There’s a decent likelihood that many of the people who stumble upon this article don’t even know what bitcoin is, but their mate’s cousin made a fortune after he bought a bunch of bitcoin mining hardware and struck gold. So, where do we even begin? We will start by telling you the most important thing to know which is that ICOs are not an investment or an asset class as they exist today. Then, we’ll briefly talk about the potential of blockchain technology which is the technology that makes Bitcoin and all the other cryptocurrencies or tokens possible. Then, we’ll show you this chart which helps explain how bummed you would be feeling right now if you bought some bitcoins at “peak hype”:
Now that we’ve got the basic introductions out of the way, we’ll move to talk about bitcoin mining.
An Introduction to Bitcoin Mining
Trying to understand how the whole system functions may be interesting to some and cause tears of boredom for others. Since the thought of having to explain how the whole thing works bores us to tears, we’ll keep it really simple. Mining bitcoin is kind of like how your laptop freezes sometimes and you get all pissed off and curse at it. Your computer “freezes” because your computer processor is busy working its ass off on some complicated task while you make things worse by being impatient. In this example we see how a computer is rendered useless when it’s being used at full capacity to process something. Bitcoin mining operates in much the same manner. It uses all a computer’s resources to solve complex calculations as quickly as possible. That speed is referred to as a “hash rate”. (While it’s not important to know that term, we like to throw it around a bit so it sounds like we know what we’re talking about.)
If you dedicate a computer to mining bitcoins, it will create a fraction of a bitcoin by solving calculations that make it very busy. For each calculation the computer solves, it gets a bit of bitcoin. The bitcoin miners also serve another important purpose which is to verify bitcoin transactions as they take place for which they receive a transaction fee. It is for this reason that we can say “without bitcoin miners, there would be no Bitcoin”.
The cost to produce bitcoin using bitcoin mining hardware includes the fixed cost of purchasing the hardware plus the variable cost of electricity. Turns out Chinese coal miners are cheap labor that can be used to create cheap electricity.
Recently we wrote about 10 Ways China is Kicking America’s Ass in Tech and now we’ve found one more. China is absolutely dominating the bitcoin mining arena with more than 70% of all bitcoins being mined out of China where electricity is cheap. The cheaper the electricity, the higher the profit for mining bitcoin, the more bitcoin miners will mine.
The progression of bitcoin mining hardware has been quick and decisive. At first miners just used their desktop computers equipped with some bog-standard Intel processors. Then, it was discovered that Graphical Processing Units (GPUs) could mine at a much faster “hash rate” because the chips were better equipped for the types of calculations that bitcoin mining requires. The first company that you may think of is Nvidia. This is a good time to tell you about how not all cryptocurrency mining is bitcoin mining.
If you’ve been holding shares of Nvidia, you will keep noticing how your position keeps becoming a bigger percentage of your overall portfolio over time. That’s because the stock price is appreciating faster than the overall market, with a 5-year return of +1,720%. One reason for that is the demand for graphics cards to be used for cryptocurrency mining. The Motley Fool published a solid article last month which talks about how Nvidia wants to protect their graphics card business as opposed to selling all their graphics cards to cryptocurrency miners. As it turns out, GPUs are largely used to mine Ethereum (the second largest cryptocurrency after Bitcoin). The company estimates that Q1-2018 saw 9% of revenues attributed to cryptocurrency, and Q2-2018 is expected to be about a third of that number.
With Nvidia hardware dominating artificial intelligence applications, investors in Nvidia can come for the cryptocurrency mining exposure and stay for the AI exposure. That’s because the optimum way to mine bitcoin then changed to something called Field-Programmable-Gate-Arrays (FPGAs).
We previously talked about how FPGAs might be a play on artificial intelligence hardware, and pointed out how Xilinx may have somewhat of an advantage considering that they invented the FPGA. The reason that FPGAs worked so well is because (as the name implies) they can be programmed to do specific processes better. However, the use of FGPAs was short lived. Chinese entrepreneurs quickly realized that the best way to mine bitcoin wasn’t by using GPUs or FPGAs. Turns out that the best way today to mine bitcoin is by using something called Application-Specific Integrated Circuits (ASICs).
Founded in 2013, Chinese startup Bitmain has now raised $450 million in funding with Sequoia Capital leading the charge, the majority of which came in the form of a “pre-IPO round” of $400 million (announced just 3 days ago) which values the company at around $12 billion. According to Deal Street Asia, Bitmain is planning to file for a Hong Kong IPO this year which would value the company at between $30 and $40 billion – all from selling ASICs for Bitcoin mining.
