Editorial 15 August 2018Rafi Farber
5 top concerns (and possible solutions) for a Bitmain IPO
The upcoming Bitmain IPO, which, as rumor has it, will happen very soon—around Q1 2019—will be of the more mysterious type as IPOs go. The Beijing-headquartered firm is a big blob of unknown and a lot of mining machines and cryptocurrency holdings, as of now. We know from a leaked prospectus in preparation for an $18 billion IPO that it holds about 1 million Bitcoin (BCH), which represents about 5% of the total 17.3 million BCH currently in circulation and 12.5% of the 8.4 million BCH moved since the August 2017 hard fork. Bitmain committing such a large portion of their coins portfolio to BCH is a good indicator for the long term strength of the coin.
Bitmain also holds about 22,000 BTC, about 930,000 Litecoin (LTC), and a smattering of other coins. That puts its combined value just on its cryptocurrency holdings at about $800 million, representing about 4.5% of its IPO target.
Initial reports leaking put Q1 profitability at over $1 billion for the world’s leading supplier of Bitcoin mining hardware. That number was probably leaked out to give a general ballpark justification for the eventual offering price. If it’s true, a Bitmain IPO will be the biggest cryptocurrency IPO in history. Sounds fantastical, but the entire cryptocurrency industry is less than 10 years old. It’s like calling Hurricane Katrina the storm of the century. Maybe, except it happened in 2005.
Initially, assuming cryptocurrency prices hold and advance, the IPO should be a success and generate a wave of positive press about the staying power of Bitcoin in the face of market assault. Big crypto industry players are likely to buy in heavily so as to feed on and feed into the positivity. But while an initial pop on the mere excitement of the IPO itself is likely, the question is, what happens when the excitement dies down? Will Bitmain have staying power as a mainstream equity staple? Will it serve as an investment vehicle for hedge funds that want crypto exposure without actually holding currency?
Aside from the problems that every IPO faces, including increased public scrutiny forcing more conservative business practices and the like, here are where the problems begin, and there are many. They aren’t insurmountable, but these issues need to be brought to the forefront for anyone considering taking a long-term stake in Bitmain’s eventual assumed IPO.
Too much volatility
As we saw with Bitmain customer Riot Blockchain (NASDAQ:RIOT) back in December, Bitmain will be highly levered to the price of Bitcoin and BTC, which it both owns directly and sells machines for its mining. Just as gold mining stocks move more violently than the underlying price of gold, Bitcoin BCH or BTC mining stocks like Bitmain will be more volatile over time than the prices of the underlying cryptocurrencies. This could make Bitmain shares uninvestable for the majority of commercial players, which itself increases volatility still further by reducing liquidity. If Bitmain has staying power, it will power through this, but the first few years of Bitmain as a public company are likely to be a wild ride with extreme ups and downs.
One could argue that the rebirth of Bitcoin during the August 2017 fork has made transactions so efficient and cheap that eventually liquidity will come roaring back as transaction volume grows, and it might. But this will take a significant amount of time. Before we get there, Bitmain shares will likely be quite volatile. We have a lot of growing pains to go through before Bitcoin goes mainstream as a popular form of retail or commercial payment.
In order for Bitmain to grow over the long term if it focused only on Bitcoin mining rigs, it will need to sell more mining machines. That’s the bottom line. Selling more mining machines means that more people will be mining, bringing down the average profit per miner. By supply and demand, increase the supply of miners and keep demand for Bitcoin BCH and BTC transactions steady, then mining profitability goes down and so does the capital value of the mining rigs. So in order to grow, Bitmain would need to operate in an environment of continuously rising demand for Bitcoin and Segwit transactions.
But there are more layers to this problem. The more Bitcoin BCH and BTC that are mined, the higher mining difficulty goes, the more expensive and time-consuming it becomes to mine. The issue of power consumption is already a thorn in the side of many mining farms, with some jurisdictions banning mining and others doubling electricity prices on miners. This problem will only get worse, unless miners start building their own electrical grids, which is starting even now.
A growing mining base itself would require a faster growing demand for transactions in order to keep profitability per transaction steady. Mining profitability is intrinsically sloped downward though over time because reward itself keeps shrinking as more and more are mined. The demand for transactions would have to accelerate even faster to compensate for all this, over and above the increase in power costs.
Potential solution: Open up new business segments. Bitmain’s drive toward artificial intelligence in ASIC chips is an encouraging sign from the company, for example. We don’t know much about this aspect of Bitmain’s business yet, but founder Jihan Wu estimates that AI chips will constitute about 40% of its revenues over the next five years, and would be similar to Google’s AI unit. Whether this is wishful thinking or serious we have yet to find out.
