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 June 30, 2022 and June 30, 2021 quarters, respectively. Further, when we refer to the “2022 Period” and the “2021 Period” we are referring to the six months ended June 30, 2022 and June 30, 2021 periods, 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 running their own validator (“Validating”) or delegating their rights to a validator (“Delegating” or “Staking”). With Delegating or Staking, token holders indirectly participate in blockchain networks 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 Validating, a node operator and token holder combine tokens in order to improve the node’s collective odds of earning token rewards for successfully validating new transactions and blocks on the network. With both Delegating and Validating, 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 “SaaS”). A SaaS 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. 21 Apart from 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, Cosmos, Kava, Tezos, Avalanche, Kusama, Polygon and Cardano. The Company has also staked the following tokens Polkadot, Algorand, Axie Infinity 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 2021Q2 2021Q3 2021Q4 2022Q1 2022Q2 Bitcoin (BTC) 90 90 90 90 - Ethereum (ETH) 7,879 7,992 8,098 8,196 8,283 Cardano (ADA) 257,757 257,757 257,757 257,757 260,555 Kusama (KSM) 123 374 374 5,278 5,550 Tezos (XTZ) 14,966 24,172 24,504 70,453 71,369 Solana (SOL) 4,788 4,779 7,043 7,136 Polkadot (DOT) 8,032 8,032 38,816 39,986 Terra (LUNA) 3,584 3,584 3,621 - Cosmos (ATOM) 3,072 3,072 80,474 86,613 Polygon (MATIC) 67,114 67,114 454,486 466,022 Avalanche (AVAX) 2,025 2,073 14,273 14,594 Algorand (ALGO) 50,584 51,103 51,197 51,201 Axie Infinity (AXS) 22,322 31,763 Kava (KAVA) 183,966 264,917 22 Fair Market Value of Digital Assets at Period End Asset 2021Q2 2021Q3 2021Q4 2022Q1 2022Q2 Bitcoin (BTC) $ 3,153,675 $ 3,941,180 $ 4,167,579 $ 4,098,481 $ - Ethereum (ETH)* $ 17,920,148 $ 23,990,541 $ 29,820,477 $ 26,894,723 $ 8,840,595 Cardano (ADA) $ 356,600 $ 545,028 $ 337,716 $ 294,320 $ 119,555 Kusama (KSM) $ 26,501 $ 123,957 $ 103,866 $ 992,851 $ 267,583 Tezos (XTZ) $ 45,495 $ 146,914 $ 106,679 $ 262,023 $ 101,102 Solana (SOL) $ 675,373 $ 813,791 $ 863,854 $ 239,700 Polkadot (DOT) $ 229,558 $ 214,616 $ 826,875 $ 281,496 Terra (LUNA) $ 138,351 $ 306,353 $ 373,005 $ - Cosmos (ATOM) $ 111,252 $ 99,761 $ 2,325,374 $ 651,909 Polygon (MATIC) $ 75,644 $ 169,604 $ 735,034 $ 222,466 Avalanche (AVAX) $ 135,191 $ 226,499 $ 1,383,403 $ 247,059 Algorand (ALGO) $ 82,381 $ 84,830 $ 47,492 $ 16,115 Axie Infinity (AXS) $ 1,416,264 $ 461,649 Kava (KAVA) $ 828,742 $ 468,634 Total $ 21,502,420 $ 30,195,370 $ 36,451,772 $ 41,342,441 $ 11,917,863 QoQ Change 7 % 40 % 21 % 13 % -71 % YoY Change 2013 % 1780 % 825 % 105 % -45 % * Approximately 9 ETH is not staked. 23 Prices of Digital Assets at Period End Asset 2021Q2 2021Q3 2021Q4 2022Q1 2022Q2 Bitcoin (BTC) $ 35,041 $ 43,791 $ 46,306 $ 45,539 $ 19,785 Ethereum (ETH) $ 2,275 $ 3,002 $ 3,683 $ 3,282 $ 1,067 Cardano (ADA) $ 1.38 $ 2.11 $ 1.31 $ 1.14 $ 0.46 Kusama (KSM) $ 215 $ 331 $ 278 $ 188 $ 48 Tezos (XTZ) $ 3.04 $ 6.08 $ 4.35 $ 3.72 $ 1.42 Solana (SOL) $ 141 $ 170 $ 123 $ 34 Polkadot (DOT) $ 28.58 $ 26.72 $ 21.30 $ 7.04 Terra (LUNA) $ 38.60 $ 85.47 $ 103 $ - Cosmos (ATOM) $ 36.21 $ 32.47 $ 28.90 $ 7.53 Polygon (MATIC) $ 1.13 $ 2.53 $ 1.62 $ 0.48 Avalanche (AVAX) $ 66.77 $ 109 $ 96.92 $ 16.93 Algorand (ALGO) $ 1.63 $ 1.66 $ 0.93 $ 0.31 Axie Infinity (AXS) $ 63.45 $ 14.53 Kava (KAVA) $ 4.50 $ 1.77 * 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 to BTCS operated validator nodes through a non-custodial platform. 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. 