What happened

Shares of bitcoin-miner Bit Digital (BTBT 8.21%) crashed in early trading this morning because a research firm is claiming the company is a fraud. At one point, the company's stock was down 17%. But then around noon EST, Bit Digital stock began skyrocketing. I'm not sure what sparked the rally, but as of 1:15 p.m. EST, Bit Digital stock was up 11%.

So what

Yesterday, J Capital Research said it "may be" short Bit Digital stock because it believes the company is a fraud. To summarize, J Capital says Bit Digital isn't mining bitcoin, it has defrauded Chinese investors, and its management is either in jail or running from the law. Needless to say, those are gargantuan allegations and a big problem for investors, if true.

A bull figurine is juxtaposed with a bear figurine.

Image source: Getty Images.

While the allegations from J Capital are bad, Bit Digital released news of its own today. Part of the press release involved $80 million in funding from a private investor. However, the other part of the press release provided shareholders with a mining update. Bit Digital mined 291.17 bitcoin tokens during December, a 50% increase from the prior month. 

To be clear, the price of bitcoin has plummeted in recent days from all-time highs, which is generally bad for bitcoin-mining companies. However, it appears investors are finding solace in Bit Digital's increased mining production, rather than worrying about the declining price of bitcoin or the substantial short-seller allegations.

BTBT Chart

Bit Digital stock has substantially outperformed bitcoin over the past year. BTBT data by YCharts.

Now what

I'm not planning to fly to China to personally verify whether Bit Digital's business is legit or not, and I doubt any other investors will, either. For that reason, I'd recommend investors consider the argument from both sides.

If it turns out that J Capital is right and Bit Digital is a fraud, then shareholders could potentially lose 100% of their investment. Losing it all is a rare outcome when investing in stocks, but the odds increase when a company is this obscure. How much should you invest if the risk is losing it all?

If it turns out Bit Digital has successfully made the jump to mining bitcoin -- until recently it was a car rental business -- I'm not convinced the reward is all that great. The company claims to have mined close to 300 bitcoin tokens in December, which is worth about $10 million at the current price of bitcoin. But there's no way to know right now if Bit Digital sold any and, if it did sell, at what price. Investors should be careful to not equate bitcoin tokens with revenue, as they're not the same.

For perspective, Bit Digital mined an average of 135 bitcoin per month in the third quarter of 2020. At the end of Q3, it had 1,250 petahashes per second (PH/s) of computing power. It has since increased its power by 1,003.5 PH/s through an acquisition -- almost doubling its hash rate. Therefore, 300 bitcoin tokens per month is probably going to be toward the high end of monthly mining capability. Indeed, the company said its new mining equipment was 95% deployed by the end of December.

At the current price of bitcoin, we can roughly estimate Bit Digital's annual revenue at $126 million from these numbers. For perspective, the company's market capitalization is already over $1 billion. Trading at nine times future sales seems pricy to me already. I'm not sure shareholders should expect multibagger returns going forward at this price. Moreover, the valuation will only get pricier if bitcoin keeps falling.

For this reason, I don't believe Bit Digital currently presents a favorable risk-reward scenario for investors. In the end, I could be wrong. But I don't think it's worth the risk when there are so many rewarding opportunities out there that have far less downside risk.