[Special Analysis] Hong Kong-Listed Crypto Mining Companies to Decline, Dragged Down By Operating Performance, Relying on R&D of AI to Protect Their Future

The general public’s initial impression of the blockchain may be Bitcoin and mining. This is in part due to advertisements on social platforms; both for buying and selling cryptocurrencies and mining as an alternative stable source of income. Driven by the mining boom, a mine has moved over 10,000 yuan (~$1,400 USD), and some even reached hundreds of thousands of yuan. However, there are many disputes and grey areas in the mining business. Some of the businesses that came into being, such as mining machines, were even more accused of being scams.

Ever since three Chinese bitcoin mining companies came to Hong Kong to apply for public listing, the market finally had the opportunity to get to know the business. Canaan and Ebang International applied for listing onto the Hong Kong Stock Exchange in May and June this year, while Bitmain, China’s largest miner, also applied on September 26. From the documents submitted into the Hong Stock Exchange by these companies, you can understand the operation of the mining company and the development of the mining industry from the aspects of inventory, R&D and artificial intelligence (AI).

What is mining? To put it simply, when people solve complex mathematical calculations with computers, the first person to find out the answer and create a new block, as long as they get the results of other people’s certification calculations, can get Bitcoin as compensation. As a result, many people rushed to mine last year hoping to join the ranks of miners, using mining machines to provide computer computing power to process data blocks, and then earn bitcoin.

The computer computing requirements will increase as the mining time increases, and the return will decrease accordingly. In a bull market, when the number of people entering the market is high, miners will seek new types of mining machine to maintain the calculation power, in order to speed up mining. This ultimately means that the price of mining machines will rise. However, this year, when the cryptocurrency market is a bear market, the demand for mining machine products is naturally reduced. When the pricing power of the mining company is weakened, it also increases the inventory pressure.

As of the first half of this year, Bitmain recorded a depreciation of over $390 million USD in inventory due to the decline in the market price of cryptocurrency, reflecting the unsatisfactory sales of mining machines. At the same time, the gross profit margin of Bitmain’s mining machines also decreased from 58.4% in the whole year of 2015 to 46.2% in the previous year, and only 35.1% in the first half of this year, reflecting the increase in the cost of mining parts, and its pricing power. As for the operation of this year, there is no relevant provision for impairment in the initial prospectus. However, it is believed that this year’s market conditions may be weaker.

At the same time, among the three mining companies, Bitmain is the only ones that hold cryptocurrency assets. In the first half of this year, the company held $887 million USD worth of cryptocurrency assets, mainly from customers paying in cryptocurrency and Bitmain also has self-operated mines. It’s well known that cryptocurrency prices are very volatile, thus Bitmain uses the cost method to account for related assets, thereby reducing the impact of price volatility. However, this is only an accounting method. In fact, it will still be affected by price fluctuations and affect financial performance. Bitmain has also made a provision of $103 million USD for this cryptocurrency asset in response to market volatility.

From inventory to gross margin to cryptocurrency assets, mining companies begin to face a lot of operational risks, as well as the current market situation of cryptocurrency. The management from these companies understands that relying on mining machine sales is not a sustainable development model. Therefore, the three companies are interested in exploring the field of artificial intelligence (AI). In their preliminary prospectus documents, they repeatedly emphasized their exploration and development in AI. Bitmain wrote: “We are expanding our business into the revolutionary AI field, focusing on AI ASIC chip design and AI hardware development.” Comparing themselves to two technology giants, Google and Nvidia, it means that it is one of the few AI chip companies in the world that has the ability to develop chips for cloud training and inference.

In fact, the three companies still have a long way to go with artificial intelligence. The sales of mining machines accounted for 91.6% and 99.1% of the total revenue of Ebang and Canaan, and 94.3% of Bitmain’s revenue in the first half of this year came from mining sales. However, Jihan Wu, co-founder of Bitmain, is still very confident about the company. When interviewed by Bloomberg Businessweek in May this year, Wu said the AI chip will account for 40% of total revenue in five years.

It is worth noting the expenses of the three companies in research and development. Ebang and Canaan’s R&D expenditures last year accounted for 7.32% and 8.1%, while Bitmain only 2.9%. In contrast, chip makers such as NVIDIA, Qualcomm, and Intel have accounted for 18 to 25% of their R&D expenditures in the previous fiscal year. In addition to traditional chip makers, rising stars such as Facebook and Google are also vying to make AI chips, thus putting added pressure on the three mining machine manufacturers.

The bitcoin mining industry has gradually entered the public eye, which is undoubtedly a breakthrough in the blockchain industry. If it is successfully listed in the future, the industry is expected to become more transparent. However, from the current business perspective, it is still a hardware sales business, rather than a technology company as emphasized by the three. At the same time, mining has relied too much on the trend and atmosphere of the cryptocurrency market. A number of important operational indicators have fallen, which is also being dragged down by the current bear market. Even if we turn our attention to AI chips, it is still unknown whether the mining company can break through in the field under the control of many technology giants.