Bitcoin Mining’s First Major Bankruptcy Creates Uncertainty For Key Partners, Opportunity For Others
Compute North, the second-largest bitcoin mining hosting provider in the United States, filed an application Chapter 11 Bankruptcy Last week. The company quickly followed up that filing with another court order seeking a 363 bankruptcy sale to liquidate assets to cover the approximately $140 million in debt it has accumulated.
The bankruptcy is perhaps the biggest bitcoin mining news to emerge in the 2022 bear market. Compute North provides hosting services for $700 million worth of equipment to some 84 mining entities, including publicly traded companies such as Marathon Digital Holdings. Now, with the hosting provider looking to auction its assets, these customers could face a situation where their service agreements are rewritten under new management. Some miners may even be forced to leave their places of accommodation, while others may risk defaulting if their rates increase.
Bigger Context: Brutal Economy Crushes Compute North Margins
Large-scale bitcoin mining is expensive. By now most people know that it requires a lot of energy and expensive machinery, but miners also need very expensive electrical equipment (transformers, panels, power lines and things of that nature) that scale with the size of their fleet, and they also need containers or warehouse space to store them.
Given the scale and cost, miners will often rely on hosting providers like Compute North to reduce the cost and effort of building a Bitcoin mining farm themselves. The miners supply the machines and the host supplies the electricity. Under these agreements, both parties sign a contract that sets a hosting rate for a specific period of time. These contracts can vary, but generally they include a fixed price for electricity, which may include a profit or revenue sharing agreement.
As the graph above illustrates, Compute North has more than 20 subsidiaries that manage different aspects of this business. Most of them (the “operating company silo” companies) are 100% owned by Compute North, while others are joint ventures with NextEra Energy and Marathon Digital Holdings. Additionally, CN Borrower LLC is now owned by Compute North’s main lender, Generate Capital (more on that later).
Compute North contracts typically last 3-5 years and set a fixed electricity rate for the miner. The problem is that Compute North hasn’t locked in its own electricity rate with its electricity suppliers via a long-term power purchase agreement (PPA). Meanwhile, in Texas, a state that hosts a significant portion of Compute North’s customers and in which Compute North is growing most aggressively, average industrial electricity rates increased 64% from July 2021 to July 2022, from from $5.20/kWh to $8.21/kWh.
According to its Chapter 11 filing, Compute North stated that a ” [hosting service agreement] does not expressly allow it to pass on increased energy costs to customers,” so the hosting company has to eat up those rising electricity rates without recovering the costs from customers.
And the revenue Compute North was earning was being eroded by Bitcoin’s bear market. The hash price of Bitcoin – a measure of the income miners can reap in a day’s work – has fallen 68% since the start of the year.
So when Compute North’s core operating costs (electricity) increased, its margins, which were already squeezed by market conditions, were effectively crushed.
Detecting a problem, Compute North’s main lender triggers a technical default
Although Compute North doesn’t state it in its filing, it’s likely that the company’s unsustainable revenue situation caused its main lender, Generate Capital, to trigger a technical default.
Generate Capital opened a $300 million line of credit for Compute North in February, of which Compute North has drawn $101 million. According to Compute North’s bankruptcy filing, Generate Capital claimed Compute North was in technical default, which cut off Compute North’s access to credit and gave Generate Capital the right to take control of two of Compute North’s facilities. Compute North (one in Kearney, Nebraska and one in Granbury, Texas, as well as a $23.6 million bank account.
Outlook and implications: Compute North facilities are operational at the moment, but will soon be sold
With its main line of credit closed and its margins evaporated, Compute North filed for Chapter 11 bankruptcy. Commonly referred to as a reorganization bankruptcy, a Chapter 11 allows the company to continue operations while developing a plan to satisfy creditors. .
In terms of creditors, Compute North owes $99,809,696 to NextEra Energy, an electric utility with which Compute North entered into a joint venture for one of its facilities in Texas; $21,013,027 to public Bitcoin miner Marathon Digital Holdings; $7,466,005 to Foundry, a subsidiary of Digital Currency Group; and $18,374,138 to approximately 30 other entities.
To repay this debt, Compute North has filed a petition in the U.S. Bankruptcy Court for the Southern District of Texas to auction off its assets in a 363 bankruptcy sale. If the sale is approved, Compute North could sell up to ‘at $1,000,000 in assets outside of the auction under a de minimis sale.
The lion’s share of the sale, however, will take place in an auction that would begin on November 1, 2022. This auction would include anything and everything that Compute North controls, including bitcoin mining containers, bitcoin mining machines and its data centers, the latter of which will be the most coveted assets.
Decision points: What happens to customers if Compute North’s business is siled?
The asset auction is sure to attract bidders from all corners of the Bitcoin mining industry, including financial institutions and energy companies active in the sector. These players will now have the ability to gobble up assets for pennies on the dollar.
Anyone can guess right now where the tokens are dropping when it comes to buying, but depending on who ends up with which data center, it could mean headaches or hell for customers operating in those locations. Given that current hosting service agreements are not profitable, new management may wish to rewrite these agreements. Some minors may be kicked out of their agreements, while others may choose to leave.
Marathon Digital, for example, has already got an agreement with Compute North competitor Applied Blockchain for another supply and warehouse space to house the public miner’s current and future fleet of mining machines. Regarding the bankruptcy, Marathon Digital’s stock fell 10% on the day the news broke, but the stock price has largely rebounded over the past week. It should also be noted that the computing power of Marathon, via its proprietary Marapool mining pool, did not decrease over the past month in light of the bankruptcy.
In addition to Applied Blockchain, bitcoin miners who may be squeezed out by the restructuring could look to Core Scientific, the largest bitcoin mining host in the United States, for a new home. Core Scientific, however, lost $4.7 million from its hosting services in Q2 2022, according to his 10-Q record.
Without insight into Core Scientific’s operations, it’s impossible to tell whether this loss is the result of rising electricity rates and a lack of PPA or whether it’s the result of data center downtime during heat waves. summer (Core Scientific has significant operations in Texas). That said, industry sources claim that Core Scientific has the ability to pass on rising electricity costs to its customers should electricity rates rise.
The situation is a stark reminder that public and private miners who own their own power contracts and run their own data centers, albeit expensive, have one less thing to worry about in times of market uncertainty. Riot, Argo, Hut 8, Bitfarms, and Cleanspark, among others, don’t have to worry about host counterparty risk.
For those using hosting providers, with mining margins shrinking and electricity costs rising, uncertainty looms over hosting alternatives. It was not uncommon for Bitcoin miners in recent years to forgo long-term PPAs because electricity costs tended to drop and hosting rates increased on average for the industry.
As such, Compute North customers could be stuck between choosing the better of two bad situations by remaining in limbo amid Compute North’s restructuring or seeking new uncertainty with another hosting provider.
It’s too early to tell whether or not the situation will evolve into credit contagion, but the effect of the bankruptcy on other miners will become clearer as Compute North’s data centers are sold to new management.
Investors in these companies would be well placed to understand the source of energy of portfolio companies to determine if reallocations or additional diversification are needed.