BTCS Inc. 10-Q

ITEM 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of financial condition and results of operations should be read in conjunction with our historical financial statements and the notes to those statements that appear elsewhere in this report. Certain statements in the discussion contain forward-looking statements based upon current expectations that involve risks and uncertainties, such as plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those discussed in the Risk Factors contained in our Annual Report on Form 10-K for the year ended December 31, 2021. When we refer to the “2022 Quarter” and the “2021 Quarter” we are referring to the three months ended March 31, 2022 and March 31, 2021 quarters, respectively. Additionally, the twelve months ending December 31, 2022 is referred to as “Fiscal 2022.” Overview BTCS is an early entrant in the Digital Asset market and one of the first U.S. publicly-traded companies to focus on Digital Assets and blockchain technologies. Through our blockchain-infrastructure operations, we secure disruptive next-generation blockchains and operate validator nodes on various proof of stake-based blockchain networks, earning rewards of additional Digital Assets by actively validating transactions on the networks. While this process is similar to Bitcoin mining the consensus mechanism is different. Now we are building on the foundation of our pre-established infrastructure with the development of a Digital Asset Platform. The first feature of the dashboard, which is an open beta, allows users to evaluate their Digital Asset portfolios from multiple exchanges on a single platform. We also are developing and plan to integrate into the platform a Staking-as-a-Service feature that, once launched, will allow users to participate in asset leveraging through securing blockchain protocols. Blockchain Infrastructure Blockchain infrastructure operations can broadly be defined as earning a reward for securing a blockchain by validating transactions on that blockchain. There are currently two main consensus mechanisms used to secure blockchains: i) proof-of-work (“PoW”), in which nodes dedicate computational resources, and ii) proof-of-stake (“PoS”), in which nodes dedicate financial resources. The intention behind both PoW and PoS is to make it practically impossible for any single malicious actor to have enough computational power or ownership stake to successfully attack the blockchain. In the case of PoW, a miner does “work” using energy-consuming computers and is rewarded for this “work” with Digital Assets. The miner, typically through pools running nodes, validates transactions on the blockchain, essentially converting electricity and computing power into a digital currency reward comprised of transaction fees and newly-minted Digital Assets. Bitcoin is an example of PoW and is by far the largest and most secure PoW blockchain. PoS miners, often referred to as validators in PoS systems, actively operate nodes and validate transactions. Validators are required to stake holdings of a digital currency to participate in the consensus algorithm and are rewarded in tokens for aligning behavior with the rules of the algorithm. Bad behavior can be penalized by “slashing” the validator’s holdings and/or rewards. Validators can also be removed from the network for breaking the rules. Ill-intentioned behavior among validators is discouraged, allowing for the blockchain to be properly maintained and secured. Compared to PoW, PoS blockchains require less energy. Depending on the PoS blockchain protocol, native token holders have the opportunity to leverage their asset holdings by either delegating their rights to a validator (“Delegating”), staking their token holdings in a staking pool (“Staking”), or running their own validator (“Pooling”). With Delegating, token holders indirectly participate by maintaining control of their private keys and delegating their tokens to an existing validator. Therefore, delegating is more akin to assigning voting rights of stock to another person or entity via a power of attorney. With Pooling, an operator and token holder combine tokens in order to improve the constituents’ collective odds of validating new blocks, and typically the operator takes custody of token holders funds i.e. private keys. If chosen for validation, the group is rewarded in tokens. With both Delegating and Pooling, the validator operators earn a fee for providing the technical capabilities of running a node 24/7 that requires regular, active maintenance and industry expertise. BTCS uses its blockchain infrastructure to operate validator nodes on various proof of