Big news across the pond in Yankville for you Brits out there. A copy of the American Constitution was being auctioned off at Sotheby’s, and a group of attention seekers crypto thought leaders decided to pull together funds to buy it. That’s right. ConstitutionDAO crowdfunded upwards of 40 million USD (about 29.6 million quid) to purchase a copy of the U.S. constitution. One wonders how many of the 17,437 people who contributed funds thought they were purchasing fractional ownership of the infamous document. They weren’t.
The six-minute instruction video telling people how to throw their hard-earned money away donate to this amazing cause included use of a platform called Juicebox. When the below popup gets displayed, they were instructed to click “I Understand.” And don’t ask any questions, got it?
When it came time to donate money to the cause, people were supposed to ignore the transaction fee (gas fee) which ranged from $50 to $80 per transaction. Why is the fee so high? That’s just how it is right now, okay? Stop asking so many questions and start enjoying the autonomy and freedom of decentralized finance.
They lost the bid. Probably had nothing to do with the fact that they publicly disclosed how much they were going to bid. So now everyone needs to wait and see if they’ll get their money back, minus the fees. Assuming an average fee of $60, that’s (17,437 X $60) over a million dollars in fees that was pissed away. Given the median donation of $206.26, your average muppet who participated in this Web 3.0 revolution made a return of -29%. Well done lads. That’s better than winning the bid and losing it all though, amirite? Today, we’re going to talk about one of the “safer” crypto-related investments – what they’re calling “crypto equities.”
The Crypto Equity
Any company whose value is highly correlated to cryptocurrencies would be considered a crypto equity. Grayscale Bitcoin Trust (GBTC) is highly correlated to bitcoin and Coinbase (COIN) is highly correlated to a broad basket of the most popular cryptocurrencies at the moment, several of which – DOGE and SHIBA – are running jokes with absolutely no intrinsic value. We would also argue Robinhood (HOOD) is a crypto equity given the majority of their profits comes from crypto trading. But the most popular crypto equities at the moment are probably bitcoin miners.
To understand bitcoin mining sufficiently, all you need to know is that bitcoin miners turn electricity and specialized computing equipment into bitcoin. The amount of bitcoin they can create for any given unit of effort diminishes over time, halving every four years.
There are only 21 million Bitcoins that can be mined in total. Of these, around 18 million have already been mined. For the 3 million Bitcoins remaining to be mined, the rewards decrease over time, while the need for resources increases over time. You would need to emphatically believe that Bitcoin can only increase in value over time for this investment thesis to make sense.
The more companies or individuals trying to mine bitcoin, the less you can mine for the same effort. Then, you need to consider the price of bitcoin which represents the value of the reward given in exchange for your efforts. When bitcoin falls, bitcoin mining becomes less profitable. The only way a bitcoin miner stays in business is if the price of bitcoin stays above a certain price.
So, if bitcoin mining is highly correlated to the price of bitcoin, why not just buy the bitcoin? One reason is that bitcoin miners can use leverage and create more value in much the same way a triple leveraged ETF works. While you may enjoy a 3X return, you’re also taking on company-specific risk.
A 10% increase or decrease in the market value of Bitcoin and other cryptocurrencies over the course of 2020 would have increased or decreased our revenue by 10% for the year.
Credit: Argo Blockchain
(All numbers below in USD unless specified otherwise.)
About Argo Blockchain Stock
Argo Blockchain Plc (ARB.L) is a British company that pivoted from “bitcoin mining as a service” to mining their own cryptocurrencies (the majority of which happen to be bitcoin) and then keeping their on their balance sheet. They trade on the London Stock Exchange using the ticker symbol ARB, and also on the Nasdaq under the ticker symbol ARBK as a proper ADR. Bitcoin comprises around 24% of their total assets and a large amount of that is being held as collateral.
They’re also choosing to hold other cryptocurrencies, which means they’re now speculating across the riskiest asset class known to man. Argo Blockchain has also made an investment in a cryptocurrency venture capital firm called Pluto Digital PLC to the tune of about $11.25 million (about 8,362,500 quid). Seems rather incestuous when you consider that Peter Wall, CEO of Argo, also happens to be a director at Pluto. In perusing through Argo Blockchain’s financials, it’s clear that directors passing business to themselves is no big deal.