ASICs are like FPGAs in that they can be programmed, except all the programming happens before the chip is sold which results in much better performance. Bitmain is today’s leader in building ASICs chips for mining bitcoin with a +70% market share. We first came across the company in an article we published asking “Can Chinese AI Chip Makers Compete with Nvidia? ” in which we talked about the new AI chip from Bitmain, the Sophon BM1680, specialized for both training and executing deep-learning algorithms.
For Bitcoin mining, Bitmain offers their newest 16-nanometer ASIC chip – “BM1387” – which happens to be the world’s most efficient bitcoin mining chip at the moment. Their latest bitcoin mining rig may use a Xilinx FPGA chip, but that’s only to control the 189 BM1387 chips found within the mining rig.
According to an article by Digitimes, “China’s Bitmain, Canaan Creative, and Ebang Communication are the world’s top-3 suppliers of Bitcoin mining solutions in terms of shipments, with Bitmain alone commanding a 70% share of the global market for such miners.” That same article goes on to talk about how “Bitmain’s orders are enough to occupy 90% of Taiwan Semiconductor’s ASIC foundry capacity during off-peak season”. If you want to buy shares of Taiwan Semiconductor (TSM), be aware of what you’re buying with your ownership in a $200 billion firm. TSM is the world’s largest pure-play semiconductor foundry, so you’re also making incidental bets on the success of their other customers – like Apple, TSM’s largest client, accounting for one-fifth of sales according to Investopedia.
Founded in 2013, Canaan Creative has taken in around $46.9 million in funding to develop their “Avalon” brand of bitcoin mining hardware, followed by an attempted acquisition in 2016 by Shandong Luyitong Intelligent Electric (300423.SZ), a $1 billion company that manufactures industrial and commercial electric apparatus and equipment. Like Bitmain, Canaan also sells ASICs, but at a much lower volume. An article by Bloomberg talks about how Canaan enjoys about a 15% market share compared to the 70-80% share that Bitmain commands, and Bitmain’s 2017 revenues of $2.5 billion are about 12X those of Canaan.
While Bitmain is thinking about filing an IPO, “the world’s second biggest maker of bitcoin mining hardware” has already filed one. According to an article by Bloomberg last month, Canaan is looking to raise a cool $1 billion from their IPO on the Hong Kong Stock Exchange which could start trading as early as next month.
The last company mentioned is called Ebang Communications, but since their website is in Chinese and their LinkedIn description is a conglomeration of Engrish sentences, we’re going to resort to their Bloomberg profile which says they sell communications equipment. Add to that mix some bitcoin mining rigs and suddenly everyone’s interested, in fact, on their Bloomberg profile it says they are working with advisers on a possible Hong Kong IPO, just like the other two Chinese startups we’ve covered here. Since Canaan and Bitmain command an estimated ~85% of the market share for bitcoin mining hardware, we’re going to consider this a wrap and assume that Bitmain is now the Ilumina of bitcoin mining hardware and will be the dominant provider of bitcoin mining hardware and chips going forward.
This article has purposely oversimplified things, so we didn’t talk much about about how processing bitcoin transactions (also called bitcoin mining) simultaneously rewards the miners with bitcoin. We didn’t tell you that the reward for mining bitcoins keeps halving itself, and eventually fewer and fewer bitcoins can be mined as the number outstanding reaches a limit of 21 million. We didn’t want to mention that bitcoin needs to stay above a certain price or people will stop mining it because it won’t be profitable to mine as shown in this incredibly interesting chart by Bloomberg New Energy Finance:
We didn’t tell you about the controversial viewpoint that the entire system is not sustainable over time, because we didn’t want to spoil your fantasy of becoming a bitcoin mining millionaire like your mate’s cousin.
For those of you who don’t feel like moving to China and setting up your own bitcoin mining firm, you can always just buy bitcoin and your returns will be highly correlated to the bitcoin miners out there. As for the bitcoin mining hardware companies, both Bitmain and Canaan are expecting to have IPOs in Hong Kong. If you want to get in on that, you’ll need to open an account with Interactive Brokers which will let you trade stocks on exchanges around the world.
Bitcoin keeps hitting new highs. While we don’t have any meaningful amounts of money in bitcoin at the moment, we’d be more likely to
invest speculate by holding the actual bitcoin. As we said before, we are slowly accumulating bitcoins on Coinbase and logging in to a one-stop-shop couldn’t be easier. If you click this link and put $100 in Coinbase, they’ll give you $10 in free bitcoins (immediate return) and we’ll get $10 in free bitcoins to help feed our MBAs.