go into debt, choose equity financing. Or we could also say: they should have sold a portion of their bitcoin treasury sooner when the price was still high to crystallize it.
The issue with the former is that it dilutes shareholders equity and the latter is that timing the market is extremely difficult. Obviously a fine line can be drawn between each of these mechanisms and ensure a well balanced system as can be seen in the other public miners which are still paying up their debt and expanding.
What if there could be another solution which could be added to the mix and that would help in solving the debt servicing problem for bitcoin miners?
Companies like Coinchange.io are able to generate yield using DeFi strategies that have BTC as the underlying asset. The APY fluctuates over time and depends on the strategy but rates are around 5% as of Feb 2024. Now let's go through a concrete example and calculate how yield could help miners offset their debt servicing cost, ultimately helping their bottom line.
Let's start with Core Scientific’s situation:
Core Scientific’s $836 million debt consisted of $224 million in equipment financing, $215 million in secured convertible notes, $300 million in convertible notes, and $75 million in bridge notes as per December 2022 from a source close to the matter. The monthly debt financing for this debt was $17 million in December 2022. Meaning that on aggregate the interest rate on all of the debt was 24.5% per year. Again this is a rough estimation, a more detailed rate could be found to adjust the interest rate per loan.
Now Core Scientific at the time was producing 1200 bitcoin per month, equivalent to $25 million around October-November 2022.
Let's also assume that instead of fire selling their bitcoin treasury in May at 50% discount than the month prior, they still had the $365M in bitcoin (9,618 bitcoin) at $40k in April.
Lets calculate how much Bitcoin should be allocated to earn yield in kind, in order to offset the debt servicing cost significantly.
We have Core Scientific allocate 40% of its treasury to earn yield on Bitcoin, in kind, while selling the yield earned each quarter toward the debt repayment. The earned bitcoin are sold at the average bitcoin price for the quarter. In this setup, the earned yield contributes on average 3.7% of the quarterly repayment on the debt. The debt in the first quarter of 2022 was approximately $51 millions. So how does this impact Core Scientific’s treasury? The quarterly earned yield represents, on averag 64 bitcoin that do not need to be sold away from the treasury as its coming from yield strategies earning in kind.
In cumulative sense, at the end of the year, Core Scientific would have saved 258 bitcoin ($4.7M @ Q4 2022 avg price of 18,500/BTC) from being sold away from its treasury. With a consistent repayment schedule the average ~$1.7 millions earned via strategies would have help Core Scientific repayments and other expenses while it would have still be able to make quarterly repayment by selling on average 13% of its treasury each quarter; in native units this would mean selling between 1041 to 2211 bitcoin per quarter to cover payments, instead of paying 64 more bitcoins each quarter if they did not earn yield.
There are many assumptions in this example but the main point of the explanation still holds true. By earning yield on its treasury, a mining company can prevent unnecessary sales of its assets which participate in shareholder value, reduce debt servicing cost, enable new investment opportunities with the freed up capital.
Let this example be a reminder of Core Scientific’s poor management practices in this upcoming halving while also providing ideas around tools that existing miners could use to strengthen their bottom line.
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