Bitcoin Mining M&A in Crypto Downturn Requires Due Diligence
As the blockchain industry navigates a troubled cryptocurrency market, acquisition opportunities have arisen across different asset types. The bitcoin mining industry is no exception.
Bitcoin miners play a key role as validators of transactions in lieu of a traditional intermediary bank. Specialized computer equipment (mining equipment) solves a complex math problem created by the bitcoin software, which validates a block of bitcoin transactions recorded on the digital ledger. The miner that solves the problem is awarded with bitcoin.
Bitcoin prices reached $65,000 in November 2021, and just a year later the price is below $20,000. The combination of this precipitous price decline, higher energy prices, and use of debt to finance mining equipment purchases have battered the mining industry. As a result, mining equipment and operations are available for purchase as distressed companies scramble for cash.
As always, the devil is in the details when looking at asset acquisitions during a downturn. This is especially the case in the crypto mining industry where companies rushed to purchase mining equipment and quickly establish facilities to take advantage of market conditions.
Mining equipment has been selling for 50% to 75%, and at even larger discounts to prices one year ago. What are the practical considerations as more mining equipment and facilities become available on the marketplace?
Hash Rate Warranty
Crypto mining is all about the computational power of the mining equipment, which is called the hash rate. Hash rate is needed to solve the complex math problem to validate a block of bitcoin transactions that yields the bitcoin reward to the successful miner.
It is critically important to have a hash rate warranty and to verify prior to purchase that the equipment meets this warranty. You may want to build in the concept of a purchase price adjustment to the extent the machines cannot meet the hash-rate warranty. There are also considerations for the testing conditions to verify mining equipment hash rate.
A seller might adjust the configuration of the chips in their mining equipment to boost their hash rate to meet the warranty, but such configuration may not be consistent with how you may configure your mining equipment. For this reason, it’s important to establish clear procedures for this verification process.
Additionally, if you are buying several thousand miners, you need a process to confirm you are buying 5,000 Bitmain S19 miners versus a prior version with a lower hash rate. For some sellers with poor records, this could also necessitate an inspection period before accepting the miners coupled with a purchase price adjustment in case the equipment is not what was promised.
And, much like a more traditional asset purchase, you will want to take adequate steps to ensure mining assets are not encumbered. Operational, financial, and legal due diligence are each critical to the success of this type of transaction.
Power Usage, Cybersecurity, Other Concerns
Crypto mining facilities acquisitions are generally hybrid asset/real estate transactions coupled with a power contract. The power contract is the single biggest determinant of whether a mining facility acquisition is economically feasible.
For environmentally conscious mining operations, evaluating and confirming the source of power is important. From an industry perspective, power usage and environmental concerns will continue to shape the entire industry and will influence where mining operations take place.
Another consideration is whether you will assume hosting contracts to host mining equipment of third parties. This presents two challenges.
First, you may have to provide hosting services and be concerned about payment risk of that third party. This will continue to be a significant concern as more mining operations, especially hosting operations, may seek bankruptcy protection.
In such cases, your contractual remedies for your hosting customers failure to pay will be superseded by the bankruptcy court. These risks may be considered within the purchase price.
Second, you have cybersecurity concerns if your mining equipment is not on a separate network from the hosted miners. Have you considered what might happen if a ransomware event encrypted your hosting customer’s data and your connection with them allowed the threat actor to move across to your network and encrypt it as well?
While bitcoin mining is a new industry, good old-fashioned diligence is important.
Don’t assume that the facility warehouse was not built inside a utility easement right of way. In the rush to build facilities quickly, there was economic incentive to get to market and not worry about the time and expense of a mundane property survey.
There are also instances where a seller may promise expansion rights in the negotiation only to read the contract and find out such rights are not guaranteed. That can change financial terms from cash in hand to an earn-out in the bush pending amendment of the contract.
The last quarter of 2022 will provide acquisition opportunities to those firms who are operating efficiently and are well-capitalized. At the same time, many firms in this industry focused on speed to market. A thorough and thoughtful diligence process can ferret out these key details.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Justin Daniels is an attorney at Baker, Donelson, Bearman, Caldwell & Berkowitz where he co-chairs the Blockchain and Digital Assets Technology practice.
Rachel Silverstein is general counsel and SVP of compliance for CleanSpark, a sustainable bitcoin mining company.