The Basics of Commodity Production

Bitcoin mining is a commodity production business and if you don't understand the basics, having success mining Bitcoin becomes very difficult. For those that don't know, I come from a long line of farmers in north central Iowa. Commodity production is in my blood. Below is a list of principles I have learned over the years to ensure our family farming business continues on from generation to generation. I will share a lot of examples from our farming business that we implement into our Bitcoin mining business. While the commodities produced are different, the fundamentals are not so surprisingly different.

Being a low cost producer

The first and most important part is being able to produce your commodity at a price below the competition. Being a high cost producer having a breakeven production cost in the top 50% means you are the first to have your unit economics go negative. There is no way to charge a premium for your commodity since by definition a bushel of corn and a satoshi are all the same. The only way to gain an advantage is by having your costs to produce lower than the next guy.

Strong balance sheet

A strong balance sheet is what allows you to survive the downturns and even capitalize on opportunities when competition is fighting to stay alive. A mix of assets you can borrow against and cash or cash equivalents with minimal liabilities is what makes up a strong balance sheet. The balance sheet is the last line of defense to keep your business alive during downturns and also your greatest opportunity to play offense. When commodity prices are low and profitability is low/breakeven, growth is not really an option because you don't have the profits to pay for it. With a strong balance sheet you can borrow to capitalize on great opportunities when others can't.

In the late 1990's to early 2000's there was a short recession in agriculture that caused farmland prices to drop significantly. During this time farmers were fighting to stay alive and many were having to sell land they couldn't afford anymore. My parents made the single greatest financial decision of their lives and bought as much farmland as they possibly could. Without a strong balance sheet no bank would have lent them money and that opportunity would have come and gone. In Bitcoin mining a short recession happens every 4 years immediately following the halving. Since so much of our revenue as miners is tied to the block subsidy, right now you can pretty easily predict when these times will happen and position yourself to capitalize on them.

Additional revenue streams

This has been one of the secrets to our success long term. Both my parents worked normal W2 jobs to support the family. Any farming related income was not needed to pay the bills. They hired two farmers/operators to do the actual farming aspect of the business. We own the farmland, run the business, and take all of the risk. This is similar to how our Bitcoin mining hosting business works. Our customers own the ASICs and hire us to do the day to day operations for them. They own the asset and take all the risk and we provide the labor and expertise.

Not needing to take out money from the business to pay lifestyle bills is a huge advantage. You can manage downturns much easier since your bills are covered by income uncorrelated to your commodity.

Cycles are part of the business

If you are looking for steady consistent returns, this is not the place for you. Go buy bonds and index funds like a virgin. In commodity businesses there are times of little to no profit followed by times of outrageous profits. You really need to understand this because. If you don't, the times of little profit will make you question your investment and the times of outrageous profits will make you think this is the best investment in the world. Both are not true. It's easy to quit when times are bad and just as easy to over expand when times are good. We live by the motto "The good times don't last forever, neither do the bad".

Long term debt will kill you

Debt has its place in every business. But a commodity business is not like a real estate business where you can use 80% debt over a multi decade timeframe. The main reason for this is commodity price risk. If you can pay the debt payments with $6 corn, $80 oil, and $80PH hashprice and the price drops 50%, which happens in every one of these commodities, and the price stays there for a couple of years. Things start getting real tough and you're in quite the pickle.

If you are going to take debt, the goal needs to be to pay it down as fast as possible. In the above example of my parents, they took out a lot of debt to buy that farmland. During the next 5 years, they paid it off extremely aggressively. If they would not have done this then during 2016-2020 when we made very little money they would have certainly went bankrupt.

During the good years take the extra profit and pay down the debt. This is so hard to do in practice but is absolutely necessary. If you hold high amounts of long term debt, it's not a matter of if but when you go bankrupt.

Return on invested capital(ROIC)

Commodity businesses are capital intensive. There is always someone trying to sell you some brand new equipment to increase efficiency, yield, output, etc. The question you should always ask yourself is "at what cost?". How much will this capital investment decrease my cost of production? How long until my competitors implement the same thing? What will be my expected return? If you can't answer these questions it's best not to make the investment. Everything comes at a cost and just because your breakeven cost of production is lower doesn't mean something is a good investment.

If you don't take a price you like, you will be forced to take a price you don't

This one is simple. Whether it's buying farmland or ASICs, take the price you like. You are probably not a good trader and won't have much success hitting the best spots to buy and sell. So have a number in your head that works for your business and when presented with an opportunity that fits that, take it. Or you can wait and try to get a slightly better price while risking that you might then have to pay a price you don't like. Just keep it simple and move when you get a good price.

Downside protection is overrated

In all our years of farming not once have we ever done a profit sharing deal. It's very common during downturns for everyone to want to profit share for downside protection. Basically meaning to take some risk off the table. If you have a good balance sheet and relatively low cost of production, you should never want to share profits to help protect against the downside. Nobody makes any money during downturns and that is ok. All of the money is made during the boom years. You want to be in a position to capture all of these profits. Profit sharing is VERY expensive when times are good and helps only marginally during bad times.

Size isn't as important as efficiency

If your current business has efficiency problems, making it bigger won't help. You will still have all the same problems. They will just be bigger and much more expensive. Focus on making what you currently have better and grow slowly over time.

Never listen to the armchair analysts who claim the small guys can never compete against the big companies. They sit in chairs all day and claim to know how things work without ever stepping foot in the game. Pay them no mind.

As you ponder starting a Bitcoin mining business, I hope these lessons help you make informed decisions and ultimately set you up for success like they have for me.

Steven Wilson