stake-based blockchain networks. In connection with the validation of transactions occurring on those blockchain networks, BTCS will stake the Digital Assets native to those blockchains on the validator nodes it operates in order to earn staking rewards. BTCS may also use its blockchain infrastructure to validate and sign transactions on behalf of customers that delegate their validation and voting rights to BTCS-operated validator nodes (referred to as “Staking-as-a-Service” or “StaaS”). A StaaS provider maintains an active role in validating transactions on a given PoS network on behalf of its delegators by (1) arranging transactions using software to stake the relevant Digital Assets; (2) monitoring the nodes it is operating to ensure they remain online, ready to validate transactions; and (3) verifying transactions on the network when required to earn rewards. 19 Apart from Bitcoin and Ethereum, all of the Company’s Digital Asset holdings are in tokens secured by PoS or similar consensus mechanisms that allow for Delegating and asset leveraging. The Company is currently actively operating validator nodes on Ethereum’s beacon chain, Cardano, Tezos, Avalanche, Kusama, and Cosmos. The Company has also staked the following tokens Polkadot, Terra, Algorand, and Solana. Building on that base, the Company plans to expand its PoS operations to secure other disruptive blockchain protocols that also allow for delegating. The Company believes its blockchain infrastructure efforts will form the core growth for its Digital Asset Platform. The Company utilizes cloud infrastructure to operate and run its validator nodes and does not maintain its own physical assets, but may add this infrastructure in the future. The Company currently holds the following Digital Assets which are core to its blockchain infrastructure efforts. The table also includes Bitcoin which is not core to our infrastructure operations. Digital Assets Held at Period End Asset 2021Q1 2021Q2 2021Q3 2021Q4 2022Q1 Bitcoin (BTC) 90 90 90 90 90 Ethereum (ETH) 7,733 7,879 7,992 8,098 8,196 Cardano (ADA) 257,757 257,757 257,757 257,757 Kusama (KSM) 123 374 374 5,278 Tezos (XTZ) 14,966 24,172 24,504 70,453 Solana (SOL) 4,788 4,779 7,043 Polkadot (DOT) 8,032 8,032 38,816 Terra (LUNA) 3,584 3,584 3,621 Cosmos (ATOM) 3,072 3,072 80,474 Polygon (MATIC) 67,114 67,114 454,486 Avalanche (AVAX) 2,025 2,073 14,273 Algorand (ALGO) 50,584 51,103 51,197 Axie Infinity (AXS) 22,322 Kava (KAVA) 183,966 20 Fair Market Value of Digital Assets at Period End Asset 2021Q1 2021Q2 2021Q3 2021Q4 2022Q1 Bitcoin (BTC) $ 5,302,695 $ 3,153,675 $ 3,941,180 $ 4,167,579 $ 4,098,481 Ethereum (ETH)* $ 14,833,709 $ 17,920,148 $ 23,990,541 $ 29,820,477 $ 26,894,723 Cardano (ADA) $ 356,600 $ 545,028 $ 337,716 $ 294,320 Kusama (KSM) $ 26,501 $ 123,957 $ 103,866 $ 992,851 Tezos (XTZ) $ 45,495 $ 146,914 $ 106,679 $ 262,023 Solana (SOL) $ 675,373 $ 813,791 $ 863,854 Polkadot (DOT) $ 229,558 $ 214,616 $ 826,875 Terra (LUNA) $ 138,351 $ 306,353 $ 373,005 Cosmos (ATOM) $ 111,252 $ 99,761 $ 2,325,374 Polygon (MATIC) $ 75,644 $ 169,604 $ 735,034 Avalanche (AVAX) $ 135,191 $ 226,499 $ 1,383,403 Algorand (ALGO) $ 82,381 $ 84,830 $ 47,492 Axie Infinity (AXS) $ 1,416,264 Kava (KAVA) $ 828,742 Total $ 20,136,404 $ 21,502,420 $ 30,195,370 $ 36,451,772 $ 41,342,441 QoQ Change 411 % 7 % 40 % 21 % 13 % YoY Change 7516 % 2013 % 1780 % 825 % 105 % * Approximately 9 ETH is not staked on Ethereum 2.0’s Beacon Chain. 21 Prices of Digital Assets at Period End Asset 2021Q1 2021Q2 2021Q3 2021Q4 2022Q1 Bitcoin (BTC) $ 58,919 $ 35,041 $ 43,791 $ 46,306 $ 45,539 Ethereum (ETH) $ 1,918 $ 2,275 $ 3,002 $ 3,683 $ 3,282 Cardano (ADA) $ 1.38 $ 2.11 $ 1.31 $ 1.14 Kusama (KSM) $ 215 $ 331 $ 278 $ 188 Tezos (XTZ) $ 3.04 $ 6.08 $ 4.35 $ 3.72 Solana (SOL) $ 141 $ 170 $ 123 Polkadot (DOT) $ 28.58 $ 26.72 $ 21.30 Terra (LUNA) $ 38.60 $ 85.47 $ 103 Cosmos (ATOM) $ 36.21 $ 32.47 $ 28.90 Polygon (MATIC) $ 1.13 $ 2.53 $ 1.62 Avalanche (AVAX) $ 66.77 $ 109 $ 96.92 Algorand (ALGO) $ 1.63 $ 1.66 $ 0.93 Axie Infinity (AXS) $ 63.45 Kava (KAVA) $ 4.50 * The prices have been rounded to the nearest whole dollar for prices above $100 Digital Asset Platform The Company is also developing a proprietary Digital Asset Platform aimed at allowing users to evaluate their crypto portfolio holdings across multiple exchanges and chains on a single platform. The internally-developed dashboard utilizes Digital Asset exchange APIs to read user data and does not allow for the trading of assets. In addition to portfolio monitoring, we are also working to integrate a full suite of other features including decentralized exchanges, wallets, risk metrics and