Bitcoin mining is less profitable than selling power for Stronghold Digital

by James · August 16, 2022

Call it the new economy of Bitcoin.

In its earnings call on August 18, Stronghold Digital Mining announced two major strategic changes designed to mitigate the steep fall in Bitcoin prices. First, Stronghold returns no less than two-thirds of its mining machines to the lender that financed them—not unlike the way homeowners in some states can give their house back to the bank in a foreclosure, wiping out their mortgage in the process. Second, the Pennsylvania outfit now plans to generate the bulk of its revenue not by pursuing its original mission of producing the flagship cryptocurrency, but by selling power — at far fatter margins — to the electric grid that serves the region’s homes and businesses.

If Bitcoin remains shut down, we will likely see many miners follow at least part of Stronghold’s playbook to survive. In Texas, various miners are coping with the crisis by closing their data centers and selling unused power to the Lonestar grid, a sideline that makes more money than hatching Bitcoin at current prices. “We’re the first to restructure in a really massive way,” Stronghold CEO Greg Beard told me Fortune the day of the result announcement. “But many miners don’t have our flexibility to return the machines that are now underwater. Many may not be able to make the payments on those computers, so they risk insolvency.”

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Stronghold’s unusual Bitcoin mining model

Unlike the Texas miners who use the state grid to power their data centers, Stronghold supplies its own power. It stands for the “flexibility” that Beard referred to. Under an environmental program in the state of Pennsylvania, the company collects piles of waste coal dumped decades ago that dot the landscape and stand in black hills that pollute streams and groundwater. Stronghold burns the black stuff to generate all the electricity that powers the data centers. These code-churning facilities sit next to boilers at two plants, one near Pittsburgh and the other in the state’s eastern tier, north of Allentown.

Therefore, Stronghold is a rarity as a “vertically integrated” player. When the miner went public in October 2021, the miner planned to install enough machines to achieve over 4 exahashes in computing power by the end of this year. At that level, it could be around 6,600 Bitcoin a year. And founders Beard, formerly head of natural resources investments at Apollo Global, and Bill Spence, a waste coal veteran who oversees operations, had a plan to grow quickly from there.

But the collapse in Bitcoin’s price from nearly $70,000 late last year to the low $20,000s since mid-June changed that plan. (The coin was trading at just under $24,000 by mid-Tuesday.) For the just-announced second quarter, Stronghold recorded a net loss of $40 million. Since its IPO, its share price has cratered from $27 to $3.50, in a swoon that mirrors the trajectory of nearly every miner, cutting its market cap from $600 million to $72 million.

Sending back the computers

Today, the two plants have a capacity of 165 megawatts. That’s enough to reach the year’s first goal of over 4 exahash and stamp 6600 Bitcoin. At the price of almost $50,000 in April, Stronghold by Fortune’s estimates would have yielded about $330 million a year in revenue, with super-rich margins, if they had hit those targets. Stronghold had most of the computers it needed, either on site or to meet its big year-end goal. But the collapse in Bitcoin prices was so severe that by June it was running only about a third of those machines.

Stronghold had borrowed $67 million to collect 26,000 of its roughly 40,000 computers from Nydig, a platform that finances equipment purchases for miners. As a negotiated point, the listed company does not guarantee the credit: it was only secured by the equipment. Since mining Bitcoin has become unprofitable, Stronghold no longer needed the Nydig-backed computers.

“Additionally, the market was flooded with machines, and the same ones carrying the $67 million in debt could be bought for less than $50 million,” says Beard. So Stronghold will soon send the machines back to Nydig, and the lender will eliminate a whopping $67 million in loans. It will be a lifeline for Stronghold: The principal, plus $10 million in interest, is due over the next 18 months. Beard further eased the pressure by restructuring a $40 million loan from another lender, WhiteHawk, extending the term from the remaining 14 months to three years. WhiteHawk also agreed to provide an additional $20 million line of credit.

Stronghold revolves around sales force

Stronghold plans to continue running only 15,000 Bitcoin mining machines. But they will only absorb about a third of the megawatt hours generated by the two plants. For months, Stronghold has diverted much of that power for sale to the PJM grid, which covers thirteen states, including Pennsylvania and parts of New Jersey and Ohio. Market prices for power have been extremely high compared to recent years, partly because the transition to renewables makes supplies much more variable. “It’s a record high environment,” says Beard.

But a “capacity” agreement with PJM prevented Stronghold’s ability to sell megawatt-hours at the rich “spot” prices. The pact required the miner to provide guaranteed amounts of power to PJM, but limited payments to where electricity is openly traded. Stronghold recently left the PJM scheme, leaving it free to capitalize on the hot MWh bidding.

The “forward curve” that indicates future electricity prices, Beard says, suggests average prices of about $100 per MWh over the next six months. During the day, when the power price is highest, Stronghold will sell to the grid. But at night, prices can drop by $30 to $40 per MWh. So the company is doing better in these hours of mining Bitcoin. All told, about two-thirds of Stronghold’s electricity for the rest of the year should go to spot sales, assuming current prices stay around $100. The old model was practically 100% Bitcoin mining. The balance would improve its margins over the number from just mining Bitcoin 24 hours a day.

In fact, Stronghold’s average power cost is only $40 per MWh. At $80 per MWh of Bitcoin mining, it’s not enough to nearly cover the amortization of all these expensive machines. But with the debt down and most of the computers gone, less mining and more power sales should generate safe, modestly positive cash flow.

For Beard, Stronghold’s ability to generate its own power gives it an edge over rivals when it comes to countering the collapse in Bitcoin prices. “We wouldn’t have the guts to disconnect 26,000 computers if we couldn’t replace the power they were using by selling our own power as a backup business,” he says. Beard also wants to rebuild the Bitcoin business. “We have 26,000 empty slots for miners that we fortunately don’t pay for,” he says. “We have the $20 million line of credit, much less leverage and positive cash flow. We could use that liquidity to buy computers at much cheaper prices than we originally paid. We’re in no big rush. We want to do it slowly and do it right .”

Beard floated a different path for Stronghold’s future. “Strength can be an acquisition target,” he notes. “If you’re a listed company that has a lot of machines and needs a place to plug them in to get great deals, Stronghold could be the place. And now we are much more attractive because we have reduced leverage. Or we can buy someone who has a lot of unused machines, via the agreement we can get the equipment at the right prices.”

It all adds up to a new chapter in the handbook for living beyond the crypto winter.