24 Results of Operations for the Three and Six Months Ended June 30, 2022 and 2021 The following tables reflect our operating results for the three and six months ended June 30, 2022 and 2021: For the Three Months Ended June 30, $ Change % Change 2022 2021 2022 2022 Revenues Validator revenue $ 514,349 $ 380,499 $ 133,850 35 % Total revenues 514,349 380,499 133,850 35 Cost of revenues Validator expense 93,900 59,249 34,651 58 Gross profit 420,449 321,250 99,199 31 Operating expenses: General and administrative $ 512,051 $ 312,967 $ 199,084 64 % Research and development 185,004 245,336 (60,332 ) (25 ) Compensation and related expenses 638,025 1,703,771 (1,065,746 ) (63 ) Marketing 23,691 1,365 22,326 1,636 Impairment loss on digital assets/currencies 8,894,797 2,267,374 6,627,423 292 Realized gains on digital asset/currency transactions (398,446 ) - (398,446 ) N/A Total operating expenses 9,855,122 4,530,813 5,324,309 118 Other income (expenses): Interest expense - (59,835 ) 59,835 (100 ) Amortization on debt discount - (572,675 ) 572,675 (100 ) Change in fair value of warrant liabilities 1,710,000 - 1,710,000 N/A Distributions to warrant holders - - - N/A Total other income (expenses) 1,710,000 (632,510 ) 2,342,510 370 Net loss $ (7,724,673 ) $ (4,842,073 ) (2,882,600 ) 60 25 For the Six Months Ended June 30, $ Change % Change 2022 2021 2022 2022 Revenues Validator revenue $ 1,077,364 $ 453,023 $ 624,341 138 % Total revenues 1,077,364 453,023 624,341 138 Cost of revenues Validator expense 231,769 74,245 157,524 212 Gross profit 845,595 378,778 466,817 123 Operating expenses: General and administrative $ 1,162,340 $ 866,948 $ 295,392 34 % Research and development 321,722 328,269 (6,547 ) (2 ) Compensation and related expenses 2,061,921 9,041,450 (6,979,529 ) (77 ) Marketing 65,484 2,786 62,698 2,250 Impairment loss on digital assets/currencies 12,202,225 3,569,138 8,633,087 242 Realized gains on digital asset/currency transactions (469,556 ) (3,054,418 ) 2,584,862 85 Total operating expenses 15,344,136 10,754,173 4,589,963 43 Other income (expenses): Interest expense - (114,082 ) 114,082 (100 ) Amortization on debt discount - (1,134,771 ) 1,134,771 (100 ) Change in fair value of warrant liabilities 1,068,750 - 1,068,750 N/A Distributions to warrant holders (35,625 ) - (35,625 ) N/A Total other income (expenses) 1,033,125 (1,248,853 ) 2,281,978 183 Net loss $ (13,465,416 ) $ (11,624,248 ) (1,841,168 ) 16 26 Validator Revenue The increase in revenue during the 2022 Quarter and 2022 Period as compared to the 2021 Quarter and 2021 Period is from our blockchain infrastructure validating revenue. We believe revenues will decrease for the period ending September 30, 2022 and potentially for the remainder of 2022 as a result of decline in market prices of the Digital Assets we have earned and/or purchased. Cost of Revenues The increase in cost of revenues is due to 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 and reduce costs as a result of increased operational efficiencies, leading to improved gross profits. Operating Expenses The increase in operating expenses in the 2022 Quarter is primarily due to the $8.9 million impairment loss on Digital Assets (“Digital Asset Impairment”) in the 2022 Quarter, compared to only $2.3 million Digital Asset Impairment in the 2021 Quarter. This is partially offset by the $1.6 million non-cash contingent bonuses granted to employees and our non-employee directors during the 2021 Quarter for the achievement of performance milestones. The increase in operating expenses in the 2022 Period is primarily due to the $12.2 million Digital Asset Impairment in the 2022 Period, compared to only $3.6 million Digital Asset Impairment in the 2021 Period. This is partially offset by the $8.7 million non-cash contingent bonuses granted to employees and our non-employee directors during the 2021 Period for the achievement of performance milestones. 