How does Chinese Government Influence Mining Industry？
Co-author: Elaine| IOSG Ventures
With China announcing it will impose tougher regulations on cryptocurrencies on May 19, 2020; the market has been crashing with Bitcoin price down to $30,000 and altcoins dropping in value by 30%. This is not the first time the Chinese government clamped down on cryptocurrency or threatened to ban it. In this article, we make an attempt to evaluate the implications of the current trending news.
The Sword of Damocles
The Chinese crypto degens are acclimated to the on-again and off-again crypto bans on Bitcoin by the Chinese government which has often influenced the crypto markets.
On December 5, 2013, the Chinese Central Bank announced a ban on all Bitcoin-related businesses for Chinese banks and payment services. The People’s Bank of China claimed that Bitcoin was an illegal currency, but private trading of the asset will be allowed — at the user’s own risk. Following this press release, Bitcoin’s valuation fell by 5 billion dollars (-50%).
In November 2017, China released a report on the prevention of token-issued financing risk. Together with seven ministries, the Chinese central bank said that ICOs were illegal and domestic exchanges were shut down, forbidding any new registrations.
On May 21, 2021, the minutes of the recent meeting of the “China Financial Stability Board” read as follows:
We resolutely prevent and control financial risk to enhance the supervision of financial activities of platform companies. We shall crack down mining and crypto trading activities in order to prevent individual risks from being spread to the social level”
On May 25, the Development and Reform Commission of Inner Mongolia Autonomous Region published a draft of “Eight Measures to Combat Crypto Mining” which included the prohibition of Internet cafe mining, default blacklist, etc.
Government regulations are like the sword of Damocles hanging above the industry. Every new announcement by the Chinese government threatens the stability of the market sending it on a selling — spree.
Government’s Concerns
The reasons for Chinese regulatory towards crypto mining are as follows:
- Financial Risk Prevention. Chinese officials have banned initial token offerings (ICOs) and domestic cryptocurrency trading since 2017, but many people can still trade cryptocurrency through overseas exchanges. Bitcoin’s permissionless nature makes it easier for Chinese crypto traders to move money overseas, causing capital outflows. This is not in China’s best interest and does not comply with their stance on forex. Capital outflows caused by the trading chaos can risk violations of AML clauses as well as become a catalyst for bigger financial risks.
- Carbon Neutrality and Energy Saving. The 14th Five-Year Plan’s goal of “double control of energy consumption” refers to strict control of high energy-consuming and high-emission projects. This year, Chinese government agencies have proposed “carbon peaking” and “carbon neutral” targets. The power consumption of crypto mining is exploding, and most of these mining sites are concentrated in the southwest and northwest of China, which brings huge pressure on the energy supply.
- Cryptocurrency Trading Chaos. In the bull market, BTC, ETH, storage coins like FIL, and shit coins without fundamentals were seen rising. Inexperienced investors sold their position during the crash. Huge profits have driven many mining companies to use cloud computing to continue their mining operations. There are inevitably unreliable intermediaries, and many products do not have the ability to payout. This situation may even trigger social unrest. It is difficult to say whether it’s “uniformed measures for all” or combat the unqualified products. We need to wait and see the subsequent implementation details.
Mining Industry Before Clampdowns
Mining Bitcoin refers to the practice of continuously performing “hash collision” operations in the blocks generated by the system with the use of the machines computing power for bookkeeping rights and thus the system’s reward of Bitcoin. The entire industry chain from top to bottom is divided into different roles such as mining machine manufacturers, miners, mining sites, and mining pools, who are well-positioned and aligned with each other.
Mining machine manufacturers: mainly for production and sales of mining machines. There are also some mining machine manufacturers who will move downwards to participate in mining, as part of the role of miners. The mainstream bitcoin mining machine manufacturers are as below.
Miners: For those who own machines to mine bitcoins (or other digital currencies) it is essentially an investment, they are going long on the thesis of mining profit and holding Bitcoin minus the electricity service fee and management fee. There are also some whale miners who will build their own mining farms in order to protect their asset security.
Mining Pools: As the system’s computing power and mining difficulty continues to rise, it has become difficult for individual miners to sustain a stable profit from mining. Therefore, mining pools combine users’ computing power for mining, greatly reducing the instability of revenue. As long as there is a block emerging in the pool, they can distribute rewards according to the miners’ “contribution”. In addition, mining pools lower the technical threshold for miners, who only need to know how to connect the mining machine to the pool, without an in-depth understanding of packaging and corresponding technology. Generally speaking, mining pools earn proportional profits through collective mining. The top 5 Bitcoin mining pools are Chinese.
Mining spots are mainly in the southwest and northwest local areas of China, which is also the key area of this regulatory crackdown.
Southwest China, such as Sichuan and Yunnan: Sichuan, Guizhou and Yunnan are rich in water resources from May to October of the years, which is cheaper for hydropower generation.
Northwest China, such as Inner Mongolia, Xinjiang, and other places: Rich in coal resources, they generate mainly thermal power. Compared to hydropower, thermal power is a non-renewable energy. “Carbon neutral” and:“Energy Saving and Emission Reduction” are also the main reasons why the Inner Mongolia region bears the brunt of it.
How did the mining industry survive as a kind of grey industry? Because mining machines are heavy assets and generate fixed-income, traditional capitals prefer involving the mining industry. In China, direct cryptocurrency buying can not be accounted for legally. Thus, they choose to manipulate financially to categorize mining machines as fixed assets and can be accounted for when it’s depreciated. As for compliance, there are two main ways.
