Bitcoin Mining M&A in Crypto Decline Requires Due Diligence
As the blockchain industry navigates a turbulent cryptocurrency market, acquisition opportunities have arisen across various asset types. The Bitcoin mining industry is no exception.
Bitcoin miners play a key role as validators of transactions rather than a traditional middleman. Specialized computing equipment (mining equipment) solves a complex mathematical problem created by the bitcoin software, which validates a block of bitcoin transactions recorded on the digital ledger. The miner who solves the problem gets bitcoin.
Bitcoin prices reached $65,000 in November 2021, and just a year later, the price is below $20,000. The combination of this steep drop in prices, higher energy prices and the use of debt to finance the purchase of mining equipment has hit the mining industry hard. As a result, mining equipment and operations are available for purchase while distressed companies hunt 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 buy mining equipment and quickly set up facilities to take advantage of market conditions.
Mining equipment has sold for 50% to 75%, and at even greater discounts to prices a year ago. What are the practical considerations as more mining equipment and facilities become available on the market?
Hash Rate Guarantee
Crypto mining is about the computing power of the mining equipment, which is called the hash rate. Hash rate is needed to solve the complex math problem of validating a block of bitcoin transactions that provides the bitcoin reward to the successful miner.
It is very important to have a hashrate guarantee and to check before purchase that the equipment meets this guarantee. You may want to build in the concept of a purchase price adjustment to the extent that the machines cannot meet the hash rate guarantee. There is also consideration of the test conditions to verify the hash rate of mining equipment.
A seller can adjust the configuration of the chips in the mining rig to increase the hash rate to meet the guarantee, but such configuration may not match how you might configure your mining rig. 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 verify that you are buying 5000 Bitmain S19 miners versus an earlier version with a lower hash rate. For some sellers with poor results, this may also necessitate an inspection period before accepting the miners combined with a 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 that mining values are not encumbered. Operational, financial and legal due diligence is critical to the success of this type of transaction.
Power consumption, cyber security, other concerns
Purchases of crypto mining facilities are generally hybrid asset/property transactions combined with a power contract. The power contract is the biggest single factor in whether the acquisition of a mining facility is financially feasible.
For environmentally conscious mining operations, it is important to evaluate and confirm the power source. From an industry perspective, power use and environmental concerns will continue to affect the entire industry and will affect where mining takes place.
Another consideration is whether you want to assume hosting contracts to host third-party mining equipment. This presents two challenges.
First, you may have to offer hosting services and be concerned about the payment risk of that third party. This will continue to be a significant concern as more mining operations, especially host operations, may seek bankruptcy protection.
In such cases, your contractual remedies for non-payment by your hosting customers will be superseded by the bankruptcy court. These risks can be assessed 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 incident encrypted your hosting customer’s data and your connection with them allowed the threat actor to move over to your network and encrypt it as well?
While bitcoin mining is a new industry, good old fashioned diligence is essential.
Do not assume that the facility warehouse was not built inside a utility easement. In the rush to build facilities quickly, there was financial incentive to get on the market and not worry about the time and cost of a mundane property survey.
There are also cases where a seller may promise extension rights in the negotiation only to read the contract and find that such rights are not guaranteed. It can change financial terms from cash in hand to an earn-out in the bush pending a change to the contract.
The last quarter of 2022 will provide acquisition opportunities for those companies that operate efficiently and are well capitalized. At the same time, many firms in this industry focused on speed to market. A thorough and thoughtful due diligence process can remove 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.
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Justin Daniels is an attorney at Baker, Donelson, Bearman, Caldwell & Berkowitz where he co-leads the Blockchain and Digital Assets Technology practice.
Rachel Silverstein is general counsel and SVP of compliance for CleanSpark, a sustainable bitcoin mining company.