Noelle Acheson is a veteran of company analysis and member of CoinDesk's product team.
The following article originally appeared in Institutional Crypto by CoinDesk, a newsletter for the institutional market, with news and views on crypto infrastructure delivered every Tuesday. Sign up here.
Last week, CoinDesk was first to give its readers a glimpse at the application documents of the much-anticipated initial public offering (IPO) of Bitmain, a mining chip manufacturer and one of the cryptocurrency sector's largest companies in terms of revenue.
What does this have to do with investing in cryptocurrencies, you may ask?
It signals the emergence of a new type of crypto investment – actual (*gasp*) shares in a listed company. Yes, a bet on the financials, operating strength and macro outlook of a business. But with a difference.
The difference is the exposure to cryptocurrencies. And here is where things get complicated.
Pure play?
Bitmain's cryptocurrency holdings account for 28 percent of its total assets. Does that make it effectively a soon-to-be-listed crypto fund, as some have suggested?
No. While cryptocurrencies have significant weight in the health of the business, the other assets (largely physical inventory and financial instruments) offer different types of risk and diversification.
What's more, the cryptocurrencies are valued at cost. They will not be revalued if the cryptocurrency price increases, so a bull market will not have a direct impact on the balance sheet. (It will, obviously, have a positive impact on sales of mining equipment and on profit from cryptocurrency sales.)
Nor will they necessarily be written down if the price falls. As the draft prospectus states, "if circumstances indicate that the carrying amount of cryptocurrencies may not be recoverable, an impairment loss may be recognized" (my emphasis).
It's not clear how that carrying amount breaks down - the prospectus says that it's calculated using the weighted average of cost. Since over $700 million-worth of crypto entered the balance sheet in the second half of 2017, we can presume that the bulk of that was at prices higher than today's.
In the first half of 2018, Bitmain logged an "impairment loss" of over $100 million. Given that a large chunk of the crypto holdings is apparently in bitcoin cash, it's notable that the write-down wasn't larger.
There could well be more coming in the second half of the year, which will have a negative effect on the bottom line. But it's worth noting that, under the accounting principles Bitmain is using, an impairment loss can be reversed if market conditions change.
It's also worth noting that, in spite of the weak markets so far this year, Bitmain earned over $180 million of profit on cryptocurrency sales in the first half.
So, while the cryptocurrency markets largely determine the health of its business, Bitmain is not a pure cryptocurrency play. And, on top of market volatility, we have to add the additional risks of operational error, declining margins, supplier concentration, technology obsolescence, increasing competition and financial mismanagement.
Not to mention security – in 2017, Bitmain suffered the theft of almost $27 million-worth of cryptocurrencies. No details are given in the draft prospectus of its custody arrangements.
Something different
So what type of investment is Bitmain? A manufacturing company? A mining stock?
Just as we struggle to fit cryptocurrencies into the pre-established categories of financial instruments, it is hard to label Bitmain as well.
It is a business that makes a physical product. It also produces a virtual asset, and offers a service to others in the sector. Then, there's its exposure – direct and indirect – to the cryptocurrency markets. As the application recognizes: "Our business and financial condition correlate closely with the market price of cryptocurrencies."
Will its share price move in line with the price of bitcoin or bitcoin cash? We don't know.
That makes it not just a new type of crypto investment, but a new type of investment, period.
Values
Does this make Bitmain a good investment?
It does have a staggering historical revenue growth, and a dominant position in its sector. What's more, it is diversifying into artificial intelligence chip design, and spreading its geographical concentration.
But whether or not it is a good opportunity depends 1) on your market view, 2) your opinion of the management and assessment of the risks, and 3), even more important, on the IPO price. Fundamentals are crucial, obviously – but the key metric is perceived value.
As Howard Marks of Oaktree Capital Management put it: "It's not what you buy, it's what you pay."
Looking forward, the Bitmain IPO is especially encouraging in that it sets a benchmark for others to follow. It's not the only one in the pipeline – two more (Canaan and Ebang) have publicly expressed their intention to file for a listing, and we eagerly await a chance to see their financials. Others will no doubt follow, and not just from the mining segment.
This does much more than present investors with a wider range of crypto-focused assets to choose from. It also brings in even more participants from traditional finance (investors, analysts, investment bankers, even more lawyers), which, while possibly betraying crypto's "alternative" origins, narrows the gap between the two concepts and bestows even greater legitimacy on cryptocurrencies as a product.
Perhaps even more important is that both investors and entrepreneurs will be armed with a deeper well of information. Greater transparency and a better understanding of how the sector works should contribute to a more resilient infrastructure, which in turn will generate a greater variety of investment and financing opportunities. Whatever happens to the cryptocurrency markets, surely there is value in that.
Jihan Wu image via CoinDesk Consensus archives