Bitcoin miners took on billions in debt to ‘pump their stock’—leading to a crypto catastrophe

The phone just won’t stop ringing, beams Zach Bradford, the CEO of Bitcoin mining company CleanSpark. The calls are from other mining bosses—and they’re panicking. After Bitcoin crashed and energy costs spiraled over the summer, mining firms that took out expensive short-term loans to buy hardware during the bull run now teeter on bankruptcy. Lenders are breathing down their necks, and the miners need quick cash. But only a handful of companies are buying mining rigs these days—and Bradford’s CleanSpark, which only took on a small amount of debt during the bull run, is one of them.

Having always sold 70% of the Bitcoin it mined using mostly cheap nuclear energy, CleanSpark is in the enviable position of being rich enough to swoop in to buy box-fresh, top-of-the-line machines from near-bankrupt miners at sensible prices. At the start of the month, CleanSpark spent $5.9 million on 3,843 miners that Bradford says cost about $1,500 each—down from $13,000 last November during peak Bitcoin mania. Crypto finance giant Grayscale also had hopes of buying miners on the cheap but then pulled back amid economic troubles at its parent company, while Bitdeer set up a $250 million fund to exploit the crisis.

Meanwhile, the pressure has only continued to build at companies that bungled the Bitcoin crash. Core Scientific, America’s largest Bitcoin miner, took on a debt-to-equity ratio almost 12 times greater than CleanSpark during the bull run and now risks bankruptcy if it doesn't raise money by the end of the year, having lost $1.7 billion in 2022 alone. Another miner, Argo, told investors it’ll shut down if it can’t sell miners it hasn’t even taken out of the box. Another, Iris, defaulted on a $108 million loan.

And there is the state of Texas, whose bold experiment to welcome Bitcoin miners to help balance the power grid risks turned into a Lone Star State-sized disaster. In the wake of rising energy prices and debt burdens among miners, one state executive bemoaned a situation where “transformers, switch gears, and mobile data centers and containers for mining...are just sitting there.”

So how exactly did this mess develop? One would expect that miners, who had to wait months for out-of-stock rigs to arrive, would have played it safe in a market known for volatility. But Guzman Pintos, the cofounder of mining company Luxor, says that these mining companies were incentivized to load up with debt to “pump their stock.” The premise is simple enough: The more mining rigs a company operates, the more Bitcoin they can produce, the greater its revenue, the higher its stock’s value—so long as Bitcoin’s price continues to fly.

During the bull run, publicly traded Core Scientific increased mining income by 3,440% to $210.8 million, having raised its Bitcoin mining power by 4.5 times to 13.5 EH/s at the end of 2021 (EH/s is a measure of “hash rate” or deployed computing power). Bitcoin miner Hut8 added 9,592 machines in the first quarter of this year, increasing its capacity by nearly a third. The sudden increase in capacity “was insane, it was ridiculous—but that was what public markets were paying for,” says Pintos.

Miners used their debt to stretch their money even further, holding onto Bitcoin they produced and speculating on its worth. To cover their spiraling costs, Pintos says some miners collected premiums on futures contracts. He says industry financiers were practically “giving money away,” relaxing the amount of collateral requireded for loans and even accepting deposits of Bitcoin while the cryptocurrency’s price continued to soar.

And then the party came to an abrupt end. For the riskier miners, things took a turn for the worse when energy prices rose over the summer and Bitcoin crashed. “Nobody was expecting both,” says Pintos. Electricity costs for Argo’s Texas operation were almost three times the average prices for August, owing to an overwhelmed grid and an energy agreement that priced electricity at market rates.

Pintos estimates margins dropped from 70% to 20%—not nearly enough to pay for energy costs and repay loans. “The financial return on investment became almost impossible for miners,” says Dan Ives, a managing director of Wedbush Securities. ”It's been a near-term gut punch to the industry—no different than the burst of the dot-com bubble.”

Indebted miners are now in a tight spot. For those who held Bitcoin mined during the bull run, selling it now will fetch a quarter of its all-time high, while mining rigs, whose prices strongly correlate with Bitcoin’s own price, have collapsed in value. Pintos says secondary sales of unused individual miners are cheaper than the listing price of their wholesale manufacturers—and they even come with the same warranty. Stock prices of all mining companies have almost universally plummeted as soaring operating costs squeeze the pulp from their margins.

Lenders now hold all the power. Financiers have already begun to repossess mining equipment—lender NYDIG took back 26,200 machines from miner Stronghold. Generate Capital has bought a $5 million stake in its bankrupt debtor, mining firm Compute North. [hotlink ignore=true]Compass Point, an investment company, wrote in an investment note that lenders should lower the monthly payments they extract from miners to stop them from returning rigs and using the money to buy new computers at a lower price.

Still, Pintos says the worst is over. As miners unplug, the Bitcoin blockchain will make it easier to mine new coins, thereby increasing the revenue of the miners who survive. But if Bitcoin’s price rises, the cycle of short-term loans and cascading crashes may continue once more. CleanSpark's Bradford thinks that none of the current roster of lenders would issue longer-term debt—with repayment terms of at least three years, and ideally five to seven—that could prevent another liquidity crisis. But it’ll be years until that happens, he says. After the collapse of FTX shakes the industry to its core, it’ll take a long time until institutional lenders trust crypto again.

This story was originally featured on Fortune.com

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