1. U.S. listed companies have ownership of mining machines. In this case, the main body is allocated overseas, while domestic companies only do operational services for these machines, which can perform normal financial reporting and auditing.
2. The mining machine computing power is exported. With its ownership in China, the mining machine is leased to an overseas company. The transfer, mostly from crypto to fiat, takes place overseas, and the owner company charges technical service fees in the form of dollars.
What are the Impacts?
Amidst the storm, stakeholders believe that mining farms and miners stand to lose the most if mining is banned altogether.
Mining Farm: It will almost vanish. Although they are registered as big-data enterprises or cloud computing centers, they don’t reach construction standards. Besides, they are located in remote areas without supporting and surrounding industries. Transformation is rather difficult.
Miners: The value of the machine is discounted by half, and some miners may sell the machine at a lower price to recover some of their losses. But miners typically don’t sell cryptos even if they sell machines unless they have added leverage and need to recover from any losses.
Mining Machine Manufacturers: Most of the customers will be lost under high pressure. But as long as the price is high and the demand really exists, the revenue and profit will gradually come back.
Mining Pools: Chinese mining pools may face a sudden reduction in computing power. Therefore, whether they can timely transform and access overseas computing power and machines is the key to survival in the future.
Great Chance for Overseas Mining Industry
In the past, China’s computing power once occupied 70% of the industry. Filecoin was even nicknamed “Chinese coins” because most of its computing power came from China. Under the tightened regulation, Chinese miners are suffering losses but waiting to see what will happen. On the other side of the coin, overseas mining pools and farms have a better chance of taking off.
Globally, Central Asia (Kazakhstan), North America (Canada, USA), Southeast Asia (Indonesia, Vietnam), Russia and the Middle East are the locations that miners are considering with strategies welcoming the mining industry prosperity. Some degens are not optimistic about moving abroad because of higher costs in construction. More importantly, it’s not controllable to deal with local government and corporate relations. At the moment of high uncertainty, some choose to first seal the mining machine, and only new machines of higher value will be re-activated.
Nevertheless, mining computing power reallocation is an indisputable trend. Therefore, the industry generally believes that the 94 events in 2017 completed the de-Chinalization of cryptocurrency trading in exchanges, and this time it will be the de-Chinalization of the mining industry and computing power. On the one hand, foreign policies are encouraging the rise of mining, and on the other hand, domestic miners are moving abroad. In the future, will China still be able to maintain its merits in the mining industry?
Complete Ban or Not?
After regulations, products of mining companies such as Lepit Mining Pool and Bitmain’s BitDeer are no longer available to Chinese users. Those Chinese users who have already purchased them have also been through a clearance process. Many mining miners are also waiting to see what the domestic policy will be. If it is explicitly banned, they can only seal or sell their mining machines to overseas miners and will not make any new investments until then.
Large mining pools, for now, are those being mainly affected. The entire domestic mining industry may become decentralized with a family approach if the policy is getting tightened: domestic miners face the situation of declined computing power, cheap mining machines, shortened payback cycle with only a few months. Family model mining power consumption is not that politically sensitive. It’s attractive for miners to put one or two mining machines at home to earn a few thousand dollars per month. Major miners have a higher willingness to comply with the law because of larger capital volume; while individuals and small family-style miners might neglect law or regulations just for profits.
Therefore, the upcoming month is essential when the central government will further refine the policy and how the Xinjiang and Sichuan principal governments will implement it. It also will play a critical role in deciding whether the domestic mining pools will shut down or stay.
Admittedly, as a substantial industry, the mining industry contributes income and GDP to the local power station, power grid and the government by connecting a large number of entity resources and offering jobs. There could be a conflict between the central government and the local government. Yet it is merely impossible for the local government to violate the will of the central government. In China, the local government can only reflect the situation and allow the central government to consider people’s livelihood and local development decisions.
Industry practitioners are anxiously waiting for implementation policy. Some senior miners suggest that the government could take into account the actual situation as most of them are investing legally with their own capital; thus they asked for sufficient time for them to exit and achieve a soft landing. At the same time, they are also actively looking for reliable partners overseas, to do legal compliance and to minimize losses.
IOSG’s Perspectives
After the “94 Event” in 2017, the market started a short and violent bull run followed by a 3-year bear market. Many of the crypto unicorns that explode in 2020–2021 have gone through a few years of the cooling-off period before that. As Fred Ehrsam, former co-founder of Coinbase and now co-founder of Paradigm Fund, said in an open letter to his portfolio companies, “Cycles are neither good nor bad; they are natural. The thrill of the pinnacle offers the world a chance to dream about the future, while utter despair forces practicality and clarity. When things get good, they are not as good as they seem. When things go bad, they are never as bad as they look”. The only way to get through the fog of the bull and bear cycle and obtain the holy grail of value investing is to adhere to it long-term and keep your feet on the ground in the industry.
Thanks to the rest of the IOSG team & miner friends for their valuable feedback!
🦄 About IOSG
Founded in 2017, IOSG Ventures is research and community-driven with offices across China, US and Singapore. We focus on Open Finance, Web3.0 and cross-chain ecosystems, investing in teams with top potential worldwide. Our portfolio covers more than 60 projects, including Layer-1 blockchains (Near, Polkadot, Cosmos), middleware (Celer, Raiden, Reach) and applications including DeFi (MakerDAO, Synthetix, UMA). We have been actively involved in various developer & DAO communities. We believe in long-term partnership and we work closely with our portfolios to advise and support them along their journey of entrepreneurship.
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