The recently announced $3 billion Bitmain IPO has left many crypto enthusiasts excited for the possibility of a legitimate publicly-traded crypto business. However, when a company creates an exit for a high margin cash flowing business, it usually indicates diminishing growth or margins. This could also indicate a continued bear market for Bitcoin.
Background on Bitmain
Bitmain was founded in 2013 by Jihan Wu (CEO) and Micree Zhan, who came up with an idea for ASIC chip miners, the next generation of CPU and GPU mining chip graphics cards. ASICs allow for faster processing of Bitcoin node computations and are now considered the only viable chip for mining Bitcoin and its forks.
Bitmain currently manufactures an estimated 70-80% of the ASICs used in Bitcoin mining. Other producers include Intel, Canaan Creative and most recently Samsung.
Besides building chips for Bitcoin mining operations, Bitmain began working last year on an artificial intelligence product (Sophon) to compete with other giants (Google, Nvidia).
Bitmain also owns and operates Antpool and BTC.com, which mine about 42% of all blocks. They also mine an estimated 21% of all Bitcoin Cash, a hard fork of Bitcoin occurring on August of 2017.
Wu has been fairly controversial in his beliefs about Bitcoin and scaling, much of which has been at odds with by the community at large. He was a big proponent of the Segwit update which created the Bitcoin Cash (BCH) hard fork, and many conspiracy theories hold that Bitmain has been manipulating the price of BCH due to at least a 1mm BCH position they hold, which is difficult to trade out of due to lack of demand and volume.
According to an interview with Bloomberg, Wu said Bitmain booked revenue of $2.5 billion in 2017, as well as claiming revenues of $1.1 billion in Q1 2018.
In April, 2017 the Antbleed backdoor is discovered in the Antminer hardware by Bitmain. Antbleed essentially gave Bitmain the ability to look into customers mining activities and provide them a “false” response, shutting down their mining.
This backdoor would essentially give Bitmain the ability to shut down 70% of mining operations. Heavy criticism followed the announcement of this vulnerability, which Bitmain patched very quickly.
Also last year, Bitmain’s lead ASIC designer, Yang Zuni, left the firm to start Shenma, a direct competitor. Since, Bitmain has fallen behind other chip competitors such as Nvidia, Intel, AMD, Canaan, and Ebang.
Bitmain’s altcoin miners have been less power efficient than these competitors’ miners, causing a decrease in those orders. Yang Zuni’s S7/9 chip designs helped Bitmain to survive Bitcoin’s last bear market in 2015/2016, however, since his departure, Bitmain has been using the same 2016 design and has had repeated stumbles with the 16nm BM1X89, 12nm BM1X90, and the10nm BM1X93. Bitmain spent $1B RMB to purchase the untested 12nm wafers, and $3B RMB on the 10nm in 2018 Q1, both of which failed.
At the peak of the bull market in 2017 Q4, Bitmain received massive pre-orders for their latest chip. After over 6 months that it took to manufacture, burn in, ship, setup, and configure, the gear has begun to come online, increasing BTC’s hash rate by about 25% since July.
Now with higher hashrates, lower BTC prices, and lack of miner innovation, we expect orders for new miners to be extremely soft for the rest of 2018.
Initial Public Offering
In early June, Bitmain announced they were considering an IPO on the Hong Kong Stock Exchange, claiming this is to expand on AI chip making operations. Wu said it will eventually account for 40% of revenues in 5 years. Important to note is Canaan Creative and Ebang are planning to launch IPOs, also on the Hong Kong Stock Exchange.
In January, Samsung announced that they are entering the ASIC chip market for crypto mining. Competition from Samsung, an electronics giant with global distribution, could be a perceived threat, causing “early investors” such as Sequoia to pressure Wu into an IPO. A liquidity event would be a great exit ahead of a margin squeeze. Additionally, leaked info on $15B valuation pre-IPO round suggested that investors in new round included Softbank, Tencent and DST Global, all of whom have now denied these claims. In reality, these funds had access to the round, signaled that they would take as large of allocation as possible in the round, then later backed out upon seeing the subscription terms. However, they syndicated out most of their allotments directly to their LPs and other relationships.