potentially a way for users to calculate end-of year-reports for tax purposes. We believe that increasing the number of features we offer may create a sticky user experience across multiple, interrelated products. The Company is also currently developing and plans to integrate into the Digital Asset Platform a proprietary Staking-as-a-Service feature aimed at allowing users to delegate supported cryptocurrencies through a non-custodial platform to BTCS operated validator nodes. Staking allows users to generate an annual percentage yield (“APY”) on their staked assets whereas validator node operators charge a fee on users’ staked asset rewards earned in addition to earning an APY on staked assets. In turn, the highly scalable nature of both staking Digital Assets as well as allowing users to stake Digital Assets to earn token rewards is the premise behind BTCS’ Staking-as-a-Service platform. Digital Asset Treasury Strategy The Company employs a Digital Asset treasury strategy with a primary focus on disruptive protocol layer assets such as Bitcoin which are not able to be staked (i.e. non-productive). They are distinct from Digital Assets used as the foundation for our blockchain infrastructure operations previously discussed. The Company’s Digital Asset treasury holding is comprised of 90 Bitcoins as set forth above. The Company is not limiting its assets to a single type of Digital Asset and may hold a variety of Digital Assets. The Company will carefully review its purchases of digital securities to avoid violating the Investment Company Act of 1940 and seek to reduce potential liabilities under the federal securities laws. The market is rapidly evolving and there can be no assurances that we will be competitive with industry participants that have or may have greater resources than us. 22 Non-GAAP financial measure In addition to our results determined in accordance with GAAP, we believe Adjusted EBITDA, a non-GAAP measure, is useful in evaluating our operating performance. We believe that Adjusted EBITDA may be helpful to investors because it provides consistency and comparability with past financial performance and the economic realities of our business. However, Adjusted EBITDA is presented for supplemental informational purposes only, has limitations as an analytical tool, and should not be considered in isolation or as a substitute for financial information presented in accordance with GAAP. Among other non-cash and non-recurring items, Adjusted EBITDA excludes stock-based compensation expense (including stock-based compensation issued to service providers), which has recently been, and will continue to be for the foreseeable future, a significant recurring expense for our business and an important part of our compensation strategy. In addition, other companies, including companies in our industry, may calculate similarly titled non-GAAP measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures as tools for comparison. A reconciliation is provided below for each non-GAAP financial measure to the most directly comparable financial measure stated in accordance with GAAP. Investors are encouraged to review the related GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures, and not to rely on any single financial measure to evaluate our business. We calculate Adjusted EBITDA as net income (loss), adjusted to exclude, depreciation and amortization, interest expense, change in fair value of warrant liabilities, and stock-based compensation expense (including stock-based compensation issued to service providers). Adjusted EBITDA presented does not include adjustments for impairment of intangible Digital Assets. The following table provides a reconciliation of net income (loss) to Adjusted EBITDA: Three Months Ended March 31, 2022 2021 Net income (loss) $ (5,740,743 ) $ (6,782,175 ) Adjusted to exclude the following: Depreciation and amortization 797 562,096 Interest expense - 54,247 Change in fair value of warrant liabilities 641,250 - Stock-based compensation 1,364,276 7,281,477 Adjusted EBITDA (3,734,420 ) 1,115,645 23 Results of Operations for the Three Months Ended March 31, 2022 and 2021 The following table reflects our operating results for the three months ended March 31, 2022 and 2021: For the Three Months Ended March 31, $ Change % Change 2022 2021 2022 2022 Revenues Validator revenue $ 563,015 $ 72,524 $ 490,491 676 % Total revenues 563,015 72,524 490,491 676 Cost of revenues Validator expense 137,869 14,996 122,873 819 Gross profit 425,146 57,528 367,618 639 Operating expenses: General and administrative $ 650,289 $ 553,981 $ 96,308 17 % Research and development 136,718 82,933 53,784 65 