Summary Ordinals and BRC-20 tokens are creating a dramatic shift in Bitcoin's transaction fee market. If this continues, the biggest beneficiaries are arguably the miners. Over the last 3 months, Bitfarms has grown operating exahash and the BTC in treasury. The company is well positioned to benefit from the May fee spike. When I last covered Bitfarms ( BITF ) for Seeking Alpha, I was impressed by how aggressively the company has been reducing its debt burden. Three months later, we have less debt, more production data, an earnings call, and a potentially different setup for the entire mining industry. While I think most of the public miners will benefit from that setup to some degree, in this article I'll lay out why I've personally decided to go long BITF shares. The Setup For Miners Before we get to the information that specifically pertains to Bitfarms, we have to acknowledge how the emergence of Ordinals and BRC-20 tokens has the potential to dramatically change the fee market for Bitcoin ( BTC-USD ) users going forward. In the last several months, we've seen Ordinals go from what was viewed as a silly side attraction for "degens" to a legitimate NFT protocol that is responsible for $36 million in fees paid to Bitcoin miners. Ordinals Fees (Dune Analytics/dgtl_assets) I detailed why I felt Ordinals had the potential to lead to conflict within the Bitcoin community back in early February, and that assessment is closer to coming to fruition. Regardless of whether everyone likes Ordinals or not, this is a significant fundamental development for the miners. Despite short-lived spikes to fees over the years, the industry has been almost entirely reliant on fresh BTC supply emissions from the block reward. Fee rewards (IntoTheBlock) Earlier this month, we had the biggest spike in transaction fees paid to miners since the 2017 bull run. This fee spike is attributable to Ordinals and BRC-20 tokens. A robust fee market changes the game for miners because it reduces the negative impact of the halving next year if network fees can continue to be a growing portion of total miner revenue. We don't know to what degree these transaction fees will be sticky. It'd be easy to dismiss this bounce in fees as just another short-lived spike like we've seen in the past, but I'm less certain of that. Ordinals Mints (Dune Analytics/dgtl_assets) Ordinals mints haven't shown any sign of slowing down, and there is now over $500 million in paper wealth underpinning the recently emerged BRC-20 token market on Bitcoin. Again, there is no guarantee this trend in activity continues. But if it does, it benefits the miners. Even without a larger share of revenue from fees, the setup for Bitfarms has also improved. Bitfarms Update For Bitfarms specifically, we have a continuation of the debt reduction story from the prior quarter, growth in exahash, and a small bump in BTC on the balance sheet. In the company's earnings presentation for Q1-23, Bitfarms noted debt on the balance sheet of just $19 million as of the end of April. This is down from 24% from the $25 million in obligations that the company disclosed in February. Bitfarms BTC Treasury EH/S January 2023 405 4.7 February 2023 405 4.7 March 2023 435 4.8 April 2023 465 5.0 Source: Bitfarms Importantly, Bitfarms has been able to accomplish this continued debt reduction over the last 3 months without sacrificing the BTC on the balance sheet or significantly drawing down cash. In the meantime, the company has also continued to slowly bring on more operating exahash; moving from 4.5 EH/s at the end of December to 5.0 as of May 15th. Bitfarms is guiding for 6 EH/s in Q3 of this year. Year to date, Bitfarms has produced 1,676 Bitcoin at an average BTC per EH/s of 87.5: Miner YTD Production Avg BTC per EH/s Iris Energy ( IREN ) 820 94.3 CleanSpark ( CLSK ) 2,395 90.1 HIVE Blockchain ( HIVE ) 1,065 90.0 Bitfarms 1,676 87.5 Bit Digital ( BTBT ) 447 87.4 Source: Company Filings through April 2023, author's calculations This makes Bitfarms the 5th most productive miner by cumulative BTC mined in 2023 and the 4th most efficient by average Bitcoin mined per exahash. Only CleanSpark can claim better efficiency with larger production. But CleanSpark has much less BTC and less cash on the balance sheet than Bitfarms. Data by YCharts Something else to consider is the trend in short shares as a percentage of shares outstanding. For Bitfarms, that trend has been lower since Q4 of last year, but that has not been the case for all the miners with strong efficiency scores. Bit Digital and CleanSpark have seen their short numbers start to move back higher from early 2023 lows. Iris Energy and Bitfarms are the ones that are at fresh lows for 2023 as of the article submission. Risks Many of the same risks from my last Bitfarms article still apply. BITF is still very close to $1 per share and could be at significant risk of being non-compliant with Nasdaq listing requirements if the price of Bitcoin moves lower from current levels. And there is certainly no guarantee that Bitcoin's price will remain in the $27-29k range. Beyond that, if Bitcoin's price increases, it creates a scenario where more competition can viably start mining for block rewards. Cost to produce (Bitfarms) To keep up with global exahash expansion, miners have to keep growing their own operating EH/s in line with the global growth rate, or they risk losing mining share to peers. Of course, this comes with a cost, and we can see that the cost to produce a Bitcoin has been increasing for Bitfarms in the graph above. Another risk to consider is the company's participation in market derivatives. CFO Jeff Lucas from the Q1 call : We're stepping in here very carefully and very thoughtful here. We're not being overly aggressive by any means. And the goal here, quite frankly, is the means of insulating and protecting our downside here. And right now, we're doing that primarily either by writing or by buying options in place here, though we're looking for some other more sophisticated instruments as we get more advanced here. And also to a degree on the upside, we do offset some of that premium cost by actually writing some dramatically out-of-the-money calls here. There is nothing wrong with hedging production in an attempt to diminish revenue volatility due to BTC price swings. But it is still something that investors should consider. These types of internal programs can work great when those running them guess right. But incorrect guesses can ultimately lead to unnecessary losses. It would be a shame if Bitfarms had BTC called away right before the halving. Summary In February, I liked the improving fundamental story in Bitfarms and rated the stock a buy, even though I didn't yet have a position at the time. Since then, the stock hasn't really gone anywhere, but the macro setup for the industry is arguably much better. Bitfarms has decreased debt by $140 million in 10 months. It has shown an ability to decrease that debt while growing both exahash and BTC on the balance sheet, and without significantly diluting shareholders in the process. Data by YCharts Despite the increasingly favorable setup for the industry and for Bitfarms specifically, it's lagging several of its larger peers and even similarly capitalized peers that have diluted to a larger degree. In my view, Bitfarms is going to play catch up, and I think this is a good time to take a shot on BITF shares.
