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 September 30, 2022 and September 30, 2021 quarters, respectively. Further, when we refer to the “2022 Period” and the “2021 Period” we are referring to the nine months ended September 30, 2022 and September 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 blockchain networks, earning rewards of additional Digital Assets by authenticating and validating transactions on the networks. The Company is in the late stages of developing a Digital Asset Platform that would enable users to aggregate their Digital Asset portfolio holdings from multiple exchanges and wallets into a single platform to view and analyze performance, risk metrics, and potential tax implications. The internally developed platform utilizes Digital Asset exchange APIs to read user data and does not allow for the trading of assets. We also are developing an integrated proprietary Staking-as-a-Service feature on the Digital Asset Platform that would enable users to participate in asset leveraging through securing blockchain protocols and to stake and delegating supported cryptocurrencies to BTCS operated validator nodes through a non-custodial platform. 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, 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 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 administerial capabilities of running a node 24/7 that requires regular, 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 authenticate 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 administerial role in validating transactions on a given PoS network on behalf of its delegators by maintaining the validator nodes we operate to ensure they remain online and ready to validate transactions. 20 All of the Company’s Digital Asset holdings are in tokens secured by PoS or similar consensus mechanisms. The Company is currently actively operating validator nodes on Ethereum, Cosmos, Kava, Tezos, Avalanche, Kusama, Polygon, Mina, Akash and Cardano. The Company has also staked the following tokens Polkadot, Algorand, Axie Infinity, Oasis 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 and asset leveraging. 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 table below describes our Digital Asset holdings as of the end of the third quarter of 2021 until the end of the 2022 Period. Digital Assets Held at Period End Asset 2021 Q3 2021 Q4 2022 Q1 2022 Q2 2022 Q3 Bitcoin (BTC) 90 90 90 - - Ethereum (ETH) 7,992 8,098 8,196 8,283 8,380 Cardano (ADA) 257,757 257,757 257,757 260,555 262,860 Kusama (KSM) 374 374 5,278 5,550 6,297 Tezos (XTZ) 24,172 24,504 70,453 71,369 72,578 Solana (SOL) 4,788 4,779 7,043 7,136 7,238 Polkadot (DOT) 8,032 8,032 38,816 39,986 23,905 Terra (LUNA) 3,584 3,584 3,621 - - Cosmos (ATOM) 3,072 3,072 80,474 86,613 91,181 Polygon (MATIC) 67,114 67,114 454,486 466,022 474,207 Avalanche (AVAX) 2,025 2,073 14,273 14,594 14,888 Algorand (ALGO) 50,584 51,103 51,197 51,201 51,201 Axie Infinity (AXS) 22,322 31,763 37,402 Kava (KAVA) 183,966 264,917 280,293 Band Protocol (BAND) 992 Mina (MINA) 71,297 Oasis Network (ROSE) 349,661 Akash (AKT) 103,730 21 Fair Market Value of Digital Assets at Period End Asset 2021 Q3 2021 Q4 2022 Q1 2022 Q2 2022 Q3 Bitcoin (BTC) 3,941,180 4,167,579 4,098,481 - - Ethereum (ETH)* 23,990,541 29,820,477 26,894,723 8,840,595 11,128,675 Cardano (ADA) 545,028 337,716 294,320 119,555 114,190 Kusama (KSM) 123,957 103,866 992,851 267,583 265,505 Tezos (XTZ) 146,914 106,679 262,023 101,102 103,210 Solana (SOL) 675,373 813,791 863,854 239,700 240,377 Polkadot (DOT) 229,558 214,616 826,875 281,496 150,964 Terra (LUNA) 138,351 306,353 373,005 - - Cosmos (ATOM) 111,252 99,761 2,325,374 651,909 1,186,824 Polygon (MATIC) 75,644 169,604 735,034 222,466 368,671 Avalanche (AVAX) 135,191 226,499 1,383,403 247,059 256,021 Algorand (ALGO) 82,381 84,830 47,492 16,115 18,044 Axie Infinity (AXS) 1,416,264 461,649 470,116 Kava (KAVA) 828,742 468,634 423,326 Band Protocol (BAND) 1,215 Mina (MINA) 42,085 Oasis Network (ROSE) 21,330 Akash (AKT) 26,881 Total 30,195,370 36,451,772 41,342,441 11,917,864 14,817,434 QoQ Change 40 % 21 % 13 % -71 % 24 % YoY Change 1780 % 825 % 105 % -45 % -51 % * Approximately 9 ETH is not staked. 