Recently the cryptocurrency company “Bitmain” has been making news for its upcoming Initial Public Offering (IPO) in order to transition the company from private ownership to a publicly owned and traded company listed on the Hong Kong Stock Exchange. This is scheduled to occur in either Q4 of ’18 or Q1 of ’19 and if the wheels stay on the wagon (which we’ll get into in a second) some are estimating that Bitmain could raise more capital during this offering than Visa ($18B) and Facebook ($16B). The number to beat if they want to take gold in the global IPO game would be Alibaba’s offering almost exactly 4 years ago in Q3 of 2014, coming in at $25B.
Let’s take a second to describe exactly what Bitmain does in the cryptocurrency space without getting too far into the weeds.
Bitmain brings in the vast majority of its profit in two ways: mining and Application-Specific Integrated Circuit (“ASIC” for short) sales, with a heavy focus on catering to the bitcoin hashing algorithm. This article will only focus on the relationship between Bitmain and Bitcoin (and also Bitcoin Cash, but let’s hold off on that for a second).
For the moment, let’s just focus on Bitcoin. Bitcoin is a protocol and digital currency that uses competing and cooperating incentive structures to maintain the value of its underlying currency “Bitcoin” and also prevent fraud, keeping accurate track of who owns each coin in a public ledger without relying on a centralized authority. It’s an abstract concept for beginners so I’m going to keep it light. For the moment, just imagine that it’s digital gold. New gold can’t come into the marketplace without first being “mined” from the earth. This, in some sense, gives it value since consumers understand that a large quantity of “work” must go into gold extraction. And so, they’re protected from monetary inflation (read: devaluation of their savings) by the sheer fact that gold is really hard to move from the earth to the market. It can’t just happen overnight, so they perceive that their gold holdings will retain value in the future.
Bitcoin operates in the same manner. Bitcoins must be “mined” using brute-force guess work by computers that involves powerful machines and lots of electricity. The miners take all of the recent transactions by users of the bitcoin protocol, put them into a cardboard box, and place that box next to the previous cardboard box. This happens every 10 minutes. Every 10 minutes a bunch of miners around the world toss a pile of clothes into a box and place it next to the last cardboard box filled with a pile of clothes. And for this, they’re rewarded. Everyone KNOWS who owns that gross mauve v-neck that Chuck’s Aunt gave him on June 6th of 2013 because we can check all the boxes between June 6th of 2013 and August 13th of 2018. Each box represents the ownership during that 10-minute period of time. You can actually trace that V-neck from the Target SuperStore, to Aunt Becky’s house, to Chuck, to Goodwill, to the homeless shelter at 8th and Park Ave. You just look in each of the boxes that are in a line filled with clothes. Replace the word “box” with “block,” the word “line” with “chain,” and pretend the clothes are transactions. Boom — now you’re cooking with gas.
So. Miners are rewarded for moving boxes of clothes. Or, if you prefer: “confirming transactions” between bitcoin users. Back in the day, say pre-2013, you could successfully mine Bitcoin with a gaming computer. The good old days. This was arguably the original intent of the bitcoin protocol, to be supported by a bunch of very decentralized ‘small-time’ miners, never concentrating power in one person or entity’s hands. This is a product of the cypherpunks after all isn’t it?
As time went on people began to realize that they could make chips that were specifically built to solve the puzzles of underlying cryptography used to secure bitcoin, ASICs. Bitmain was one of the pioneers in this field selling their brand of ASIC, the Antminer, and founding large mining pools, Antpool & BTC.com among others, to consolidate mining power. Moving boxes is always easier with friends right? Well Bitmain bought a keg and the bro’s are all revved up about Vinny’s new place. They’re here to crush Natty and move boxes.
Now, there’s a very interesting question that rears its head when a single entity has most of the muscle, most of the mining power. Say Vinny has been absolutely crushing leg day. Guy’s an absolute monster; bulging everywhere it’s like a physical manifestation of the movie Tremors. He can get a box of clothes in line and then sprint back to grab the next one before Rocky and Skylar can. What’s to prevent him, if he has the majority (51%) of the muscle, from taking those boxes right out the door and to his bachelor pad down on 10th Street? The answer? Nothing. So we want to make sure that we can keep Rocky and Skylar in the gym OR cut Vinny off from the steroids (ASICs) to ensure proper distribution of muscle outside of Vin’s absolutely ridonculous quads.
But, Vinny would have every incentive to keep manhandling iron and mainlining roids to attempt to control as much of the network as possible. As he likes to shout through a mouthfull of cheap foamy lager: “Vinny is my name and crushing cardboard is my game!” This is for several reasons, the first of which is immediate profit from moving the most boxes. But, there are some network governance implications involved as well. You see, the way the incentive structure of bitcoin works, everyone involved in the actual framework of the network is slightly at odds with each other within the greater context of being on the same team to preserve a sustainable protocol that won’t tank and kill everyone’s profit, savings, and children. So the miners will want to gain power in order to ensure the direction of bitcoin’s development favors them as much as possible. Node operators the same. Users the same. Some of this influence is ‘soft’ and some of it is more concrete. But ultimately this is all balanced by the fact that we’re on the same ship and we don’t want to put too much weight in one spot or it could topple and then we’ve got a USS Indy situation on our hands which totally stinks.
