What happened
After taking a brief step back earlier this week, popular cryptocurrency Bitcoin (BTC 0.94%) has come roaring back to life today. According to CoinDesk, its price has recovered about 7% from lows hit earlier this week -- lows hit after Tesla CEO Elon Musk took to social media and criticized Bitcoin's carbon footprint.
That said, Bitcoin is still down over 20% from its all-time high earlier this year. As Bitcoin has gone down, many Bitcoin stocks have plummeted as well. This includes cryptocurrency miners like Marathon Digital Holdings (MARA 2.68%) and Riot Blockchain (RIOT 0.61%), as well as mining hardware company Canaan (CAN +0.69%). But with Bitcoin back on the rise, these stocks are skyrocketing today, up 16%, 16%, and 12%, respectively, as of 12:45 p.m. EDT.
Image source: Getty Images.
So what
Supply and demand dictate prices for cryptocurrencies like Bitcoin. It was once something only a relatively few people wanted to hold. But over time, more people have become comfortable with the idea of investing in cryptocurrency. However, Bitcoin supporters argue that we've entered the "fourth wave" of adoption over the past year: demand from corporations.
For example, technology company MicroStrategy has started holding Bitcoin in lieu of cash. Just yesterday, the company announced it had converted around $15 million into 271 Bitcoin tokens, taking its total holdings to 91,850. For its part, Tesla spent $1.5 billion to acquire Bitcoin on March 31. While MicroStrategy has spent more at over $2.2 billion, the move from Tesla was seen as a bigger deal because it's a much bigger company. It seemed the fourth wave of Bitcoin adoption was picking up steam, and the price of Bitcoin was steadily trending higher as a result.
Along with buying Bitcoin, Tesla also began to accept Bitcoin as a form of payment. Many people hold Bitcoin as one would hold gold: They don't use it to buy and sell things. But transactional utility like what Tesla was offering is another thing that could help drive future demand and, consequently, higher prices long term.
Then, Musk announced on social media this week that Tesla was going back on its plan to accept Bitcoin payments, due to high energy costs of transactions. The price of Bitcoin plummeted moments later.
Companies like Marathon Digital and Riot Blockchain know all about the energy costs of running the blockchain network. Each transaction has to be processed by independent computers, and that's what Marathon Digital and Riot Blockchain provide. For this, they incur real-world electric bills (among other things). And for their service, they're compensated in Bitcoin. This process is called mining. One of the tricks to being a good cryptocurrency miner is securing a low-cost supply of energy.
Among Bitcoin stocks, Marathon Digital and Riot Blockchain are acutely affected by Bitcoin's volatility because they choose to keep what they mine and currently hold 5,324 Bitcoin and 1,771 Bitcoin, respectively. Furthermore, both companies are ramping up computing power (measured by a metric called their hash rate) to mine more Bitcoin and increase revenue. Therefore, when Bitcoin goes down, the value of their digital assets and their future revenue potential both take a hit, and their stocks get hammered.
The opposite is also true. The drop following Musk's comments is proving to be short-lived. And these Bitcoin stocks are skyrocketing today as Bitcoin bounces back.
Despite pullbacks in 2021, Marathon Digital, Riot Blockchain, and Canaan stocks are outperforming the S&P 500 over the past year, as is Bitcoin. MARA data by YCharts.
Now what
As long as the price of Bitcoin remains elevated, expect Bitcoin miners to continue spending to increase their hash rates. That's where Canaan comes in. The company sells hardware used for mining Bitcoin and expects strong demand throughout 2021. And that's good news; when Bitcoin crashed in past years, demand for mining fell and Canaan had a hard time moving inventory. That's why this stock is also bouncing back today: Higher prices point to sustained mining activity.
Expect sustained and growing mining activity from Marathon Digital and Riot Blockchain in 2021. While Canaan is selling mining equipment, these miners will be buying. Both have big plans to increase their hash rates and are buying new equipment throughout the year.
For the record, this spending isn't really optional. Bitcoin payouts are proportional to the amount of hash rate each is giving the Bitcoin blockchain network. With the total hash rate of the network increasing, miners have to at least increase their power proportionally to keep getting paid as they were before.
Understanding how companies use cash flows is crucial for making investing decisions. Without question, Riot Blockchain and Marathon Digital can make money mining Bitcoin for now. The remaining question is how much cash flow will be left over to reward shareholders. Much is used for mining equipment in an effort to keep up.
