From CoinDesk

To finance mining rigs running in the down market. Firms will have to look beyond stock issuance. They may have to borrow against their machines, mined crypto, or put themselves up for sale.

Access to capital is the backbone of any industry, not least of all for cryptocurrency-linked companies that are relatively young and in a hyper-growth mode. For digital asset miners, the need for capital is more pronounced because these companies require a large amount of funding for infrastructure and equipment to prosper.

This post is part of CoinDesk’s Mining Week.

In 2021, when bitcoin (BTC) was hitting new highs, investors were pouring money into miners both private and public. But now that bitcoin and the broader crypto market have been pulled off from their peak last year, the capital market has dried up for the digital asset industry as investors became more risk-averse.

With miners’ margins being compressed from their peak of as much as 90% to around 60% to 70% this year, thriving in the brutally competitive industry has become even more challenging.

That hasn’t stopped minors from spending to expand their companies by adding mining computers and processing power, or hashrate. Most of them have signed contracts to receive mining computers throughout this year.

Read more: 8 Trends That Will Shape Bitcoin Mining in 2022

So how can mining companies raise capital for growth, assuming the bitcoin price stays at current levels for a prolonged period of time and investors remain skeptical of risky assets?

Miners will need to get creative and are likely to go through a period of consolidation, according to industry experts and participants.

Why invest in crypto miners?

Before digging deeper into the future of mining finance, let’s get this often-asked question answered first: Why invest in mining companies when an investor can just simply buy digital assets from an exchange?

The main reason investors put their money into public crypto mining equities is that they act as a proxy for investing in bitcoin, given that many institutional investors remain hesitant to invest directly in cryptocurrencies due to regulatory concerns. Theoretically, by investing in mining equities that hold onto their mined bitcoin, investors are gaining a way to profit on the mined currency at a lower cost than its market price, while owning a real business. At the same time, shares of the public miners are easy for these traditional investors to buy or sell. No need to set up a fancy bitcoin wallet or open an account with some online exchange or specialized market maker; just call your stockbroker as usual.

“Public miners are the best option for most investors because they provide exposure to this fast-growing asset class through their existing portfolios with liquidity to more optimally enter and exit positions,” said Ben Gagnon, chief mining officer of publicly-traded mining company Bitfarms (BITF).

Particularly, in a down market, publicly-traded miners can offer a better value for investors as their prices are highly correlated (sometimes as much as 70%) with those of crypto assets and the shares often provide a better upside when the market eventually rallies.

“Given the market is weaker and mining is more discounted, it is advantageous to invest in mining as miners function effectively as leveraged exposure to bitcoin,” Gagnon added.

Year of reckoning for the crypto mining industry

However, such a high correlation also exposes investors to the downside.

If broader cryptocurrency prices decline significantly, as seen this year, the miners’ shares react even more swiftly, causing a sea of red for investors. This is when funding dries up and investors start to scrutinize individual miners and look for companies that can differentiate themselves from the pack in the long run, rather than buying all the equities in bulk.

On top of that, during the rally of 2021 lucrative margins brought in many new entrants into the sector, saturating it with too many miners with similar business models. This became a problem when bitcoin prices pulled back from their peak.

“Investors have expressed frustration with a seeming lack of differentiation in the digital asset mining industry,” said Wall Street investment bank B Riley’s analyst Lucas Pipes in a recent research note.

Access to capital will be fairly limited for miners that cannot distinguish themselves from the pack.

“I think what you’re going to see, hopefully, in 2022, ‘the year of reckoning for some of the publicly traded miners, where the market really starts to mature and starts to recognize all the publicly traded miners on an individual basis,” said John Warren, CEO of privately held bitcoin mining company GEM Mining, which was formed recently, after raising over $200 million in institutional capital.

Investors will likely dig deeper into the publicly traded companies’ growth plans and ask if they have paid for the mining computers that they said they would. If they haven’t, the question becomes whether these miners have enough cash to pay for the machines, Warren said. If they don’t, they will have to raise money by issuing more equity – and diluting their shareholders’ stakes.

