As the blockchain industry navigates a struggling cryptocurrency market, acquisition opportunities have arisen across different asset types. The bitcoin mining industry is no exception.
Bitcoin miners play a key role as transaction validators instead of a traditional intermediary bank. Specialized computer equipment (mining equipment) solves a complex mathematical problem created by bitcoin software, which validates a block of bitcoin transactions recorded on the digital ledger. The miner who solves the problem is rewarded with bitcoin.
Bitcoin prices hit $65,000 in November 2021, and just a year later the price is below $20,000. The combination of this precipitous drop in prices, rising energy prices and the reliance on debt to fund mining equipment purchases has hurt the mining industry. As a result, mining equipment and operations are available for purchase as struggling companies scramble for cash.
As always, the devil is in the details when it comes to acquiring assets during a downturn. This is especially the case in the crypto mining industry where companies have rushed to buy mining hardware and quickly establish facilities to take advantage of market conditions.
Mining equipment was selling for 50% to 75%, and at even deeper discounts from prices a year ago. What are the practical considerations as more and more mining equipment and facilities become available on the market?
Hash rate guarantee
Crypto mining is all about the computing power of the mining equipment, called the hash rate. The hash rate is needed to solve the complex mathematical problem to validate a block of bitcoin transactions that earns the bitcoin reward to the successful miner.
It is extremely important to have a hash rate guarantee and to verify before purchase that the equipment meets this guarantee. You may want to incorporate the concept of purchase price adjustment as machines cannot meet the hash rate guarantee. There are also considerations for the test conditions to verify the hash rate of the mining equipment.
A vendor may adjust the chip configuration of their mining equipment to increase their hash rate to meet warranty, but such a configuration may not be consistent with how you might configure your mining equipment. For this reason, it is important to establish clear procedures for this verification process.
Also, if you are buying several thousand miners, you need a process to confirm that you are buying 5,000 Bitmain S19 miners over a previous version with a lower hash rate. For some sellers with poor track records, this could also require a period of inspection before accepting minors, coupled with an adjustment of the purchase price in case the equipment does not match what was promised.
And, just like a more traditional asset purchase, you’ll want to take adequate steps to ensure mining assets aren’t encumbered. Operational, financial and legal due diligence are all essential to the success of this type of transaction.
Energy consumption, cybersecurity, other concerns
Acquisitions of crypto mining facilities are typically hybrid asset/real estate transactions coupled with a power contract. The electricity contract is the main determinant of the economic feasibility of acquiring mining facilities.
For environmentally responsible mining operations, it is important to assess and confirm the power source. From an industry perspective, energy consumption and environmental concerns will continue to shape the entire industry and influence where mining operations take place.
Another consideration is whether you will be taking on hosting contracts to host third-party mining equipment. This presents two challenges.
First, you may need to provide hosting services and worry about the risk of paying that third party. This will continue to be a significant concern as more and more mining operations, especially hosting operations, may file for bankruptcy protection.
In such cases, your contractual remedies for non-payment from your hosting customers will be overridden by the bankruptcy court. These risks can be taken into account in the purchase price.
Second, you have cybersecurity issues if your mining equipment is not on a separate network from the hosted miners. Have you thought about what could happen if a ransomware event encrypts your hosting client’s data and your connection to it allows the threat actor to roam your network and encrypt it as well?
Although bitcoin mining is a new industry, good old-fashioned due diligence is important.
Do not assume that the facility warehouse was not constructed within a utility right-of-way. In the rush to build facilities quickly, there was an economic incentive to get to market and not worry about the time and expense of a mundane land survey.
There are also instances where a seller may promise expansion rights in the negotiation only to read the contract and find that these rights are not guaranteed. This can change the financial terms from cash in hand to earnout in the bush pending contract change.
The last quarter of 2022 will provide acquisition opportunities for companies that are operating efficiently and are well capitalized. At the same time, many companies in this industry have focused on speed to market. A thorough and thoughtful due diligence process can unearth these key details.
This article does not necessarily reflect the views of Bloomberg Industry Group, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Justin Daniels is an associate at Baker, Donelson, Bearman, Caldwell & Berkowitz where he co-chairs the Blockchain and Digital Assets Technology practice.
Rachel Silverstein is General Counsel and Senior Vice President of Compliance for CleanSpark, a sustainable bitcoin mining company.