22 Prices of Digital Assets at Period End Asset 2021 Q3 2021 Q4 2022 Q1 2022 Q2 2022 Q3 Bitcoin (BTC) $ 43,791 $ 46,306 $ 45,539 $ 19,785 $ 19,432 Ethereum (ETH) $ 3,002 $ 3,683 $ 3,282 $ 1,067 $ 1,328 Cardano (ADA) $ 2.11 $ 1.31 $ 1.14 $ 0.46 $ 0.43 Kusama (KSM) $ 331 $ 278 $ 188 $ 48 $ 42 Tezos (XTZ) $ 6.08 $ 4.35 $ 3.72 $ 1.42 $ 1.42 Solana (SOL) $ 141 $ 170 $ 123 $ 34 $ 33 Polkadot (DOT) $ 28.58 $ 26.72 $ 21.30 $ 7.04 $ 6.32 Terra (LUNA) $ 38.60 $ 85.47 $ 103 $ - $ - Cosmos (ATOM) $ 36.21 $ 32.47 $ 28.90 $ 7.53 $ 13.02 Polygon (MATIC) $ 1.13 $ 2.53 $ 1.62 $ 0.48 $ 0.78 Avalanche (AVAX) $ 66.77 $ 109 $ 96.92 $ 16.93 $ 17.20 Algorand (ALGO) $ 1.63 $ 1.66 $ 0.93 $ 0.31 $ 0.35 Axie Infinity (AXS) $ 63.45 $ 14.53 $ 12.57 Kava (KAVA) $ 4.50 $ 1.77 $ 1.51 Band Protocol (BAND) $ 1.22 Mina (MINA) $ 0.59 Oasis Network (ROSE) $ 0.06 Akash (AKT) $ 0.26 * The prices have been rounded to the nearest whole dollar for prices above $100 The following table presents the Fair Market Value of Digital Assets held compared to the GAAP Book Value reported on the Company’s balance sheet. September 30, 2022 December 31, 2021 Book Value Fair Value Book Value Fair Value Bitcoin (BTC) $ - $ - $ 2,600,426 $ 4,167,579 Ethereum (ETH) 5,633,111 11,128,675 8,642,983 29,820,477 Cardano (ADA) 106,883 114,190 258,527 337,716 Kusama (KSM) 237,906 265,505 81,296 103,866 Tezos (XTZ) 87,412 103,210 62,651 106,679 Solana (SOL) 189,103 240,377 248,698 813,791 Polkadot (DOT) 143,413 150,964 182,570 214,616 Terra (LUNA) - - 80,968 306,353 Cosmos (ATOM) 532,006 1,186,824 46,174 99,761 Polygon (MATIC) 156,353 368,671 68,362 169,604 Avalanche (AVAX) 206,808 256,021 50,190 226,499 Algorand (ALGO) 14,157 18,044 43,948 84,830 Axie Infinity (AXS) 437,876 470,116 - - Kava (KAVA) 394,140 423,326 - - Band Protocol (BAND) 1,076 1,215 - - Mina (MINA) 40,180 42,085 - - Oasis Network (ROSE) 16,322 21,330 - - Akash (AKT) 26,513 26,881 - - Total $ 8,223,259 $ 14,817,434 $ 12,366,792 $ 36,451,772 23 Digital Asset Platform The Company is in the late stages of developing a proprietary Digital Asset Platform aimed at allowing users to evaluate their crypto portfolio holdings across multiple exchanges and wallets on a single platform. The internally-developed dashboard utilizes 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 additional analytical, tracking and reporting features. 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. Delegation (or “staking”) involves committing (or locking) Digital Assets on a blockchain network to support and secure the network and allows delegators to earn native token rewards on their staked assets during the duration of their stake. Validator node operators charge a fee on delegated staked asset rewards earned in addition to earning rewards on their own 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. Results of Operations for the Three and Nine Months Ended September 30, 2022 and 2021 The following tables reflect our operating results for the three and nine months ended September 30, 2022 and 2021: For the Three Months Ended September 30, $ Change % Change 2022 2021 2022 2022 Revenues Validator revenue $ 344,196 $ 323,376 $ 20,820 6 % Total revenues 344,196 323,376 20,820 6 Cost of revenues Validator expense 82,203 71,690 10,513 15 Gross profit 261,993 251,686 10,307 4 Operating expenses: General and administrative $ 432,956 $ 282,558 $ 150,398 53 % Research and development 126,857 273,909 (147,052 ) (54 ) Compensation and related expenses 669,792 4,747,106 (4,077,314 ) (86 ) Marketing 8,765 7,559 1,206 16 Impairment loss on digital assets/currencies 145,247 208,647 (63,400 ) (30 ) Realized gains on digital asset/currency transactions (20,126 ) - (20,126 ) N/A Total operating expenses 1,363,491 5,519,779 (4,156,288 ) (75 ) Other income (expenses): Interest expense - (58,521 ) 58,521 (100 ) Amortization on debt discount - (581,973 ) 581,973 (100 ) Change in fair value of warrant liabilities 71,250 