Given the Bitmain’s issues, there are two likely explanations for an IPO:
1) pressure from early investors to exit while they are in optimal position, and
2) further expectation of cash flow decline.
Since there are few early investors and such a short period of time (the first institutions including Sequoia and IDG invested in a $50mm round a year ago), we predict that Bitmain sees their cash flows decreasing significantly in the near future. If Bitmain’s cash flow continues its decline, then there is an expectation of BTC going lower on fundamentals, or a Bitmain dump of BTC.
Lower Cash-Flow Hypothesis
A scenario where orders are decreasing on hardware lowers demand for chips. If a slowdown occurs, and equipment orders drop then so will the value of BTC and BCH.
If BTC drops to $4k, miners will stop mining and the algorithm will become easier therefore the price of BTC will end up staying extremely low. Bitmain is seeing the possibility of future cash flows decreasing therefore they need to IPO and exit while the market is hot.
Additionally, ASICs are really only considered viable hardware for crypto mining (unlike GPUs which can be used for gaming or AI). Therefore if a decline in mining occurs, Bitmain will fare worse than competitors like Nvidia that produce GPUs.
Prices of ASIC and GPU hardware are based on miner demand. Likely a decline in orders will push prices lower and narrow margins. This indicates that miners are seeing diminishing returns on mining operations (as rewards are scarce and decreasing). Companies like Bitmain and Canaan will be pressured to produce better chips at lower prices. The BCH fork occurred at $4800 which also happens to be the breakeven price for mining at the 6 cent per kilowatt.
We believe that a squeeze is always occurring for the mining business, companies such as Nvidia and AMD have reported lower sales.
Despite strong earnings on their Q2 reports related to crypto, AMD now states that the crypto boom is over for their business. Nvidia, a US-based chipmaker, saw their stock rise 769% since the beginning of 2016. In the last week, their stock fell 5% after news that the chipmaker expected profits to decline from cryptocurrency chip making activities. Nvidia stated;
“Our revenue outlook had anticipated cryptocurrency-specific products declining to approximately $100 million, while actual crypto-specific product revenue was $18 million. Whereas we had previously anticipated cryptocurrency to be meaningful for the year, we are now projecting no contributions going forward.”
HOWEVER, Nvidia produces GPUs, which are considered inferior to ASICs and are mostly used in ETH mining, therefore their slowdown may be more reflective of the market turning more towards ASICs for mining versus a decline in mining demand in general.
Price Floor for BTC
We set a price floor on Bitcoin by examining the average of mining costs in China, Sweden, Georgia, and the United States, as about 80% of all mining occurs in these locations. The average cost to mine one Bitcoin in these locations is $4,500, providing a potential price floor around that amount.
BTC Mine Costs (before the 25% hashrate increase):
- At discounted rate of $0.03/kWh = $3,900
- At wholesale rate of $0.06/kWh = $4,800
- At industrial rate of $0.13/kWh = $6,900
BCH Mining Costs (before hashrate increases)
BCH mining is about as 38% as efficient as BTC, and already in the red for miners. Breakeven points are estimated to be:
- Discounted rate of $0.03/kwh = $821
- Wholesale rate of $0.06/kwh =$1010.52
- Industrial rate of $0.13/kwh =$1452.63 (edited)
LTC Mining Costs
Though there are no good data points for breakeven pricing for Litecoin, a confidential source states, “it has been profitless for quite some time … I mine LTC in the US (Oklahoma) and I mine $2.10 a day – it costs $3 a day to mine.”
Outlook for Bitcoin
We believe that an IPO for Bitmain is a negative for the price of BTC in the short run, and could lead to Bitcoin Cash becoming obsolete. Bitcoin Cash already has very few supporters who seem to be publicly pumping the price. At a price below breakeven mining, transactions become less secure and therefore less meaningful. Bitcoin could be pushed back into a lower trading range, below the 2018 lows.
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Steven McClurg is a founding partner and CIO at Arca Funds, a full service asset management firm specializing in blockchain. Prior to Arca Funds, Mr. McClurg was a Managing Director and Portfolio Manager at Guggenheim Partners. Mr. McClurg holds an MBA and MS from Pepperdine University, where he has served as a guest lecturer.