Since December, Argo Blockchain (OTCMKTS:ARBKF) stock has ridden the Bitcoin (CCC:BTC-USD) rocket ship to new heights. After listing on the OTC markets last year, the U.K.-listed blockchain mining company has seen shares rise from $0.17 to $2.72 — a stunning 1,500% return. The reason for the outsized returns is simple: cryptocurrency miners have incredibly high operating leverage. That means the doubling in Bitcoin prices since late last year will increase mining profitability by an even greater magnitude.
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But dig deeper and another truth emerges: U.S. investors are so starved for suitable cryptocurrency investments that value has ceased to matter. As ARBKF stock continues to outrun its primary U.K. listing, smart traders will quickly realize the lunacy of the situation.
So, buyer beware. ARBKF’s latest rise is not what it seems.
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ARBKF Stock: Detached from ARB
Argo Blockchain runs a relatively simple business, operating around 18,000 cryptocurrency mining machines across Quebec, Canada. The company also owns a large chunk of Bitcoin. Beyond that, however, things start to get complicated.
That’s because it has two different listings. Its ordinary shares list on the London Stock Exchange (LSE), generating about 70% of the firm’s trading volume. But it also has stock that trades over-the-counter in the United States. These grey-market shares make up the balance of the stock’s trading volume. Typically, shares on different exchanges should march in lockstep since they represent ownership in the same company. Arbitrage traders can eliminate any difference with long-short strategies, earning themselves virtually risk-free profits in the process.
But these are not regular times. On Friday, ARBKF jumped about 44% as investors digested news of Argo opening a Texas-based mining operation. The OTC listing now trades at an over 40% premium to its London-based counterpart, a spread that would make most arbitrage traders blink in disbelief.
Source: Data courtesy of Thompson Reuters
Can Regular Investors Profit?
In practice, taking advantage of arbitrage opportunities is harder than it seems. ARBKF stock’s run came fifteen minutes after the London Exchange’s closing bell, so buyers would have needed access to an after-hours market. And on the U.S. side, most brokerages do not allow investors to short OTC stocks, making ARBFK far harder to sell.
The price difference, however, should serve as a clear warning to investors buying ARBKF stock. Though prices can act irrationally in the short-run, they eventually converge to fair value. A similar run sent the stock soaring to $0.75 on Dec. 28, a 200% premium to its underlying London shares. The two converged the following day, leaving U.S. investors nursing significant losses. When markets reopen next week, investors can expect the same story to eventually play out.
Argo to Investors: “Crypto Investing is Broken”
It’s easy to see the allure of cryptocurrency stocks like ARBKF stock. With significant companies — from Tesla (NASDAQ:TSLA) to Mastercard (NYSE:MA) — starting to get into Bitcoin, any firm that provides the tools of the trade should profit. And mining companies fall in that bucket.
The mania, however, has also highlighted the flaws in cryptocurrency mining businesses. In January, Argo announced they had bought 172.5 Bitcoin, joining Marathon Patent Group (NASDAQ:MARA) in switching from mining the currency to buying it outright. That’s because cryptocurrency mining is a low-margin business — miners exist only to convert cash and electricity into cryptocurrency. Few of them have any special sauce of their own.
Instead, most mining firms wait for months to buy the latest Antminers (mining hardware), usually at a handsome premium to list prices. And by the time these firms receive the machines, a new generation of miners would have rendered the old ones halfway-obsolete. Instead, they rely on rising cryptocurrency prices to outweigh their massive energy costs.
The winners, meanwhile, are companies like Bitmain and MicroBT that produce mining equipment. Some believe these firms are worth upwards of $50 billion.
What to Do with Argo Blockchain?
As investors look for their next cryptocurrency investment, they should remember this: crypto miners are a leveraged play on Bitcoin prices. People looking for the same upside can buy Bitcoin options on the Chicago Mercantile Exchange (CME). And as a bonus, call options have limited downside.
So, when it comes to companies like Argo Blockchain, investors might consider BTC options instead of ARBKF stock. Because when shares on a London exchange rise only slightly one day and the same stock on the OTC one goes up over 40%, something is amiss.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.
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