Sometimes Cash Isn’t Trash?

Ray Dalio, legendary investor and founder of the world’s largest hedge fund Bridgewater Associates, coined the term “cash is trash”. However, arguably over the past 8 months cash has weathered the economic storm the best, with the dollar being the strongest among the major currencies. 

This week we saw examples of multiple fiat currencies taking severe hits against the dollar. The Dollar Currency Index (DXY), which measures the strength of the dollar relative to six other currencies, reached its highest level since 2002 this week.

The Turkish Lira was reported to have experienced annual inflation of 78.6% – the highest in 24 years resulting in a 3% decline against the dollar. Europe’s continued energy crisis has resulted in the euro also approaching parity with the dollar, with a 3.5% fortnight decline as investors seek safety. Argentinians have been trying to escape the Argentinian peso by swapping into Tether (USDT) as their economic minister was replaced by a candidate perceived to be less concerned with their 60% inflation. When denominated in Argentinian pesos, this drove the price of USDT up by over 12% from before the replacement.

However, it is not all good news for Tether. USDT’s market capitalisation has taken a hit over the past two months, falling from $83 billion, at the beginning of May, by 19% to $66 billion. Meanwhile, Circle’s USD Coin (USDC) continues to make new all-time highs in market capitalization reaching $55 billion this week – suggesting we may have a stablecoin flippening on the horizon.

Increasing energy costs combined with the declining bitcoin price has led miners to attempt to strengthen their balance sheets throughout the second quarter of 2022. In aggregate, miners sold more than the amount they mined in May and Core Scientific, who was the largest publicly traded bitcoin miner in terms of bitcoin holdings, released news this week that they have sold 7,202 bitcoin during June. This sale has reduced their holdings by 79% to cover debt repayments and invest in their infrastructure. Bitfarms also sold 3,000 BTC in June – reducing their holdings by 47%. Compass Mining was also reported to have lost one of its facilities due to not making electricity payments and hosting fees to its facility owner.  

Bitcoin miners are the most susceptible to the asset’s price swings with their revenue and profit margins being derived from bitcoin’s price. During a bull market, miners’ objective is to hold as much bitcoin as possible – increasing the value of their asset base and enabling them to raise additional finance. This incentive is even greater for publicly-traded miners as the value of their shares can also increase in tandem as their balance sheet grows. During bull markets, this acts as a positive and mitigates new coins entering the market acting as sell-side liquidity – prolonging the bull market and resulting in potentially higher valuations for bitcoin and thus the miner’s balance sheets. 

Conversely, when bitcoin is declining during a bear market, miners’ safest and most sustainable option is to sell their rewards for cash to pay debt repayments and operational expenses. They may also sell the bitcoin held in their treasuries, as seen over the past quarter, to ensure they have sufficient liquidity. During bear markets, this acts as additional selling pressure dampening price further and prolonging the decline as miners capitulate.  

The decreased demand for mining equipment, that miners classify as assets on their balance sheets, also causes them to suffer. Some miners utilise their equipment as collateral to access additional financing. When the demand and value of the equipment declines, they are required to post additional collateral to back their loans. This is a problem for participants who do not have access to additional cash – driving them to sell their assets, in most cases the bitcoin held in their treasuries. Alternatively, they can become increasingly levered and take on more debt with less attractive terms to pay off previous debt. It is reported there is $4 billion worth of these equipment-backed loans demonstrating the fragility of the industry if prices continue to fall.

These factors appear to have contributed to the decline we have seen over the past quarter leading to bitcoin’s worst-performing quarter since 2011. The main question is whether miners will have sufficient income and cash reserves to survive further downside.

The demise of less financially sound miners could lead to the consolidation of the industry. The most capitalised may survive and acquire the smaller entities whilst their valuations are reduced. In the long run, this could prove to be a benefit, leading to more financially strong miners potentially holding increased amounts of coins – further limiting additional coins from being sold on the market by retaining more of their rewards. 

Bitcoin’s hash rate, the total computing power dedicated to bitcoin mining, reached a new all time high of 237 EH/s in June, since then it has declined by approximately 15%. Bitcoin’s difficulty adjustment, a measurement of how hard miners need to compete for block rewards and is derived from the hash rate, dropped by 1.41% over the past two weeks and declined 2.35% the two weeks before that, suggesting mining activity is on the decline. Reviewing this could provide a good gauge of overall miner participation and some insight into the health of Bitcoin’s mining infrastructure.

The miners’ short term move to cash may prove to be the wisest decision to survive these pessimistic times. However, over the long-run the trajectory of bitcoin’s price has demonstrated it is the superior asset in growing and preserving wealth. The next Bitcoin halving, less than two years away, will also affect the economics of mining. Miners will seek lower energy costs, increased efficiency of their machines and a higher bitcoin price to outweigh the lower block rewards. Until we see some strength in the price of bitcoin, maybe cash isn’t trash.