As the blockchain industry navigates the troubled cryptocurrency market, acquisition opportunities have arisen across various asset classes. The Bitcoin mining industry is no exception.
Bitcoin miners play a key role as validators of transactions instead of the traditional intermediary bank. Specialized computer hardware (mining hardware) solves a complex mathematical problem created by bitcoin software that validates a block of bitcoin transactions recorded in a digital ledger. The miner who solves the problem is rewarded with bitcoins.
Bitcoin prices reached $65,000 in November 2021 and fell below $20,000 just one year later. The combination of this sharp drop in prices, high energy prices and the use of debt to finance the purchase of mining equipment has shaken the mining industry. As a result, mining equipment and operations can be bought as struggling companies struggle for cash.
As always, the devil is in the details when looking at buying assets during a downturn. This is especially the case in the cryptocurrency industry, where companies rush to buy mining equipment and quickly set up facilities to take advantage of market conditions.
Mining equipment is on sale at 50% to 75% and even greater discounts than a year ago. What are the practical considerations as more mining equipment and facilities become available on the market?
Hash Rate Guarantee
Crypto mining refers to the computing power of mining hardware called hash rate. A hash rate is needed to solve the complex mathematical problem of validating a block of bitcoin transactions, which rewards the successful miner with a bitcoin.
It is very important to have a hash rate guarantee and check that the hardware meets this guarantee before purchasing. You may want to set up the concept of adjusting the purchase price to the extent that the machines cannot meet the hash rate guarantee. There are also considerations regarding the test conditions for verifying the hash rate of mining equipment.
The vendor may adjust the configuration of the chips in the mining hardware to increase the hash rate to meet the warranty, but such configuration may not be compatible with how you may configure your mining hardware. For this reason, it is important to establish clear procedures for this verification process.
Additionally, if you are buying several thousand miners, you need a process to confirm that you are buying 5,000 Bitmain S19 miners compared to the previous version with a lower hash rate. For some vendors with poor records, this may require a verification period before accepting miners and an adjustment to the purchase price if the equipment is not as promised.
And like a more traditional asset purchase, you’ll want to take adequate steps to ensure that mining assets are not encumbered. Operational, financial and legal due diligence is critical to the success of this type of transaction.
Energy Usage, Cyber Security, Other Concerns
The purchase of crypto mining facilities is generally a hybrid asset/real estate transaction combined with an electricity contract. A power contract is the single biggest determinant of whether a mining facility is economically viable.
Energy source evaluation and validation is essential for environmentally conscious mining operations. From an industry perspective, energy use and environmental concerns will continue to shape the entire industry and affect where mining operations take place.
Another issue is whether or not you will accept hosting contracts to host third-party mining hardware. This presents two problems.
First, you may need to provide hosting services and worry about that third-party payment risk. This will remain a significant concern as more mining operations, especially hosting operations, may require bankruptcy protection.
In such cases, your contractual remedies for non-payment by your hosting customers will be superseded by the bankruptcy court. These risks may be factored into the purchase price.
Second, if your mining hardware is not on a separate network from the hosted miners, you have cybersecurity concerns. Have you ever wondered what could happen if a ransomware incident encrypts your hosting client’s data and your connection to them allows a threat actor to get into your network and encrypt it too?
Although Bitcoin mining is a new industry, good old fashioned diligence is essential.
Do not assume that the facility’s storage is not built within a utility easement. There was an economic incentive to rush to the market to build properties quickly and not worry about the time and expense of a conventional property survey.
There are also cases where the seller may promise extension rights in negotiations only to read the contract and find out that these rights are not guaranteed. This may change the financial terms to profit from cash on hand until the contract is amended.
The last quarter of 2022 will provide buying opportunities for companies with efficient operations and good capital. At the same time, many firms in this industry focused on speed to market. A thorough and thoughtful research process can reveal these key details.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.
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Justin Daniels Baker is an attorney at Donelson, Bearman, Caldwell & Berkowitz, where he co-chairs the Blockchain and Digital Asset Technology practice.
Rachel Silverstein is general counsel and SVP of compliance for CleanSpark, a sustainable bitcoin mining company.