Less than four years ago, Riot Blockchain (NASDAQ:RIOT) was a failed animal health company named Bioptix. What is now RIOT stock was then BIOP stock — and it traded for less than $4 per share.
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That wasn’t because investors put much value on the business: Bioptix in fact had more than $2 per share in cash at the end of 2017’s second quarter. BIOP was basically just another penny stock in the biotech space.
But in October of that year, Bioptix rebranded to Riot Blockchain. It was a move that invited a huge rally — and quite a bit of skepticism.
Blockchain and other cryptocurrencies were hot then, with Bitcoin (CCC:BTC-USD) at one point rising from $900 to $20,000 during 2017. Riot was not alone in moving into crypto and blockchain: Eastman Kodak (NYSE:KODK) infamously was involved in a “KodakCoin” project which never came to fruition. That didn’t stop KODK stock from soaring.
Overstock (NASDAQ:OSTK) launched tZERO. Other penny stocks like MGT Digital (OTCMKTS:MGTI) tried their own pivots, usually with little success.
Riot’s own move was met with some skepticism. And as Bitcoin crashed in 2018, so too did RIOT stock. It would fall 80% in a matter of months.
Yet even skeptics (myself included) have to give credit where credit is due. Riot’s pivot into crypto mining, even during the 2018 bust, laid the seeds for a massive rally of late.
That rally can continue — if the Bitcoin price cooperates. But even if it does, there’s one more key factor that investors need to keep in mind.
The Case for RIOT Stock
Particularly for Bitcoin bulls, there’s an attractive case for RIOT stock.
Broadly speaking, RIOT should provide leverage to the Bitcoin price. That’s how miners work — whether it’s gold, silver, or cryptocurrency. As Bitcoin rises, Riot Blockchain’s revenue increases — but its costs, outside of taxes and management compensation, remain largely the same.
If Bitcoin rallies, RIOT stock should rally faster. Indeed, we’ve seen precisely that play out so far in 2021. Even with both the crypto and the miner seeing declines of late, RIOT’s 210% year-to-date gain is more than triple the 60% move in Bitcoin.
Of course, that broad case applies to other mining stocks as well. Marathon Digital (NASDAQ:MARA) and Bit Digital (NASDAQ:BTBT) offer roughly the same leverage.
But Riot Blockchain seems to have the lead in terms of capacity. Bit Digital has cited a hash rate of 2.2 EH/s (exahashes per second). Marathon projects roughly 1.4 EH/s by the end of this month.
Riot believes that once its orders are fulfilled, it can get to 3.8 EH/s. More mining power should mean more crypto. That in turn suggests more revenue and, in theory, a higher RIOT stock price.
What Goes Wrong
There are three broad risks.
First, and most obviously, Bitcoin tanks. It’s important to remember that RIOT stock provides leverage to the Bitcoin price — in both directions. This, too, we’ve seen so far in 2021.
From its highs on March 13, BTC has pulled back 3%. From its close the day before, RIOT is off 15%. That’s not market manipulation or “weak hands” selling — it’s how the fundamentals of mining stocks work. Leverage is a double-edged sword.
Second, there’s still the question of what, exactly, Riot Blockchain is going to do with the proceeds from its mining. For now, it’s holding crypto on its balance sheet. (As an aside, that strategy only increases the stock’s leverage to BTC. Not only do earnings rise and fall with the underlying crypto, so does the value of Riot’s assets.) The company no doubt wants to preserve resources to purchase more miners going forward.
But does Riot initiative a dividend at some point? Does it increase its 12% stake in exchange Coinsquare? Look elsewhere in the industry? An investor who owns Bitcoin directly obviously has far more control over buying and selling decisions than does an investor with a stake in Riot’s Bitcoin mining efforts and Bitcoin ownership. She has to trust Riot management.
The Difficulty Rate
Finally, there’s the difficulty rate. Riot’s current production looks impressive. In February alone, it mined 179 Bitcoin, worth over $9 million at current prices. Mining rig deliveries should triple current capacity.
There’s a big catch, though. Bitcoin’s design makes it harder and harder to mine the coin as we head toward the cap of 21 million. (That cap is its own modest concern: there are only about 2.5 million Bitcoins left to be mined.)
A higher difficulty rate essentially means the same number of Bitcoin is mined even with more mining power. And so, RIOT bulls looking for significant, if not exponential, growth in the monthly mining statistics may well be disappointed.
There’s a near-term problem as well. As Riot Blockchain itself notes, the current shortage of mining equipment (Riot’s own orders won’t be completely filled until October) is lowering the difficulty rate.
Once rigs are delivered and installed, there’s going to be far more mining power, yet not necessarily far more Bitcoins being mined.
To use a gold mining analogy, Riot is going to move quickly to lower grades, which require more effort for the same end results. That in turn means that the leverage bulls are looking for simply may not be there.
To be fair, that doesn’t mean RIOT stock won’t be able to outperform Bitcoin, or even that RIOT stock is a sell at this point. For crypto bulls, it’s probably the best mining stock out there.
What it does mean, however, is that the bull case is more, well, difficult than it might appear at first glance. At the least, expectations need to be tempered.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