Compensation and related expenses 1,423,896 7,337,679 (5,913,784 ) (81 ) Marketing 41,793 1,421 40,372 2,841 Total operating expenses 2,252,696 7,976,014 (5,723,318 ) (72 ) Other income (expenses): Interest expense - (54,247 ) 54,247 (100 ) Amortization on debt discount - (562,096 ) 562,096 (100 ) Change in fair value of warrant liabilities (641,250 ) - (641,250 ) N/A Distributions to warrant holders (35,625 ) - (35,625 ) N/A Impairment loss on digital assets/currencies (3,307,428 ) (1,301,764 ) (2,005,664 ) 154 Realized gains (loss) on digital asset/currency transactions 71,110 3,054,418 (2,983,308 ) 98 Total other income (expenses) (3,913,193 ) 1,136,311 (5,049,505 ) 444 Net loss $ (5,740,743 ) $ (6,782,175 ) 1,041,342 (15 ) Deemed dividends related to amortization of beneficial conversion feature of Series C-2 convertible preferred stock - (16,176 ) 16,176 (100 ) Deemed dividends related to recognition of downround adjustment to conversion amount for Series C-2 convertible preferred stock - (4,822,220 ) 4,822,220 (100 ) Net loss attributable to common stockholders $ (5,740,743 ) $ (11,620,571 ) 5,879,828 (51 ) 24 Validator Revenue Revenue for the three months ended March 31, 2022 and 2021 were approximately $563,000 and $73,000, respectively. The increase is from our blockchain infrastructure validating revenue. We believe revenues will increase as the Company continues to expand its blockchain infrastructure efforts. Cost of Revenues Cost of revenues for the three months ended March 31, 2022 and 2021 were approximately $138,000 and $15,000, respectively. The increase is from our blockchain infrastructure validating operating costs, including, web service hosting fees, and cash and stock-based compensation related to services provided by vendors. We believe our cost of revenues will increase as we continue to ramp up our business. However, we believe gross margin will improve as we add scale to our blockchain infrastructure operations, leading to improved gross profits. Operating Expenses Operating expenses for the three months ended March 31, 2022 and 2021 were approximately $2.2 million and $8.0 million. The decrease is primarily due to $7.3 million non-cash contingent bonuses granted to employees and our non-employee director during 2021 for the achievement of performance milestones. The equity compensation was not valued based on the Company’s stock price of $0.19, the last closing date prior to the date of issuance of January 1, 2021 but instead, in accordance with GAAP, valued as of March 31, 2021 (the date the Company received stockholder ratification). On that date, the Company’s stock price was $1.03 which caused the significant corresponding stock compensation expense. We believe operating expenses will remain consistent as the Company continues to utilize equity-based bonus incentives as a core part of its compensation strategy. Other Income (Expenses) Other income (expenses) for the three months ended March 31, 2022 and 2021 was approximately $(3.9) million and $1.1 million, respectively. The increase in other income is primarily from $3.3 million impairment loss on digital assets/currencies and $0.6 million change in fair value of warrant liabilities. Net loss Net loss for the three months ended March 31, 2022 and 2021 was approximately $5.7 million and $6.8 million, respectively. The decrease is primarily due to the decrease of operating expenses and increase in other income (expense) as discussed above. Net loss attributable to common stockholders We incurred approximately $0 and $16,000 related to amortization of beneficial conversion feature of Series C-2 convertible preferred stock, and $0 and $4.8 million of deemed dividends related to recognition of anti-dilution adjustment to the conversion amount for Series C-2 convertible preferred stock for the three months ended March 31, 2022 and 2021, respectively. Liquidity and Capital Resources Recent Financing On September 14, 2021, the Company entered into an At-The-Market Offering Agreement (the “ATM Agreement”) with H.C. Wainwright & Co., LLC, as agent (“H.C. Wainwright”), pursuant to which the Company may offer and sell, from time-to-time through H.C. Wainwright, shares of the Company’s Common Stock having an aggregate offering price of up to $98,767,500. From the period September 14, 2021 through May 9, 2022, the Company sold a total of 2,268,742 shares of Common Stock under the ATM Agreement for aggregate total gross proceeds of approximately $13,874,000 at an average selling price of $6.12 per share, resulting in net proceeds of approximately $13,440,000 after deducting commissions and other transaction costs. Liquidit y The Company’s financial statements have been prepared assuming that it will continue as a going concern, which contemplates continuity of operations, realization of assets, and liquidation of liabilities in the normal course of business. 