What happened
Shares of Bitcoin (BTC 0.16%) mining stocks jumped on Friday on a rise in Bitcoin prices themselves. But there may be more to the story than that.
Stocks were up across the board, but CleanSpark (CLSK -1.21%) was up as much as 11.4%, while Canaan (CAN -6.19%) jumped 21.1%, Ebang International Holdings (EBON 0.13%) was up as much as 16.8%, and Bit Digital (BTBT -0.45%) popped 12.1%. The stocks closed the day up 7%, 9.6%, 15.9%, and 8.6% respectively.
Image source: Getty Images.
So what
An increase in the price of Bitcoin is certainly helping mining stocks today. Bitcoin is up 2.9% as of 4:40 p.m. EDT on Friday; since miners generate revenue from mining Bitcoin and often hold a significant amount of Bitcoin on their balance sheets, the increase in price is a double benefit.
But there may be a bigger benefit on the Bitcoin network. CoinDesk is reporting that the difficulty of Bitcoin mining dropped slightly on Thursday for the second time in March. This could be because unprofitable miners were leaving the network after a rise in difficulty from November through February.
This reduction in difficulty should lower costs slightly for miners, and the higher price of Bitcoin will increase revenue. Both result in higher profitability, which is why we're seeing valuations jump today.
Now what
Bitcoin mining stocks continue to be extremely volatile and move directly with the price of Bitcoin itself. Sometimes that works in investors' favor and sometimes it doesn't.
What I worry about is that mining will end up being a low-margin game. Miners will expand if mining is profitable, and ultimately increase the hash rate -- difficulty -- for Bitcoin mining in the process. This could limit their profitability in the long term.
Miners holding more Bitcoin on their balance sheets is a double-edged sword for investors. There's often an amplified reaction when Bitcoin rises or falls; it's just that today, that dynamic is working for investors.
There's also competitive pressure from other blockchains that are aiming to lower costs long-term. The high cost of making transactions with Bitcoin will ultimately make it difficult to compete with cryptocurrencies where transactions cost a fraction of a penny. Ultimately, this is the biggest threat to Bitcoin and its miners.
While mining stocks may be hot today and they're generating significant profits in the market, I'm not a buyer on a day like this. I think the threats to their business are too big to ignore, so I'll stay on the sideline for now.