Though it could be said that Bitcoin was the result of the last economic downturn, the argument that Bitcoin and other cryptocurrencies would rise in the event of another economic downturn is a just a stab in the dark guess. It is not at all certain that Bitcoin would benefit in an economic downturn even if it was indeed born out of the last one.
Why not? Just look around. We have emerging market currencies collapsing all over the world right now. Purchasing power is being lost in these countries and Bitcoin is not saving that purchasing power. Turkey, Russia, Argentina, Brazil, South Africa, all these currencies collapsing versus the U.S. dollar, and while Bitcoin BCH and BTC transactions are rising in these countries, cryptocurrencies themselves are not rising enough to compensate for this loss. The role of hedge against currency collapse is still being played by the dollar and gold. Take Turkey, the front page emerging market currency collapse right now, as an example. The price of BTC in Turkish Lira terms has not moved out of its trading range upper bound of 44,000 since March, while the U.S. Dollar has doubled in terms of Lira. Things might be different if and when there is a global dollar crisis and cryptos become a true hedge, but at that point the U.S. government in particular might lash out at cryptocurrency traders, blaming them for dollar woes. We’ll get more into that issue shortly.
During a global liquidity scare, everything tends to go down at once except the U.S. dollar. Even gold suffers during major recessions. Bitcoin and BTC may, too. We are exactly 10 years since the last recession. The next one will likely come relatively soon.
Potential solution: Delay an IPO until after the next recession, if possible.
Bitmain doesn’t have much competition now because the mining equipment industry isn’t exactly saturated at the moment. Who remembers what Apple was before it started selling iPhones? Yup, it was a computer company. There were phone companies like Nokia and Research in Motion, and there were computer companies like Apple and Microsoft. What did one have to do with the other? Until Apple made its grand entrance with the iPhone 3 in 2007 and that was the end of Nokia and RIM. RIP. (I know, technically Nokia still exists. Technically, so does Apple.)
The size of Antminer machines brings to mind those stories from the 50’s and 60’s of vacuum tube computers the size of entire rooms that were loud and inefficient. Bitcoin and Segwit mining globally takes nearly the same amount of power as all of Ireland or the Czech Republic. There is room for improvement here. At least I hope there is.
This is where Bitmain may be caught between a rock and a hard place. The best possible outcome for Bitmain would be Bitcoin being the most used currency in the world. In that event though, Bitcoin mining won’t be just an oddball nuisance in someone’s back yard nursing a bit too hard at the electricity teat. It’ll be mainstream, and mainstream attracts mainstream predators. Companies with hundreds of billions in capital will pour what they need into improving mining efficiency, speeds, and the size of the rigs themselves. Imagine how Bitmain stock would perform in the aftermath of an announcement that, say, Tim Cook or Sundar Pichai are entering the crypto mining industry. It sounds loopy now but it’s what every cryptocurrency enthusiast actually wants.
Possible solution: Be open to a buyout early on in the event that Bitcoin becomes a mainstream currency. Unless you’re really confident you can beat Apple or Google or Microsoft, or all three.
If we assume that Bitcoin is now a mainstream global currency, that means it gets past global governments and their respective central banks. As long as Bitcoin is stuck in a speculative niche, there will be no serious assaults against it. But if it does start to seriously compete with government fiat currencies, governments will use their power to regulate in order to kill the competition, or at least to severely impair it. The power to produce fiat currency at will is the most important power any government has, as the rest of its power springs from that single power source. A true competitor to fiat currency is going to be fought savagely. It could take the form of bans, the environmentalist movement being enlisted to encourage a legislative attack or punitive tax on mining, or anything else you can imagine governments trying to do.
Possible solution: Spy for the CIA so you have an in with the Feds. (This is a joke.)
Bitmain would be the first big miner on a major stock exchange. Gold has its mining stocks, and soon so will Bitcoin. What we are likely to see is an initial wave of enthusiasm followed by a more sobering questioning period where shares fall for a while. If and when that stage is overcome, then there’s the threat of competition from without and, of course, government harassment from without. Bitmain can persevere and for those willing to hold through all of what’s to come, it could be a successful position. One suggestion, if you are a believer who wants to buy and hold, don’t check the price too often. Just tuck it away and out of your mind until you’re ready to retire.
Note: Tokens on the Bitcoin Core (SegWit) chain are referenced as BTC coins; tokens on the Bitcoin Cash ABC chain are referenced as BCH, BCH-ABC or BAB coins.
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