Consulting fees are mainly comprised of fees paid to the personal corporations of certain of our directors as compensation for the services of such directors.
Credit: Argo Blockchain
These consulting fees were less than a million dollars for 2020, but we’ve always looked at this sort of behavior as a red flag. Maybe they do things differently across the pond.
Argo Blockchain’s stated goal is to diversity outside of just mining bitcoin, and for that they need to make investments in specific types of equipment. Constantly buying the latest mining equipment to stay competitive can present some unexpected problems.
For example, we purchased more than 15,000 Bitmain Antminer 17 series mining machines in 2019 and 2020. Since deployment, our Antminer 17 series fleet has experienced a failure rate of 38%.
Credit: Argo Blockchain
Those quality problems may stem from the mad rush to produce as many bitcoin mining servers as possible while demand for them goes through the roof. The providers of bitcoin mining rigs are a third-party risk that needs to be considered. So is a custodian, Galaxy, who holds the $79 million in cryptocurrency assets that Argo Blockchain holds on their balance sheet. We’ve heard that name before. Galaxy is the firm that’s enabling the “earn a 5% to 6% yield on your cryptocurrency” offers that companies like Circle are availing themselves of. It’s part of that big house of cards we talked about before. All these entities exhibit a great deal of volatility because of the uncertainty surrounding regulatory risk.
Regulatory Risks
One reason pharmaceutical developer stocks are so volatile is because so many external variables affect their success that cannot be controlled. Regulatory risk surrounds whether the FDA will approve a drug. For Argo Blockchain, there’s the unknown around how the jurisdictions in which they operate will regulate bitcoin mining.
Concerns have been raised around just how much electricity cryptocurrency mining consumes. In 2020, the cost of power represented 65% of Argo Blockchain’s direct costs. A 10% increase or decrease in the cost of power over the course of 2020 would have increased or decreased their gross profit by 29% for the year. Controlling the cost of electricity seems critically important to the success of their business, yet Argo Blockchain doesn’t provide much assurance this is under control.
Due to these concerns around power consumption, particularly as such concerns relate to public utilities companies, various jurisdictions (including certain cities) have implemented, or are considering implementing, moratoriums on digital asset mining in their jurisdictions.
Credit: Argo Blockchain
The progress reports put out but the company don’t help much either.
Bitcoins and Bean Counters
Perhaps the biggest reason we would avoid Argo Blockchain is because of their confusing accounting methods which – we believe – stem from not converting bitcoin into fiat currencies as they’re producing it. Mining revenue should be what they received at the time they mined these bitcoins from selling them immediately on the open market. Instead, they’re keeping bitcoin on their balance sheet in hopes that it appreciates, something that results in confusing statements such as this one:
Due to favorable changes in fair value of Bitcoin and Bitcoin Equivalents in Q3 2021, gross profit and EBITDA exceeded revenue in the period.
How can income possible exceed revenues? It can’t, but in Argo Blockchain’s world, it can. We spent the better part of several hours trying to understand Argo Blockchain’s mining operations through the lens of their financial filings, and came away none the wiser. If you’re trying to get risk averse investors to invest in a process that’s extraordinarily complex, don’t make it even more complex by adopting confusing accounting methods.
Lastly, we see that Argo Blockchain has at least one analyst firm writing favorable reports about their stock, and that this firm charge fees for that service.
As we actively seek to take the majority of our fees by way of equity payment in the respective companies we cover, we believe that we are aligned with both investor and the subject company.
Credit: Align Research
So that March 2021 report where Align called Argo Blockchain a “speculative buy” at 240 pence, you may want to take that with a grain of salt.
Conclusion
Crypto today seems to epitomize greater fool theory. The FOMO mania on display, the absolute disregard for the value of money, the blatant wash sales and scams, the exorbitant fees, these are all pointing to the crypto space as being far too risky to dabble in. Looking at blockchain technology holistically, there’s definitely some “there there,” but right now we seem to be approaching Gartner’s “peak of inflated expectations.”
Retail investors need to proceed with extreme caution when looking for exposure to this space. If you’re able to remove company-specific risk in exchange for sacrificing a bit of upside, that’s probably a smart thing to do. We do not believe that the upside from whatever leverage is on offer from Argo Blockchain outweighs the added risks. If you want exposure to bitcoin, buy bitcoin from Coinbase and avoid Argo Blockchain stock.
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