Cryptocurrency prices have yet to revisit last year’s highs, but it’s the relentless increase in computing power that is making mining an increasingly unprofitable endeavor.
Canadian company Block One Capital, which entered the blockchain space by investing directly in cryptocurrency mining rigs, has exited the business and is focusing instead on early-stage blockchain technology ventures. These include stakes in mortgage industry-focused Finzat and anti-money laundering/know your customer provider Affirmation Technology Group, both of which bring with them industry-specific expertise and leadership.
Block One Capital’s CEO Sothi Thillairajah and director of research Sivakumar Arumugam spoke with ThirtyK about the challenges of mining, key opportunities in today’s market, and why as many as 90 percent of current-day ventures will fail. Before becoming CEO of Block One in February, Thillairajah was a cofounder of Finzat, a managing director of Revere Capital Advisors, and spent two decades managing and advising early-stage ventures.
ThirtyK: Block One Capital recently released a report examining the changing economics of cryptocurrency mining. What about the space led your company to abandon mining as an investment?
Thillairajah: In any kind of early-stage business, investors like what can be described as linear functions: I’m going to deploy this much capital to buy this many [mining] units, they’re going to do this many computations and there will be this much bitcoin (BTC) generated. No one understood that the global hash rate would go up so quickly – it doubled every four months…. [Even with co-location], someone was going to have to go well north of 10,000 units to even have a shot at achieving any meaningful economies of scale.
The other unknown in the mining business is what capital expenditures are required to keep up in the arms race between [application-specific integrated circuit] manufacturers. It’s not just a question of [cost], but if you have a large capital expenditure for production, you have to plan well in advance. It’s difficult to see what’s going to happen to the hash rates. They seem to have momentum that’s separate from the price market.
ThirtyK: Cryptocurrency prices have fallen dramatically from their lows last year, but if they rebound would that have an impact on your analysis?
Arumugam: If the hash rates continue to double every four months, to get a steady dollar revenue from your investment, the price also would have to double every four months, from $6,000 to $12,000, then to $24,000. That’s not realistic.
So the question you have to ask is when the [growth in the] hash rate is going to break, which people have not been doing. Then you have to answer the question about entering the mining business.
Out of Mining
ThirtyK: How did you think about the decision to exit mining?
Thillairajah: As an investment issuer, we knew our power was to analyze new opportunities in the space. One of Finzat’s founders was one of the godfathers of cryptography, and [others at Block One] had expertise in applied physics, machine learning and artificial intelligence. We had people on the ground around the globe as a function of pre-existing relationships developed over 15 to 20 years. So we started deploying the capital into taking equity stakes in early-stage blockchain enterprises.
“Although there are great technologies out there that on a three- to five-year scale will be meaningfully revenue generating, a lot of companies out there with good ideas will fail. I’d put that number generously at 90 percent.”
ThirtyK: How would you characterize the investment opportunities in today’s blockchain sector?
Thillairajah: In a bubble, valuations get stretched early and entrepreneurs tend to think their technology is worth more than it is. Even in this depressed market, we don’t think you could get the valuations we did early on in the space.
My own view is that although there are great technologies out there that on a three- to five-year scale will be meaningfully revenue generating, a lot of companies out there with good ideas will fail. I’d put that number generously at 90 percent.
It’s not that they aren’t bright or their ideas aren’t great. The various elements of blockchain technology are by their very nature disruptive. Early adopters will be open to adopting the technology, but the sustainable adoption of technology is dependent on the larger population, which is slower to adopt. For many, the [early-stage] revenue aren’t enough to sustain them.
ThirtyK: Where do you see the greatest opportunities?
Thillairajah: Places where capital is being deployed by [industries] interested in the blockchain space. Financial institutions have a clear interest in blockchain because [they realize] it’s going to be transformative in financial securities and markets in some period of time.
If you were going to look at a specific cryptocurrency exchange, you’d see the volumes are down to a fraction of the peak. But they seem to be the best [opportunity] at the moment because the financial institutions see them as long-term infrastructure.
ThirtyK: What are the key factors impacting the blockchain space?
Arumugam: There’s a confluence of two different factors. In a strongly moving market, timeframes get compressed. Everyone’s so eager to get on board, that pushes forward teams that aren’t necessarily well positioned to execute. They may have bright ideas and bright people, but they don’t have the industry experience to go in and shake things up.
The other thing is that one of the narratives that has driven a lot of price action for over a year now is this question of when and how the traditional financial industry will enter the blockchain space. One key thing about bitcoin and other cryptocurrencies is that most activity is transaction-related. Now that we’re a little more patient about [the sector], we can go back and look more closely at the space.
ThirtyK: What are the emerging trends you’re paying the most attention to?
Arumugam: The area I’m most interested in at the moment is the shifting away from mining 1.0 to mining 2.0, sometimes called generalized mining, and the development of coins based on proof of stake. [These models] require people to be actively involved in the governance and community of that coin. By far the biggest question has to do with trust. You’re moving from a trustless system to a heavily trust-based system. You need a team that’s capable of managing security and the active community presence to help with the governance of that coin. We’ve not seen that happen yet, but I think it’s something worth paying attention to.