To The Moon

Like most Bitcoin miners, Marathon Digital (NASDAQ:MARA) has been facing significant headwinds due to the prolonged selloff inBitcoin(BTC-USD) and other cryptocurrencies. Elevated energy prices and grid disruptions have also provided another dimension of challenges forBitcoin minors. Marathon has long been one of my favorite Bitcoin mining opportunities, but the recent guidance from the Federal Reserve and the general lack of interest in cryptocurrencies have started to seriously threaten even the best mining companies.

The Bitcoin Issue

For some time, some investors in the cryptocurrency in the mining space have been posing the question of whether it is better to buy the Bitcoin mining companies or the cryptocurrency that they produce. Bitcoin miners have seen the token fall precipitously to what, for most, represents an unprofitable level, as most mining companies have direct costs in the $10,000-$15,000 range and total cost per token somewhere close to $30,000.

Historically the price of mining companies closely follows the price of the underlying cryptocurrency in an upswing, but there is usually some negative deviation on prolonged downturns.

We can see in the chart above that Bitcoin has actually been a more stable investment during this downturn than just about every popular miner. When you think about it, this actually makes a lot of sense. Bitcoin is a token and doesn't have ongoing operating costs, nor is it beholden to fluctuating energy prices or depreciation on its mining fleet. We have also seen some prominent miners like Core Scientific (CORZ) take steps torestructure debtto preserve cash. With all the uncertainty in the space, it's easy to see why the remaining Bitcoin bulls would rather commit capital to the token rather than the mining companies. I would argue that Marathon Digital is probably one of the best-run companies in this space. Still, it is not immune to the widespread uncertainty gripping the sector, which was arguably capped by the recentChapter 11 filing by FTX.

Marathon's production

In October,Marathon produceda record 615 Bitcoin and increased its total holdings to 11,285 Bitcoin, worth roughly $231 million at the time of the release. This is welcome news as the company has faced production disruptions in the past, so it's good to see things are turning in a favorable direction operationally. The company has produced 3197 Bitcoin year to date, which is 27% more than the year prior, with a useful $51.2 million of unrestricted cash on hand. Their fleet comprised roughly 69,000 active units, good for roughly 7 EH/s. In the past, the sensational moves by Bitcoin made evaluating a Bitcoin mining company's progress fairly straightforward. It was more of an arms race to see who could grow their fleet quickly and produce the highest network hash rate. With signs of a prolonged Bitcoin downturn on the horizon, cash balances, forced selling, and operational costs are more heavily scrutinized as the focus has shifted from maximum production in a wildly profitable environment to weathering a downturn. This is where Marathon excels. The company has managed to maintain a good treasury without burning excessive amounts of cash in production, which puts it in a good place to cope with a short to medium-term unfavorable market. It's important to emphasize that Bitcoin mining companies tend to produce only one product. If the price of that product remains at disadvantageous levels for extended periods of time, they will all likely go out of business eventually.

Nevertheless, Marathon is turning the corner on production. We can see that the three-month average has improved significantly from the three months prior, and production figures are trending upward.

Forward-Looking Commentary

It is difficult to see a way forward for Marathon until Bitcoin prices begin to recover. The Federal Reserve has suggested that interest rates will stay higher for longer, and the recent market turmoil has shown that the idea of Bitcoin as an inflation hedge may be flawed and that the tokens fortunes are more directly tied to the fate of the broader technology sector making the token somewhat susceptible to the business cycle.

We can see from the charts above that as inflation rates swelled, Bitcoin fell apart, similarly to the NASDAQ. Ironically, it was pitched to many investors as a way to avoid the inflation and dollar devaluation that would come from excessive monetary and fiscal support by the Federal Reserve and government. But the good news is that the NASDAQ is one of the oldest and most successful baskets of companies in the history of the world. As interest rates eventually come down to earth, there is a tendency for recovery in the technology sector. This portion of the relationship has not yet been proven adequately for Bitcoin, but the heavy correlation so far is encouraging. The issue is all signs are pointing to a longer recession than previously anticipated due to the stickiness of inflation and the Federal Reserve's aggressive approach to remediating the problem they created. It's easy to see elevated rates trending upward or flat for the next six months, and this will likely disturb some of the smaller Bitcoin mining companies that may not be as well capitalized. Marathon Digital would likely be able to weather a year-long storm, but that only means that the company will likely exist on the other side of a recession. There is, however, no great reason to buy the stock at its current levels.

The Takeaway

Marathon has one of the best management teams in the Bitcoin mining space, but they are facing a problem they did not create and one that they do not have the power to fix. Bitcoin will likely have a tough start to 2023, and we will likely see more headlines from poorly capitalized Bitcoin miners, which will, of course, soften the outlook across the board. I believe Marathon will make it to the other side of a recession but what that looks like for these companies is extremely uncertain. There is no guarantee that Bitcoin prices will return to the elevated levels we have seen in the past, and we have no reliable way of predicting how low prices will go and how long they could stay there. Bitcoin mining companies tend to have a good track record of liquidity since their main product is a marketable token. Still, we could see forced selling from firms that evolves into a flat-out race to liquidate at some point. The risks are elevated, and I see no great reason to purchase a mining company until the situation becomes clearer. It would appear that Bitcoin bulls are better off parking their cash in the actual token for now or sitting on the sidelines until conditions improve. Marathon is an avoid for now. But I will revisit the stock once conditions improve.