As the blockchain industry navigates the turbulent cryptocurrency market, acquisition opportunities have arisen across different asset types. The bitcoin mining industry is no exception.
Bitcoin miners play a major role as validators of transactions rather than the traditional intermediary bank. Specialized computer equipment (mining equipment) solves a complex computational problem generated by bitcoin software, which validates a block of bitcoin transactions recorded in a digital ledger. The miner who solves the problem is awarded with bitcoin.
Bitcoin prices reached $65,000 in November 2021, and just a year later, the price fell below $20,000. The combination of this sharp price drop, soaring energy prices, and the use of debt to finance the purchase of mining equipment hurt the mining industry. As a result, mining equipment and operations are available for purchase as struggling companies scramble for cash.
As always, the devil is in the details when looking at asset acquisitions during a downturn. This is particularly the case in the crypto mining industry as companies have rushed to quickly purchase mining equipment and set up facilities to take advantage of market conditions.
Mining equipment sold at 50% to 75% off, and at even bigger price discounts, one year ago. What are the practical considerations as more mining equipment and facilities become available in the market?
Hash rate guarantee
Crypto mining is all about the computational power of the mining hardware, which is called the hash rate. The hash rate is necessary to solve the complex math problem of validating a block of bitcoin transactions that gives the bitcoin reward to the successful miner.
It is crucial to get the hash rate guarantee and to check before buying that the device meets this guarantee. You may want to include the concept of a purchase price adjustment to the extent that the hardware cannot meet the hash rate guarantee. There are also considerations for test conditions to check the hash rate of mining equipment.
The vendor may modify the configuration of the chips in their mining equipment to increase their hash rate to fulfill the guarantee, but this configuration may not be consistent with how your mining equipment is configured. For this reason, it is important to establish clear procedures for this verification process.
In addition, if you are buying several thousand miners, you need a process to ensure that you purchase 5,000 Bitmain S19 miners vs. the previous version with a lower hash rate. For some sellers with poor records, this may also require a screening period before accepting miners along with a purchase price adjustment in the event that equipment does not match promise.
And just like more traditional asset purchases, you will need to take adequate steps to ensure that your mining assets are not mortgaged. Operational, financial and legal diligence is essential to the success of this type of transaction.
Energy use, cyber security, other concerns
Acquisitions of crypto mining facilities are generally mixed asset/property transactions coupled with a power contract. The energy contract is the largest determinant of whether the acquisition of a mining facility is economically viable.
For environmentally conscious mining operations, it is important to evaluate and confirm the energy source. From an industry perspective, energy use and environmental concerns will continue to shape the entire industry and will impact where mining operations occur.
Another consideration is whether to assume hosting contracts to host third-party mining equipment. This presents two challenges.
First, you may have to provide hosting services and worry about the risks of paying for this third party. This will continue to be a major concern as more mining operations, especially hosting operations, may seek bankruptcy protection.
In such cases, the bankruptcy court will replace your contractual damages for the hosting clients’ failure to pay. These risks can be considered included in the purchase price.
Second, you have cybersecurity concerns if your mining equipment is not on a separate network from your hosted miners. Have you thought about what would happen if a ransomware event encrypted your hosting customer data and your connection to them allowed the threat actor to go into your network and also encrypt it?
While bitcoin mining is a new industry, the good old fashioned diligence is important.
Do not assume that the facility’s warehouse has not been built within a utility easement. In the rush to build facilities quickly, there was an economic incentive to get to market and not worry about the time and cost of surveying worldly possessions.
There are also cases where the seller may promise expansion rights in negotiation only to have read the contract and know that those rights are not guaranteed. That can change the financial terms from cash on hand to earnings in the bush pending contract modification.
The last quarter of 2022 will provide acquisition opportunities for those companies that operate efficiently and are well-capitalized. At the same time, many companies in this industry have focused on speed to market. A thorough and thoughtful process of due diligence can discover 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 their respective owners.
Justin Daniels Attorney at Baker, Donelson, Bearman, Caldwell & Berkowitz where he co-chairs the Blockchain and Digital Assets Technology practice.
Rachel Silverstein General Counsel and Senior Vice President of Compliance at CleanSpark, a sustainable Bitcoin mining company.
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