Generating Alpha in Bitcoin: Mine & Accumulate vs. Buy & Hold Bitcoin

By marrying the proper strategy and time horizon, Bitcoin Mining offers opportunities to significantly outperform simple buy and hold investment strategies. Bitcoin’s extreme volatility is best managed with a Dollar Cost Average Strategy, which mining best achieves. Dollar Cost Averaging is an excellent strategy applied to markets with extreme volatility and an asset that one wants to accumulate a large position in over a longer time horizon. Investors take advantage of Bear Markets because they are purchasing the lows while most are too afraid to deploy capital. A miner receives their mining rewards daily and over the course of the mining rig life cycle (3-4 years). Miners in 2018 - early 2019 were accumulating Bitcoin at $3,800, $4,000, $5,000, and $6,000.  Even in sideways or downward markets, Mining Bitcoin still generates Bitcoin Rewards/Monthly ROI. Mining is an arbitrage as miners are able to produce Bitcoin at a lower cost than purchasing Bitcoin on the open market. Presently, many efficient miners only need to expend $4,800-$6,000 in electricity to generate 1 Bitcoin.

 From 2018 to Present, Bitcoin has traded downward to sideways. Simply Holding has yielded $0, while Bitcoin Miners have made 250%+. Mining is an excellent complement to holding Bitcoin. Market participants should have exposure to both to best position themselves over the long-term to capture the opportunity in Bitcoin: a disruptive technology and commodity in its infancy.

 The Bitcoin Mining Industry is in the early innings of a new Mining Rig Hardware Upgrade Cycle coinciding with the great potential of a Halving Catalyst – just as we witnessed in 2016. It is a luxury to be deploying at the start of another Hardware Upgrade Cycle as the Next-Generation Hardware is radically more efficient than the Old and Mid-Gen Hardware presently mining on the network. Miners have the ability to deploy capital to Next-Gen Hardware, rather than simply Hodling, which we believe is the most probable strategy to outperform over the long term (2 – 4 years).

Background - The 2016 Hardware Upgrade Cycle

Miners who deployed early in the 2016 Hardware Upgrade Cycle outperformed Hodling Bitcoin by 100%+ and returned 1,249%. The Mining Market has matured significantly since 2016, so we do not expect the same magnitude of gains in 2020. However, we do expect the Mine & Play with House Money Strategy to once again outperform the Buy & Hold Strategy.

Many market participants get distracted by the illusion of being able to buy Bitcoin at the low and sell at the top. This is an improbable lottery ticket strategy. From 2017-2019, over 390 Crypto Hedge Funds were launched, but PWC estimates that there are only 150 Active Crypto Hedge Funds remaining. Not only were Fund Managers unable to outperform Bitcoin, but a majority blew out - losing their initial principal with an asset that returned many multiples.

Analysis - The 2020 Hardware Upgrade Cycle

Below, we analyze the 3 year expected performance of 2 specific strategies:

1. Buy & Hold Strategy: a miner buys Bitcoin and holds for the long-term.

2. Mine & Play with House Money Strategy: a miner buys an Antminer S19 Pro 110 TH/s Mining Rig and sells their operating expense ($0.06 kWh) to cash but holds the remainder in Bitcoin.

 We examine the results across different Bitcoin Market Environments: Bull Market, Sideways Market, & Bear Market - illustrating the competitive advantages offered by Mining vs Hodling. This analysis is NOT INVESTMENT ADVICE. The purpose of this analysis is not to project future returns, but rather to identify the optimal strategy to maximize long-term ROI.

Machine Salvage Value is a critical, but mistakenly underappreciated component of delivering alpha. The price of mining rigs are almost perfectly, positively correlated with the price of Bitcoin. During Bull Markets, “on-hand” mining rigs can be resold for significant premiums. In 2017-2018, the Antminer S9 cost $1,200-$2,750 direct from Bitmain, but sold on the secondary market between $3,000-$8,000. We expect to see a similar mania again. However, for the purpose of a conservative analysis, we model a 10-15% annual reduction in Machine Salvage Value depending on the market conditions, rather than scenarios of appreciation. Difficulty is also adjusted each year based on the Market Conditions. Annual Difficulty adjustments range from +80% in Bull Market scenarios to -20% in Bear Market scenarios.

Year 1: Sideways Market - $10,000 Bitcoin

Assuming Bitcoin remains at $10,000, the Buy & Hold Bitcoin Strategy will be dead money, having generated $0 in Year 1 - only maintaining its initial value of $3,700 on the Balance Sheet.

The Mine & Play with House Money Strategy, on the other hand, will have accumulated 0.1507 Bitcoin and retain 85% Machine Salvage Value - a Year 1 Balance Sheet value of $4,652.20 (outperforming the Buy & Hold Strategy by 25.74%).

