One of the ways we measure the health of the market at ListedReserve is researching the performance of key players in the cryptocurrency space. Often these companies — and their respective performances — provide significant insight into the fundamental aspects of market health. One company that has been in the news recently for its financial troubles is Bitmain, the Chinese mining powerhouse mainly known for their huge holdings in hash power on both Bitcoin and Bitcoin ABC. Bitmain’s last twelve months was one to remember (or to forget, depending on who you ask!).
Bitmain — The biggest player in mining
Key Metric: US$1.1 Billion Profit for Q1 2018, US$395 Million Loss for Q2
For those who aren’t familiar with Bitmain, they are the premier vendor of mining equipment on the market, while also operating a large industrial mining operation themselves. They are the biggest miners in both Bitcoin and Bitcoin Cash (or Bitcoin ABC now), holding massive hashpower and thus influence in both networks:
Despite incredible revenue and profits to begin the year as demonstrated by their Q1 profits, news coming out recently about widespread layoffs from the company indicate a very poor year end result. This performance isn’t particularly surprising given the bearish nature of markets throughout the last three quarters of the year, but a few key strategic decisions by the company made a bad situation worse.
The first of these was the decision to scale the production of mining equipment to match the massive bullish growth in markets in late 2017/early 2018. Based on the growth of mining profitability in Q4 of 2017 and even Q1 of 2018, this is probably an easy decision to criticise in hindsight knowing the drop in profitability that occurred as the market crashed, but based on the financials around Bitmain’s excess inventories in Q3, they had certainly aggressively overstepped in production. Even GPU production giants AMD and nVidia suffered a similar fate. With mining profitability down after prices declined considerably in Q1 and Q2, Bitmain’s profits were severely hit in both its mining equipment sales business and its industrial mining operation. Reports of major losses in Q3 and Q4 have circulated with $700M as the speculated figure, but none of these have been officially confirmed.
The second strategic failure of Bitmain was their sizeable bet on Bitcoin Cash. When their IPO filing in Hong Kong became public in late 2018, many analysts heavily criticised the risk of holding so much Bitcoin Cash on their books, as the company had invested over 70% of its 2017 cash flow into Bitcoin Cash (roughly US$887 Million). For a company’s whose valuation was tentatively set around US$10+ Billion, taking such a massive gamble with capital reserves on an asset with (even at that time) such a questionable future was an enormous risk to take. Probably the most striking figure out of this was that Bitmain’s position in Bitcoin Cash (BCH) was 6 times the amount they had invested into Bitcoin (a 6:1 ratio), whereas most investors in the space would even consider a ratio of 1:6 as bullish on BCH. Clearly, this bet did not end well for Bitmain, as the value of BCH tumbled and subsequently tanked further when the Bitcoin ABC/SV fork occurred in November.
The consequences were deeper than simply the loss of value from holding such a large amount of BCH, as Bitmain’s political position on the protocol had additional costs. Craig Wright’s campaign to change BCH into something more closely resmebling “Satoshi’s vision” drew a sharp response from Bitmain CEO Jihan Wu, labelling Wright “fake Satoshi” in a now infamous tweet. More importantly, when Wright’s ambitions for the protocol resulted in an eventual hard fork and hash war between the two competing chains, Bitmain were the major financial backers of the chain now known as Bitcoin ABC. Diverting significant amounts of hash power away from Bitcoin, as well as focusing mining power on simply avoiding Bitcoin SV’s reorganisation attacks was a hugely costly exercise — and not necessarily worth it either. Whist ABC is the better performing of the two forks, the future of ABC is still unclear — facing many of the same scaling issues that Bitcoin does even with the larger blocks that were implemented with BCH.
This mistake can be traced all the way back to Bitmain’s role in the genesis of Bitcoin Cash, as CEO Jihan Wu was a key figure in the movement for larger Bitcoin blocks in order to enable protocol scalability. Wu’s ideological investment into the pursuit of a ‘true bitcoin’ likely coloured his decision to invest such a significant portion of cash flow into the currency. For outside observers, a company investing capital heavily into a highly volatile and speculative asset based on the ideological position of its CEO is not ideal at all. Its unlikely that Bitmain will move away from their positions in BCH at this point, as their sunk costs into the currency are extremely high.
Regarding Bitmain’s decision to downsize considerably late in the year, its clear that their poor performance has now put them in a weaker financial position. Decisions to expand into AI and other experimental technologies have quickly been reversed, as the capital costs of these new operations are too much for their depleted reserves. The most likely outcome for the next 12 months is probably a consolidation of Bitmain’s position as both a mining equipment producer and an industrial miner, as their advantages in these areas were the driving force in their original success.
It will be interesting to see how the mining industry adjusts to a prolonged bear market, as we already have seen extended periods of zero mining profitability for many currencies. We aren’t convinced that the mining industry represents the same opportunity it did 12 months ago, when both prices for currencies and demand for equipment were astronomical. Specialised ASIC’s for new currencies are scarce, and many currencies are moving toward mining algorithms which are either ASIC proof or eschew hash power mining entirely. The potential for a significant amount of Bitmain’s inventory to be rendered obsolete at any point because of protocol changes is additionally a huge risk to the business.
All the drama ended up costing Jihan Wu his job, which is interesting in itself since he founded the company. The South China Morning Post announced in January:
“Bitmain Technologies, the world’s biggest maker of cryptocurrency mining rigs, is poised to name a new chief executive to replace company co-founders Wu Jihan and Zhan Ketuan, people with knowledge of the matter said.
The potential successor is Wang Haichao, who currently holds the position of product engineering director at the Beijing-based company, but has already taken over duties from co-chief executive Wu and Zhan in a transition period that started in December, according to the people, who asked not to be identified because the information is private.”
Makes you wonder who is really pulling the strings at Bitmain?