What happened
The bitcoin rally has faded for now. According to CoinDesk, bitcoin hit an all-time high of $24,273 on Sunday, but it's pulled back about 6% as of this writing. But even though bitcoin is down today, stocks for bitcoin miners are up. Consider how these stocks ended the day:
- Marathon Patent Group (MARA +1.41%) was up 24%.
- Riot Blockchain (RIOT +1.88%) was up 10%.
- Bit Digital (BTBT +0.30%) was up 12%.
The movement of these stocks could have a very simple explanation: Stocks don't trade on the weekends. By contrast, cryptocurrencies like bitcoin can be bought and sold 24 hours a day, seven days a week.
Image source: Getty Images.
So what
Bitcoin hit its all-time high over the weekend, while the stock market was closed. Since cryptocurrency-miner stocks tend to follow the price of bitcoin up and down, it's only logical to see them going up today now that the stock market is open.
To be clear, we can rule out alternative catalysts. None of these companies reported news, and I couldn't find new coverage from prominent stock analysts. Furthermore, there's no reason to believe Marathon, Riot Blockchain, and Bit Digital stocks are going up from a short squeeze. According to data from Nasdaq, each stock has minimal short interest (people betting against these stocks) and all can be covered in one day. Without getting too technical, suffice it to say this isn't a ripe short-squeeze situation.
Here's why cryptocurrency miner stocks follow the price of bitcoin: The bitcoin network is run by a decentralized network of computers that keep track of transactions. You could even set up your own computer to do this if you wanted, but you'd be competing against much faster and more powerful computers. These compete against each other to process transactions the fastest, and new bitcoin is awarded to the winner. This is the cryptocurrency mining process.
Mining bitcoin has a real cost to it. Miners pay for their spaces, equipment, and electricity. While each company's cost structure is unique, they've all struggled to make a profit in recent years. Over time, the cost to mine bitcoin goes up; if the price of bitcoin doesn't go up fast enough, it's not profitable.
Consider recent financial data from Bit Digital. It reported results for the third quarter of 2020 on Dec. 18, covering year-to-date results through Sept. 30. In that nine-month span, the company had a net loss from continuing operations below $1 million. In other words, its business basically broke even. However, for most of that time, the price of bitcoin was less than $10,000. The price has since more than doubled, increasing Bit Digital's opportunity to profit.
Marathon, Riot Blockchain, and Bit Digital all generate revenue by mining bitcoin. Because the price of bitcoin has more than doubled since September, these companies should start bringing in more revenue and have a shot at higher prices. That's why these stocks go up with bitcoin.
Image source: Getty Images.
Now what
Investing legend Warren Buffett once said, "A horse that can count to ten is a remarkable horse -- not a remarkable mathematician." He meant that a company can be a standout when compared to others in its industry, but that doesn't necessarily make it a great business or investment opportunity. I personally think this applies to cryptocurrency miners.
Don't get me wrong, I like some cryptocurrencies, and I even bought bitcoin and Ether. I see it as a simple case of supply and demand. Specifically, the supply of bitcoin is limited -- and recently we've seen a surge in demand from corporate entities. For example, technology company MicroStrategy (MSTR +1.91%) announced it just purchased $650 million in bitcoin, and has now invested over $1 billion in 2020. This increasing demand coupled with limited supply could keep pushing bitcoin prices higher.
So I do believe cryptocurrency prices can continue to rise. I'm just not sure that bitcoin miners are the best way to invest in this trend. Even if profits for Marathon, Riot Blockchain, and Bit Digital soar in 2021, it's only a matter of time before cash flow would need to be invested in upgrading their equipment. I'm not sure that leaves much room for creating shareholder value long-term.
There are plenty of other cryptocurrency stocks that could hold more potential. Specifically, consider companies like NVIDIA (NVDA 0.50%). NVIDIA's products are used for gaming, artificial intelligence, and more. But it has powerful hardware that can be used in bitcoin-mining operations as well. In other words, the company could benefit from bitcoin miners buying new equipment, but its business isn't dependent upon that happening. And I think Buffett would agree that that's a better horse to bet on.