Year 2: Bull Market Scenario - $15,000 Bitcoin

In Year 2, if Bitcoin is at $15,000 we estimate a Difficulty increase of 80% over the course of the year. As Bitcoin Price increases, more miners will enter the market, increasing Network Hash Rate and Difficulty - reducing Bitcoin Revenue for miners.

At the end of year 2, the investor implementing the Buy & Hold Strategy will have increased their Balance Sheet by 50% - maintaining their 0.37 Bitcoin position now worth $5,550.

The investor implementing the Mine & Play with House Money Strategy will have increased their Balance Sheet by 66.96% since inception - accumulating 0.2269 Bitcoin and retaining 75% Machine Salvage Value - a Year 2 Balance Sheet value of $6,177.84 (outperforming the Buy & Hold Strategy by 11.31%).

 Year 2: Sideways Market Scenario - Bitcoin $10,000

It's critical to understand that not all mining epochs are created equal. The competitive advantages of Mining vs. Hodling are most prevalent in sideways and downward markets.  In Year 2, if Bitcoin remains at $10,000 we estimate a Difficulty increase of 20%, as opposed to the 80% increase expected with Bitcoin at $15,000.

In this Sideways Market Scenario, at the end of Year 2, the Buy & Hold Strategy will have yielded $0 - maintaining its 0.37 Bitcoin position with a value of $3,700.

 The investor implementing the Mine & Play with House Money Strategy will have increased their Balance Sheet by 46.21% since inception - accumulating 0.2635 Bitcoin and retaining 75% Machine Salvage Value - a Year 2 Balance Sheet value of $5,409.86 (Outperforming the Buy & Hold Strategy by 46.21%).

Year 2: Bear Market Scenario - $7,500 Bitcoin

The power of Dollar Cost Averaging is exemplified in this Bear Market Scenario. Miners take advantage of this opportunity because they are accumulating Bitcoin through their daily rewards at the lows, while most Investors are too afraid to deploy capital. In Bear Market Conditions, the Mine & Play with House Money Strategy significantly outperforms the alternative Buy & Hold Strategy - positioning miners to capture capital appreciation on their accumulated Bitcoin in the next Bull Market.

 In Year 2, if Bitcoin Price declines to $7,500, we estimated a net Difficulty reduction of 20% over the course of the year as inefficient miners are forced to shut off. Due to the decrease in Bitcoin Price, we expect the Machine Salvage Value to only retain 65%.

In this environment, the Buy & Hold Strategy will experience a 25% loss - maintaining its 0.37 Bitcoin position with a Balance Sheet value of $2,775 at the end of Year 2.

In this same environment the Mine & Play with House Money strategy will have increased their Balance Sheet by 23.22% since inception - accumulating 0.2872 Bitcoin and retaining 65% Machine Salvage Value - a Year 2 Balance Sheet Value of $4,559.19 (Outperforming the Buy & Hold Strategy by 64.30%).

Year 3: Bull Market Bitcoin $20,000

In Year 3, if Bitcoin Price rallies to $20,000, we estimate a net Difficulty increase of 50% over the course of the year - reducing Bitcoin Revenue for miners.

In this environment, the Buy & Hold Strategy will experience a 100% gain - maintaining its 0.37 Bitcoin position with a Balance Sheet value of $7,400 at the end of Year 3.

The investor implementing the Mine & Play with House Money Strategy will have increased their Balance Sheet by 136.25% since inception - accumulating 0.3631 Bitcoin and retaining 40% Machine Salvage Value - a Year 2 Balance Sheet Value of $8,741.26 (Outperforming the Buy & Hold Strategy by 18.13%).

Conclusion

It is most tactical to tailor your strategy based on the volatile environments and various market cycles that one can expect when investing in Bitcoin over the long-term.  The comparative advantage of the Mine & Play with House Money Strategy vs. the Buy & Hold Strategy is favorable in each Environment. The purpose of this analysis is not to project future returns, but rather, to identify the optimal strategy to capture the opportunity in Bitcoin and deliver alpha over the long-term.

Bitcoin is a technology and commodity in its infancy that is in price discovery mode. There will be several more boom and bust cycles as it matures into Digital Gold. Investors should expect continued volatility and have long time horizons. With Bitcoin Mining, you are receiving Bitcoin everyday and therefore, effectively Dollar Cost Averaging into a long-term position. The Bitcoin Mining Industry is in the early innings of a Hardware Upgrade Cycle coinciding with the potential of a Halving Catalyst - similar to what was witnessed in the 2016 Hardware Upgrade Cycle. Deploying capital into mining rigs early in a Hardware Upgrade Cycle has historically proven to be one of the best strategies to capture the opportunity in Bitcoin. We believe this will once again be the case for miners who deploy early in the 2020 Hardware Upgrade Cycle.