The crypto space is known for its high levels of volatility and wide-ranging fluctuations. Even before the FTX debacle, the crypto landscape was a challenging and complex area to navigate. Understanding the technical aspects of blockchain technology and each unique coin can be cumbersome. Furthermore, thousands of different coins exist today with different protocols aimed at achieving different goals. As a result, cryptocurrencies can be risky, and investors should conduct extensive research before getting involved.
Before the birth of numerous cryptocurrencies, the industry started with one simple yet game-changing idea – decentralization. Cryptocurrencies gained popularity with the advent of the original cryptocurrency, Bitcoin. The pioneering cryptocurrency became prominent because individuals searched for a type of money that could not be controlled by government or a financial institution. Thanks to a pseudonymous character named Satoshi Nakamoto, the internet, blockchain technology, and a proof-of-work validation system, Bitcoin made it happen. While Bitcoin has taken a hit recently, it is hard to argue with its staggering returns since its inception. Even so, the recent downturn in the crypto market has brought to light other issues beyond falling prices. Ironically, lately, centralized cryptocurrency related firms have been getting in the most trouble. Today, we will cover three crypto-related companies to avoid for now:
Silvergate Bank SI
Silvergate Bank offers infrastructure solutions and services to the digital currency industry. The unique “crypto bank” was a beneficiary of the last equity and crypto bear market, seeing shares rise more than ten-fold in late 2020. From a fundamental perspective, the bank’s earnings have been stellar, with earnings sales rising and seeing double digit growth for several quarters in a row.
Image Source: Zacks Investment Research
Pictured: SI Debt/Equity
However, the underlying fundamental picture presents some issues.
· Leverage is increasing, as can be seen on the debt-to-equity chart above.
· Zacks Consensus EPS Estimates have been falling rapidly in recent months.
· Silvergate recently lent $200 million to Microstrategy MSTR
· The now-bankrupt FTX was a client of Silvergate. Lawmakers such as Senator Elizabeth Warren are demanding answers about the company’s dealings with FTX.
Investors are skittish over how deeply involved Silvergate was with FTX. Since FTX’s bankruptcy, little information has emerged from regulators investigating the situation. Famed short seller Marc Cohodes, who is well known for exposing the fraud at mortgage lender Novastar Financial, is sounding the alarm about the firm’s risk management practices. Prior to FTX’s bankruptcy, Cohodes attempted to warn investors about FTX.
Marathon Digital MARA
Marathon Digital is one of a handful of publicly traded crypto mining companies. In other words, the firm invests in mining rigs to solve complex mathematical equations to validate crypto transactions and gets paid to do so. As one could imagine, the company’s business has deteriorated along with most crypto-related stocks in the recent “crypto winter”.
Image Source: Zacks Investment Research
Pictured: MARA return on assets for the trailing twelve month period
For shares of Marathon Digital, the math is simple. When crypto falls like as it has, the company’s margins get squeezed. EPS has gone from $0.36 for the December 2021 quarter to $-0.65 in the last reported quarter. To make matters worse, Marathon revealed to investors that the firm had some $80 million in exposure to bankrupt data center Compute North Holdings. With crypto spiraling downward and no end in sight, there are better areas to bottom fish.
Microstrategy (MSTR)
Microstrategy was born as a software company but has transformed into a Bitcoin bag holder proxy. The strategy works well when Bitcoin goes up and not so well when it goes down. See chart below:
Image Source: Zacks Investment Research
Pictured: MSTR 5-year performance
For now, Bitcoin is steeped in a downtrend that has dragged on for months. Even more concerning is that the firm owns some 130,000 coins at an average price of around $30,000. In other words, the position is deeply under-water.
Investor Outlook for Crypto
An old Wall Street adage warns, “don’t try catch a falling knive.” The sentiment seems to hold now for the crypto space and crypto-related entities. In 2022 alone we have seen:
· Crypto lenders such as Celsius blow up.
· Assets like FTT and Luna lose most of their value in under a week.
· Money mangers like Three Arrows Capital fold.
· Exchanges such as FTX go bankrupt under suspicious circumstances.
Luckily most investors have autonomy over what they wish to invest in. Due to the extreme moves to the downside in publicly traded crypto names, the space is no longer a juicy short candidate, however investors should wait for more clarity in the form of investigations and regulation before jumping back in.
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