So this is the pretext for the last year and a half (more, really) of the bitcoin saga. For a long time there have been massive power struggles circling just beneath the surface like angsty reef sharks with the musky scent of seamen on their nose.
Bitmain never quite succeeded in getting majority control over the mining network but has come really close. As of June, Bitmain pools owned about 42% of the hashing (muscle) power securing the bitcoin network. So, what happens when enough people dislike the state of the protocol but don’t have majority control over the network? In cryptocurrency, they can initiate a “fork” and create their own rules on a separate line of cardboard boxes stemming from original. Maybe they were frustrated with the color of the cardboard and starting on 180th box, they fork off and begin packing clothes into pink boxes. Well this is exactly what happened. There was a tremendous amount of animosity developing between the brown-boxers and the pink-boxers within the community. And so, the pink-boxers went their own way and created a new line of boxes called “Bitcoin Cash,” as opposed to the original “Bitcoin.” (Unfortunately Bitcoin did not take this opportunity to rebrand as “GnarlyCoin” despite vigorous protest from yours truly). There’s a bottomless pit of technical stuff and in-community hand-slapping that we could dive into but I’m exhausted after the last year of it, so I’ll let you take the onus if you’re curious. Long story short, a new coin was created, spearheaded by a number of prominent members in the bitcoin community including Roger Ver, Craig Wright, and the head-honcho at Bitmain — Jihan Wu. If you’ve been around bitcoin for any length of time you will likely recognize these guys. If not… well let’s just say there’s a lot of intense feelings about all of them. Some love them, some hate them — and if the last month is any indication, they all hate each other.
What happens to the users of Bitcoin when the chain forks? Well, you hit pay dirt. You get both coins in your wallet! So now everyone who had 2 bitcoins in their wallet before the fork, now has both 2 Bitcoins AND 2 Bitcoin Cash in their wallet.
So in the ensuing months, users needed to decide which coin and protocol they were going to commit to. Or, alternatively they could use and hold both. There’s nothing preventing you from hedging your bets. But hedging’s for babies, right? 100x or get out.
So there were a number of hardcore bitcoin guys who sold their Bitcoin Cash assets for more Bitcoin, and there were a number of bitcoin cash guys who liquidated their Bitcoin for Bitcoin Cash. And then there were a few in between. Maybe far more interestingly, Bitmain and entities within their sphere of influence were left with both coins. Money talks and, right? So what have the power players with piles of coin on the line been doing?
One distinct attribute of a public blockchain is the ability to track transactions from wallet to wallet. You can’t necessarily know who owns the wallet, but you can make educated guesses based on activity and quantity. And as Bitmain has been a privately owned entity, a Chinese one at that, they’re shrouded in a bit of mystery. However, since the IPO paperwork has been processing, we’ve been finding out some interesting details during public disclosure — some of which was already suspected but unconfirmed.
And as it turns out, over the course of the last year they have been forced to cover their position by purchasing Bitcoin Cash on the open market with their remaining Bitcoin and the Bitcoin coming in from their mining operations. (Remember, they have staked much of their future success on the success of bitcoin cash). This is, ostensibly, in order to provide market liquidity and also prop up the price of Bitcoin Cash. From a purely financial perspective this seems ludicrous — take a look at the BCH/BTC chart and you would wonder why a company would decide to lose money. But it was likely part of a long play to gain market dominance for bitcoin cash, perceived to be a much more miner-friendly protocol in the long run — short term pain for long term gain. Additionally, they are a privately held firm in what is basically a black market; they don’t really have to answer to anyone. Really interesting stuff honestly from a business angle.
However, all of that changes with an IPO. I’m not well versed with Chinese fiduciary responsibility laws but I would suspect they somewhat reflect the posturing of those in the US: broadly speaking they must act in a way that maximizes shareholder profit. The letter of the law is to reduce malfeasance by the officers of a company who may have nefarious or counter-productive interests in mind and are just using a corporation (read: other people’s money) as a vehicle to satisfy those ends.
Let’s back up a second and return to the state of Bitmain right now. They are the biggest player in the ASIC market and have the most powerful mining pools in their back pocket. BUT they might be sitting on a bunch (like… ALOT) of soon-to-be worthless coins that they traded appreciating coins for in order to continue a ruse, a so-far failed power-play attempting to ensure that the network stayed favorable to them going forward. So they’ve built a house on a rotten foundation. What’s the next move?
They’re stuck right now. They can’t sell the Bitcoin Cash — the market is nowhere liquid enough. If they sold even a fraction of what they had the price would absolutely tank. There just isn’t a thick enough buy-side on the order book. Additionally, if they sell the Bitcoin Cash it’s a tacit admission that this whole episode was a failed power play, and quite possibly fraudulent. Remember that transactions on the blockchain are public and transparent. The Bitmain wallet addresses are being closely watched and they can’t really dump their coins on the sly. They’re a mining operation but they also sell products to consumers, many of whom are ardent libertarians who would see fraud as a moral gaffe, not just a business one.