2,066,250 (1,995,000 ) (97 ) Distributions to warrant holders - - - N/A Total other income (expenses) 71,250 1,425,756 (1,354,506 ) 95 Net loss $ (1,030,248 ) $ (3,842,337 ) 2,812,089 (73 ) 24 For the Nine Months Ended September 30, $ Change % Change 2022 2021 2022 2022 Revenues Validator revenue $ 1,421,560 $ 776,399 $ 645,161 83 % Total revenues 1,421,560 776,399 645,161 83 Cost of revenues Validator expense 313,972 145,935 168,037 115 Gross profit 1,107,588 630,464 477,124 76 Operating expenses: General and administrative $ 1,595,296 $ 1,149,506 $ 445,790 39 % Research and development 448,579 602,178 (153,599 ) (26 ) Compensation and related expenses 2,731,713 13,788,556 (11,056,843 ) (80 ) Marketing 74,249 10,345 63,904 618 Impairment loss on digital assets/currencies 12,347,472 3,777,785 8,569,687 227 Realized gains on digital asset/currency transactions (489,682 ) (3,054,418 ) 2,564,736 84 Total operating expenses 16,707,627 16,273,952 433,675 3 Other income (expenses): Interest expense - (172,603 ) 172,603 (100 ) Amortization on debt discount - (1,716,744 ) 1,716,744 (100 ) Change in fair value of warrant liabilities 1,140,000 2,066,250 (926,250 ) (45 ) Distributions to warrant holders (35,625 ) - (35,625 ) N/A Total other income (expenses) 1,104,375 176,903 927,472 (524 ) Net loss $ (14,495,664 ) $ (15,466,585 ) 970,921 (6 ) 25 Validator Revenue The increase in revenue during the 2022 Quarter and 2022 Period as compared to the 2021 Quarter and 2021 Period is from the expansion of our blockchain infrastructure validating revenue. We believe revenues may increase for the period ending December 31, 2022 as a result of an improvement in market prices of the Digital Assets we have earned and/or purchased, rebounding from 2022 market low prices in June 2022. 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 decrease in operating expenses in the 2022 Quarter is primarily due to the $4.7 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 $12.3 million impairment loss on Digital Assets (“Digital Asset Impairment”) in the 2022 Period, compared to only $3.8 million Digital Asset Impairment in the 2021 Period. This is partially offset by the $13.3 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 our 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 for 2022. Other Income (Expenses) The changes 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 decrease in our net loss for the periods reported was primarily due to the decrease in operating expenses and changes 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. 26 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 November 8, 2022, the Company sold a total of 2,639,127 shares of Common Stock under the ATM Agreement for aggregate total gross proceeds of approximately $14,465,000 at an average selling price of $5.48 per share, resulting in net proceeds of approximately $14,008,000 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 September 30, 2022, the Company had $2.9 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 November 8, 2022, the Company had approximately $2.6 million of cash and the fair market value of the Company’s liquid Digital Assets was approximately $3.3 million, which excludes $11.1 million of staked Ethereum. The Company has no outstanding debt. As of November 8, 2022, the Company also has approximately $17.6 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 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 $130,000 during the 2022 Period compared to $3.9 million for the 2021 Period. Cash used in investing activities was $8.8 million during the 2022 Period compared to $9.5 million for the 2021 Period. 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 $10.5 million during the 2022Period compared to $13.5 million for the 2021 Period. The cash inflows from financing activities were primarily from proceeds from the Common Stock sold pursuant to the ATM Agreement ($11.1 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. 27 Off Balance Sheet Transactions As of September 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.