What happened

Shares of Marathon Digital Holdings (MARA 4.31%) gained on Wednesday following the company's announcement regarding a new Bitcoin (BTC 1.15%) mining pool. As of 2:15 p.m. EST, the stock was up 10%.

So what

Understanding how a blockchain network like Bitcoin's works can help contextualize today's news from Marathon Digital. When a transaction on the network occurs, computers have to verify it and update the network. To do this, they solve complex math problems requiring substantial computing power. As a reward for running the network, they're paid in newly issued Bitcoin. The process is called mining.

A businessman draws an exponential growth curve on a line graph.

Image source: Getty Images.

If you choose to mine Bitcoin individually, payouts can be lumpy and infrequent because your individual computing power (measured with a term called "hash rate") is limited. But if you pool your computational power with other miners, the pool can earn bigger and more consistent Bitcoin paydays. The rewards can then be fairly distributed among the miners. This is what Marathon Digital is pursuing per its press release late yesterday afternoon. It's launching a Bitcoin mining pool that will be based in the U.S. and compliant with U.S. regulations. 

By the first quarter of 2022, Marathon Digital expects to have an individual hash rate of almost 10.4 exa-hashes per second (EH/s). This is substantial. For perspective, the total hash rate of the Bitcoin blockchain network is currently about 166 EH/s, according to Blockchain.com.

Marathon Digital will devote all of its individual hash rate to the mining pool. Therefore, the hash rate of the mining pool should be even bigger, though the exact size will be dependent on how many other miners join. The company will start accepting new miners to the pool on June 1.

MARA Chart

One-year returns for Marathon Digital stock, Bitcoin, and the S&P 500. MARA data by YCharts

Now what

Marathon Digital stock has given investors the greatest one-year returns that I've ever seen. Part of this makes sense, given Bitcoin's impressive run over this time. The company both mines Bitcoin and holds around 5,000 Bitcoins, so it is a direct beneficiary of its increasing value. That said, with a market capitalization of $4.8 billion as of this writing, it's valued at over 1,100 times 2020 revenue, which is a hefty price tag for any company regardless of the industry. 

Therefore, although investors are celebrating the news of the mining pool today, shareholders should recognize Marathon Digital stock has an acute valuation risk going forward. It doesn't mean the company can't overcome this risk. But shareholders should be aware nonetheless.