To add fuel to the fire, the positions taken publicly by Jihan and Bitmain are quite inflammatory and leave little room for a graceful exit. If I were on the PR squad there I would be sweating bullets and hoping not to have to craft a position that pivoted away from bitcoin cash and back to bitcoin. Crazier things have certainly happened in this space, but that one would be incredibly difficult. Think of the split between bitcoin and bitcoin cash somewhat like the Great Schism — there was a lot of BS going on beforehand, but this is the big kahuna. There’s really no going back; the wells are completely poisoned.
At this point, it would seem that most of the Bitmain team has likely said ‘damn the torpedoes’ and is trying to get out any way they can. Yes, they have a lot of money — but they also have a lot of money to lose. Someone like Jihan doesn’t like to lose.
And I’m not necessarily talking about an exit from fiscal loss. As previously mentioned, the PR pivot is going to be far more difficult than the technical pivot back to bitcoin. It would be far easier to pin a shift away from bitcoin cash onto investors than it would be to take that head on. “Hey we got bought and the investors would like to show more solidarity toward bitcoin instead of bitcoin cash.” Some public hand-wringing from Jihan would complete the package and there would certainly be some other scam the next day to take the news cycle away from Bitmain. This is crypto after all.
So how do you escape a house with a rotten foundation without losing money? Sell it to someone who doesn’t understand what a rotten foundation looks like. Or to be more specific, a group of someones who don’t know what a rotten foundation looks like. Honestly, they don’t even know what a good foundation looks like. Most of them don’t even know what the foundation is or does. I’m speaking of course of the public. The “P” in the IPO.
Bitmain could be about to engineer the most fascinating exit scam of the cryptocurrency era. If so, they are actually going to move FROM the black market TO the regulated market in an attempt to dump on their investors and save face. The 7 figures of bitcoin cash coins, at time of writing worth $575 apiece, will be transferred as a company asset to the public investors.
Enter the “Chad Hail Mary”
The far scarier scenario is that this is another chapter in their power play to keep the dominant cryptocurrency miner-friendly and under Bitmain’s control. They could be aiming to gain majority hash power of the bitcoin AND bitcoin cash networks. I don’t care which protocol/coin you favor, this is truly terrifying. One entity controlling the mining power of a single protocol is no bueno. This would be a very dynamic scenario and it’s not just as easy as purchasing the remaining 9% of computing power (especially as a public company with a board of directors to answer to), so my intent is not to over-simplify and disregard the difficulty of doing this. But, I’d like to bring attention to the fact that Bitmain is about to hit a major windfall and they don’t exactly like the competition to bitcoin cash that bitcoin brings. Their goal is to have as much influence as possible over whatever the dominant cryptocurrency is. With that influence, they can exert control over the protocol and ensure that the network’s features funnel as much money to Bitmain as possible.
If Bitmain doesn’t like a particular currency (say, Bitcoin) they could stage a 51% attack on the underlying network, levying a huge blow and quite likely destroying the faith in the protocol — ending it as a competitor. And remember, Bitmain has been dumping Bitcoin in favor of Bitcoin Cash which seems like an idiotic move at first blush, but now they have absolutely nothing to lose and everything to gain by crushing the bitcoin network. They’ve already emptied the coffers of almost all of their Bitcoins and therefore would not care if the currency went to zero. According to most reports, Bitmain is sitting on approximately 22,000 Bitcoins — hardly a farthing compared to their million+ Bitcoin Cash reserves.
So now, if you’re following along, there’s an eye of the needle that Bitmain could be aiming for. They could be trying to slowly sell their remaining Bitcoin on the open market, propping up the price of Bitcoin Cash for the next 6–8 months until the IPO goes through, at which point they would have an load of money to use for more mining rigs. As they begin to increase their mining power over the following few months we will begin to approach the ‘halving’ of bitcoin in 2020, a 1/2 reduction in the block reward for miners, which for technical reasons outside of the scope of this article is perceived to be a period of weakness where it could be advantageous to attack the bitcoin network. There’s a fair amount of damage Bitmain could do right now with so much control over the mining side of the bitcoin network, but the timing isn’t right yet. As we move close to the block reward halving and Bitmain slowly and strategically liquidates all of its Bitcoin holdings and has a fresh war chest to work with from the IPO, the timing of the final power move becomes a bit more clear. They would have nothing to lose and everything to gain. The “flippening” (reversal in market dominance from Bitcoin to Bitcoin Cash) would flood the coffers with 10x more capital to work with and Jihan & Co. would make out like fat-cat bankers from the days of yore. There’s a million moving parts, but it could be what they’re aiming for.
And I may be wrong about all of this; I certainly have nothing to lose or gain in either case — at the end of the day, I’m just a lowly civil engineer and cryptid enthusiast with a penchant for cryptocurrency and cheap lager.