25 Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations, and otherwise operate on an ongoing basis. At March 31, 2022, the Company had approximately $2.6 million of liquid Digital Assets (i.e. non-staked) and $2.2 million of cash. As of March 31, 2022, we held approximately 90 bitcoins that composed a majority of our non-staked liquid Digital Asset balance. We do not believe we will need to sell any of our bitcoins within the next twelve months to meet our working capital requirements, although we may from time to time sell bitcoins as part of treasury management operations, including to increase our cash balances. The Bitcoin market historically has been characterized by significant volatility in its price, limited liquidity and trading volumes compared to sovereign currencies markets, relative anonymity, a developing regulatory landscape, susceptibility to market abuse and manipulation, and various other risks inherent in its entirely electronic, virtual form and decentralized network. During times of instability in the Bitcoin market, we may not be able to sell our bitcoins at reasonable prices or at all. As a result, our bitcoins are less liquid than our existing cash and cash equivalents and may not be able to serve as a source of liquidity for us to the same extent as cash and cash equivalents. In addition, upon sale of our bitcoin, we may incur additional taxes related to any realized gains or we may incur capital losses as to which the tax deduction may be limited. We view our crypto asset investments as long-term holdings and we do not plan to engage in regular trading of crypto assets. During times of instability in the market of crypto assets, we may not be able to sell our crypto assets at reasonable prices or at all. As a result, our crypto assets are less liquid than our existing cash and cash equivalents and may not be able to serve as a source of liquidity for us to the same extent as cash and cash equivalents. As of May 9, 2022, the Company had approximately $1.9 million of cash and the fair market value of the Company’s liquid Digital Assets was approximately $8.7 million, which excludes $18.7 million of staked Ethereum. The Company had no notes payable or any other long-term debt outstanding. As of May 9, 2022, the Company also has approximately $18.2 million available under the At the Market Offering Agreement over the next twelve months under the Form S-3 baby shelf rules, although, the amount that we may raise under the Form S-3 may increase or decrease based upon our then stock price. The Company believes that the existing cash and liquid Digital Assets held by us, in addition to the funds available to the Company from the issuance of additional stock through the ATM Agreement, provide sufficient liquidity to meet working capital requirements, anticipated capital expenditures and contractual obligations for at least the next twelve months. Cash Flows Cash used in operating activities was $1.1 million during the three months ended March 31, 2022 compared to $2.5 million for the three months ended March 31, 2021. Cash used in investing activities was $8.2 million during the three months ended March 31, 2022 compared to $8.0 million for the three months ended March 31, 2021. Net cash outflow for investing activities was used primarily for the purchase of Digital Assets for blockchain infrastructure operations. Cash provided by financing activities was $10.1 million during the three months ended March 31, 2022 compared to $13.4 million for the three months ended March 31, 2021. The cash inflows from financing activities were primarily from proceeds from the Common Stock sold pursuant to the ATM Agreement ($10.5 million). This was partially offset by a one time return of capital distribution of $635,000 made to record holders as of March 17, 2022. The Company has plans to continue to raise proceeds from the sale of Common Stock and issuance of debt to fund operations as needed. Off Balance Sheet Transactions As of March 31, 2022, there were no off-balance sheet arrangement and we were not a party to any off-balance sheet transactions. We have no guarantees or obligations other than those which arise out of normal business operations. 26 RECENT ACCOUNTING PRONOUNCEMENTS For information on recent accounting pronouncements, see Note 3 to the Unaudited Condensed Financial Statements. ITEM 3 Quantitative and Qualitative Disclosures About Market Risk Not applicable.