Bitmain, maybe the world’s largest cryptocurrency company, told us a lot about the risks and rewards inherent in being a dominant actor in the fast moving cryptocurrency industry when it published its draft IPO prospectus. Whether that IPO will ever launch is questionable today since bitcoin prices have slid lower, but the industry insights Bitmain offered are valuable.
Let’s first quickly review what Bitmain does: it designs and sells cryptocurrency mining equipment that uses application specific integrated circuits (ASICs). The application that they specifically are used for is hashing the proof-of-work that is central to bitcoin creation. Before ASICs came to dominate, mining was successfully carried out on agnostic computer servers, whose CPUs (central processing units, as are found in a basic computer to run software) and GPUs (graphical processing units, which are faster than CPUs and intended for gaming and similar applications) were programmed for hashing.
Bitmain also runs mining pools, in which outside investors share the economics of a mining operations, and bitcoin farms, which are operations set up and managed by Bitmain for investors who mine bitcoin.
Bitmain’s revenues are tied to the cryptocurrency economy which, most recently, has been driven by speculation. In its prospectus, Bitmain states, “Our business and financial condition highly correlate with the market price of cryptocurrencies.” That is a sobering statement in light of bitcoin’s price trajectory.
Bitmain is a “fabless” design company, rendering it critically dependent on outsourced production. (Fabless refers to fabrication-less production.) Risks are elevated in Bitmain’s case by the fact that it has only ever used Taiwan Semiconductor Manufacturing Company, which not only is independent but also located neither in Bitmain’s principal business location (China) nor where Bitmain is registered (Hong Kong). So it has concentration, geographic, and cross-border risks in acquiring its key input.
The prospectus goes on to note that in addition to the risks Bitmain itself faces, other sectors of the industry face numerous potential regulatory actions. For example, mining, utilizing, and transferring cryptocurrencies could all face prohibitions and limits or punishing levels of taxation in various jurisdictions. Also, energy supplies to mining facilities might be penalized or shut off.
Bitmain’s business prospects are also susceptible to other major events or forces of change in the greater cryptocurrency industry. Wallet technology could become even more vulnerable to hacking and fraud, increasing the risk to users of cryptocurrencies. Major disruptions to internet services in Asia or other significant cryptocurrency markets might impede mining and would hurt trading volumes. In the longer run, such instability hurts the reputation for reliability and ease of access of cryptocurrencies. Additionally, bitcoin’s dominance of the cryptocurrency markets could give way to coins whose proof protocols do not rely so intensely on hashing, the thing that Bitmain’s ASICs do best.
Regarding a unique risk it faces, Bitmain notes in the prospectus, “The supply of Bitcoins available for mining is limited and we may not be able to quickly adapt to new businesses when all the Bitcoins have been mined.” This would not seem to be a very urgent risk since the forecasts are for the last bitcoins to be mined in 2140!
Due its market dominating size, Bitmain might attract regulatory attention in some jurisdictions as a monopoly. Bitmain’s size might normally lead to constraints on its merger and acquisition activities, but the market power of a bitcoin mining equipment provider is probably not high on the list of governments’ concerns about cryptocurrencies. Still, how big is Bitmain relative to its competitors?
Bitmain designs chips, and their marketability depends not just on their speed but also the inputs and outputs of the devices that Bitmain designs to house the chips. While ASICs are designed solely to hash and Bitmain’s models have speeds of up to 15000 hashes per second, their efficiency depends on how much electricity they use and how much heat – which must be cooled – they generate. Bitmain says it has 800-plus people engineering new chips and updating older designs. Bitmain’s competitive advantage manifests itself in its intellectual property.
Some mining is performed by GPU machines but at a decreasing absolute rate of deployment in light of the power of ASIC mining. The bitcoin price explosion of the fourth quarter last year created huge demand for bitcoin mining devices. Nvidia and AMD reported demand for their GPUs to be used for mining. That demand was short-lived and both companies have reported a sharp deterioration in their GPU sales for bitcoin markets. Last year, GPU processing reportedly accounted for about 20 percent of all mining hardware sales.
According to a comprehensive report on the cryptocurrency industry by the consulting firm Frost & Sullivan, as reported by Bitmain, Bitmain’s $2.3 billion in 2017 sales reflected a 75 percent share of the ASIC-based cryptocurrency mining market. (Most of the other 25 percent is split between Halong Mining and Pangolin Miner.) Bitmain enjoys about a 60 percent market share of all cryptocurrency hardware sales.
This year’s falling bitcoin price probably means that Bitmain’s market share does not provide it meaningful market power. And the current price dynamics of bitcoin and other currencies make it difficult to extrapolate from the figures in the prospectus to say where demand for bitcoin and other miners might be headed.
By investing in and leveraging its intellectual property, Bitmain dominates the cryptocurrency mining gear market. While the prospectus lays out the challenges the company faces no one has a clear idea of how the industry will respond to lower price levels, expanded infrastructure, new regulations, and broader holdings of cryptocurrencies. If the IPO goes forward, the stock market will reveal what these developments will mean for Bitmain whose considerable intellectual property has so far been focused on one thing, ASIC-based cryptocurrency mining.