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. However, volatility in the Digital Asset markets will subject the Company to the possibility of additional impairment charges on its Digital Asset holdings. The Company is evaluating additional opportunities to reduce costs. As part of our cost cutting measures, in June 2022, the Board of Directors reduced all director fees for 2022 from $50,000 to $25,000 and reduced the Audit, Compensation and Nominating and Corporate Governance committee chair fees for 2022 to $5,000. Additionally, Charles Allen and Michal Handerhan, the Company’s Chief Executive Officer and Chief Operating Officer, respectively, agreed to forfeit $25,000 of their annual base salaries for 2022. Collectively, these cost-cutting measures will result in cost savings of approximately $141,000, which the Company will see primarily in the next two quarters. Other Income (Expenses) The increase in other income for the periods reported was primarily due to the decrease in the fair value of warrant liabilities. This non-cash expense is driven by the value of our stock price at the end of each quarter which we cannot predict. Net loss The increase in our net loss for the periods reported was primarily due to the increase in operating expenses and increase in other income (expense) as discussed above. We believe that our net loss will increase as the Company incurs increased costs related to the development of its Digital Asset Platform and incurs additional Digital Asset Impairment losses due to volatility in the Digital Asset markets. 27 Liquidity and Capital Resources ATM 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 August 8, 2022, the Company sold a total of 2,559,122 shares of Common Stock under the ATM Agreement for aggregate total gross proceeds of approximately $14,340,000 at an average selling price of $5.60 per share, resulting in net proceeds of approximately $13,888,000 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. 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 June 30, 2022, the Company had approximately $2.5 million of liquid Digital Assets (i.e. non-staked) and $3.2 million of cash. We view our Digital Assets as long-term holdings and we do not plan to engage in regular trading of Digital Assets. During times of instability in the market of Digital Assets, we may not be able to sell our Digital Assets at reasonable prices or at all. As a result, our Digital Assets may not be able to serve as a source of liquidity for us to the same extent as cash and cash equivalents. As of August 8, 2022, the Company had approximately $3.2 million of cash and the fair market value of the Company’s liquid Digital Assets was approximately $4.4 million, which excludes $14.8 million of staked Ethereum. The Company has no outstanding debt. As of August 8, 2022, the Company also has approximately $17.7 million available under the At the Market Offering Agreement 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 approximately $0.7 million during the six months ended June 30, 2022 compared to $(3.3) million for the six months ended June 30, 2021. Cash used in investing activities was $8.8 million during the six months ended June 30, 2022 compared to $8.5 million for the six months ended June 30, 2021. Net cash outflow for investing activities was used primarily for the purchase of Digital Assets for our blockchain infrastructure operations. Cash provided by financing activities was $10.0 million during the six months ended June 30, 2022 compared to $14.2 million for the six months ended June 30, 2021. The cash inflows from financing activities were primarily from proceeds from the Common Stock sold pursuant to the ATM Agreement ($10.6 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 to fund operations as needed. 28 Off Balance Sheet Transactions As of June 30, 2022, there were no off-balance sheet arrangements 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. 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.