Pipes said he expects a “greater differentiation” this year among the miners, as they try to reach the targets in their business plans and pursue further exposure in adjacent markets. Pipes said miners that vertically integrate, or own their own infrastructure for power and hosting mining machines, are “ideally positioned for this evolution.” (Think of Netflix (NFLX) producing the shows it streams or, going further back, Ford Motor Company (F) making its own steel rather than buying it.)

As examples of this change in the mining business, Pipes pointed to Stronghold Mining (SDIG), which is using power for both digital mining and open market electricity sales, as well as Hut 8’s (HUT) data center business that is used for both digital asset mining and cloud computing.

In fact, diversification has become a theme among the miners recently, to differentiate themselves from their peers. Most recently, miner Argo Blockchain (ARBK) launched an in-house unit that does a variety of things other than mining in the blockchain ecosystem, and miner Hut 8 bought a cloud and colocation data center business from TeraGo to branch out into Web 3 infrastructures.

A maturing market

In a market where investors are looking for a unique investment case among a surfeit of miners, if a public company tries to raise capital by offering shares, it will dilute the shareholders, and the stock will likely be punished. Meanwhile, rising debt could also become expensive as lenders might demand higher interest rates for a growing company. To stay profitable in a hotly competitive market, miners will need to find creative ways to fund their growth plans.

“As investors become more mature, so do the financial products,” according to Ruslan Zinurov, CEO of privately held bitcoin mining company Merkle Standard, which recently announced a partnership with miner manufacturer Bitmain to develop a data center with up to 500 megawatts of capacity.

Read more: Bitcoin Mining and ESG: A Match Made in Heaven

“The offerings available for miners today are vastly different from what was available even six months ago,” Zinurov said. However, it seems that asset-backed loans (ABL) will become a popular option for miners, he added.

In February, bitcoin miner CleanSpark (CLSK) said in an earnings call that given the company has top-of-the-line, latest-generation ASIC mining machines, it will use them as leverage to raise capital.

“We believe this makes us attractive to asset-backed lenders and we are exploring the use of the ABL or similar facilities to provide the growth capital needed to expand our operations,” the company’s chief financial officer, Gary Vecchiarelli said. CleanSpark said other options include monetizing some of the company’s bitcoin holdings, which doesn’t necessarily mean only selling it; the company could deposit coins with a crypto lender to earn yield, as well.

Another form of financing that has been seen recently is bitcoin-backed loans. Last year in December, Bitfarms raised a $100 million bitcoin-backed loan from Galaxy Digital. Aside from miners, even Goldman Sachs (GS) and other Wall Street banks are exploring options for such crypto-backed loans.

Soon, there likely will be more financing options that come along, according to GEM’s Warren.

“As the market matures, you’re going to see more bank financing come in, and then you’re going to have funds and different lenders take lines of credit from the banks in order to loan it out and that’s going to bring down the cost of capital for all of the miners significantly,” he explained.

Read more: Pipe Introduces Alternative Financing Product for Bitcoin Miners

But for now, Warren thinks bitcoin-backed loans are one of the cheapest forms of debt that’s available to the miners, followed by machine financing. He thinks convertible debts are expensive at the moment, given the market is still very young.

“Again, because it’s an immature market, and it’s just so expensive to take that convertible debt if you can do the machine financing, I think that’s a better deal,” Warren said.

M&A becoming ‘more real’

However, the cash crunch could become a reality for the miners as margins compress, particularly if the bitcoin price remains stagnant for a prolonged period of time and capital remains scarce while competition intensifies.

Such a scenario would usher in an age of consolidation among the miners, particularly the ones that are smaller in size and not cashed up, according to Fred Thiel, CEO of one of the largest publicly traded bitcoin miners, Marathon Digital Holdings (MARA).

“If you are a smaller company, trying to grow, it’s gonna get very difficult,” he said. “I think [cash-strapped] companies are going to start struggling within the next year or two,” he said. Potential acquisition targets are the companies that might have access to a lot of mining computers but either didn’t deploy them or didn’t have the capital to pay for them.

“You’ll see M&A start becoming something more real later this year and into the next year,” Thiel said.

This was echoed by Sue Ennis, vice president of corporate development at Hut 8.

“It’s possible we will see some industry consolidation as the hashrate grows, particularly if the current economic, geopolitical, and inflationary environments remain volatile,” Ennis said.