Abstract: We examine the power and dynamics of the “Bitcoin Core” software project and we draw distinctions between the various different ways one can compete with the project. We address the misconception that the Bitcoin Core software repository has the unique capability to change or prevent changes to Bitcoin’s consensus rules. We also discuss some common misconceptions and explain that if the Bitcoin Core repository becomes hijacked by nefarious actors or deleted, Bitcoin should be largely unaffected.

Venn diagram illustrating the various ways to “compete” with Bitcoin Core

(Sources: Bitcoin ABC, Bitcoin UASF, BTCGPU, Bitcoin XT, BTC1, Bitcoin Classic, Bitcoin Cash Cobra, Bitcoin SV, Bitcoin Unlimited, BitcoinX, Bitprim, Bcoin, Parity Bitcoin, BTCD, Libbitcoin, Caesure, Bits of Proof, Bitcoinj, Ufasoft Coin, Bitcrust, Picocoin, Bitcoin Addrinex, Bitcoin Knots, Bitcoin-RBF, Bitcoin BitMEX Research)

The three kinds of competition

One can categorise competing software projects with Bitcoin Core into three different groups:

The debate over competing consensus rules

This topic has been widely discussed in the Bitcoin community, largely in the context of the “blocksize war”, which ran from the summer of 2015 to November 2017. We are not going to repeat all those arguments in this report, where the primary purpose is to articulate the different types of competition.

The debate on competing independent implementations

As above, this is also a very controversial and divisive topic, however we still think it’s a fundamentally different issue to competition over deliberate changes to the consensus rules.

Other competing clients

Even if one really likes a robust ruleset, opposes competition over the consensus rules and one religiously follows Satoshi’s negative view about competing implementations, this does not mean one cannot have competing software projects. The competition can simply be in the white area, outside of the circles in the above venn diagram. This form of competition, which neither initiates a deliberate change to the consensus rules nor re-implements the code, is not controversial at all, as far as we can tell.

Therefore in theory Bitcoin never needs to suffer from the apparent problems of who controls a particular software repository in Github or arguments over who has commit access to the repository. In our view, many of these apparent problems are based on a misunderstanding, by people who appreciate some of the risks of competing software projects, but fail to distinguish appropriately between the different types of competition. Therefore many seem to overestimate the power of the Bitcoin Core software repository, thinking that any competition is risky or somehow unacceptable.

Bitcoin Core’s genesis

Prior to 2013, there was no software project named Bitcoin Core. The Satoshi client was sometimes just called the reference implementation or Bitcoin-QT/Bitcoind. Then in February 2013, Gavin Andresen, a prominent Bitcoin developer, posted to the Bitcoin Foundation forum asking:

There was some discussion about renaming Bitcoin-Qt and the reference implementation in general in IRC today; I thought some of you smart people might have good name ideas.

Mike Hearn, another developer, then responded:

Oh good, about time. This has irritated me for a while. How about Bitcoin Core?
(Source: Bitcoin Foundation Forum)

Many then started referring to the software project as “Bitcoin Core”, but nothing actually changed. Bitcoin Core then began to develop a strong brand, associated with prudence and stability, or as Gavin said at the time, “[its] like a rock”.

The impact of the “blocksize war”

During the blocksize war, many characterised the debate as being Bitcoin Core vs miners or large businesses, with the Bitcoin Core side opposing hardforks and blocksize limit increases. In our view the characterisation was mostly incorrect. However, many who made this characterisation then subsequently concluded that Bitcoin Core won, since there was no hardfork. This same group therefore currently overestimate the power of Bitcoin Core, in our view.

Bitcoin Core is not as powerful as many people think

It is not the Bitcoin Core software repository that defines Bitcoin’s consensus rules. The rules are defined by the clients economically significant users currently run. These are typically previously released versions of Bitcoin Core. The Bitcoin Core software project cannot change what software users are running and the users are a lot more independent minded than many people think, in our view. Even if Bitcoin Core had released a hardfork client, which increased the blocksize limit, it is not clear if the community would have upgraded. Therefore concerns about the Bitcoin Core software repository becoming deleted, hacked or hijacked should be far less of an issue than many people think. If this happens it will not affect clients users are already running and if further upgrades or improvements are needed, one can simply switch to a different repository or many different repositories, without worrying about any coordination problem or other risks.

Actually, in the summer of 2017, in some ways, a client competing with Bitcoin Core, Bitcoin UASF, overthrew Bitcoin Core and deliberately changed the networks consensus rules. Therefore, concluding that Bitcoin Core is all powerful, is the wrong lesson to learn from the blocksize war.

BitMEX Research is launching a new client to compete with Bitcoin Core (For illustrative purposes only)

Today BitMEX Research is announcing a new client to compete with Bitcoin Core, Bitcoin BitMEX Research. Since it is a software fork of Bitcoin Core, it carries none of the risks of not being bug for bug compatible, like Satoshi was concerned about. The BitMEX Research client also doesn’t change Bitcoin’s consensus rules, so the concerns about contentious chainsplits do not apply. Therefore, if the Bitcoin Core repository gets hijacked or deleted, the codebase can still improve using the Bitcoin BitMEX Research client or any other set of clients.

Conclusion

Following the resolution of the blocksize war, there is too much emphasis on the power of the Bitcoin Core software repository. Common questions now are “Who controls the repository?”, “What if they delete the Bitcoin Core GitHub?”. In our view, these questions may illustrate one is missing the point of Bitcoin.

People tend to look for somebody who is in control of Bitcoin’s protocol rules. Prior to and during the blocksize war, many thought it was miners, large businesses or Gavin Andresen. One of the unexpected negative consequences of that war is that many seem to have switched their opinions to believing Bitcoin Core is incharge, an equally flawed view. The truth is, as hard as it is to appreciate, end users are ultimately in charge of Bitcoin.

Of course this could be unrealistic, in reality, ASIC manufacturers, large mining farms, developers, large custodians, large exchanges and even an individual software repository are highly influential. We may be idealistic in saying that users are ultimately in control. However, isn’t that what “user controlled money” means? If one doesn’t think users control Bitcoin, what exactly is Bitcoin for anyway?

Abstract: In March 2018, we wrote a piece on the SegWit capacity increase and compared it to Bitcoin Cash transaction volume. Another topic we have focused on is coins moved for the first time since the split, on both sides of the chain (our September 2017 report). In this piece we briefly provide an update on the metrics we were tracking. The data shows that SegWit is enjoying strong and consistent growth, while Bitcoin Cash volume is also slowly increasing from its lows, to around 9% of Bitcoin transaction volume. As at October 2018, very few pre-split coins are moving for the first time since the fork.

SegWit transaction volume – Percentage of Bitcoin transaction volume (Daily data)

(Source: BitMEX Research, Bitcoin blockchain)

On the Bitcoin network, SegWit adoption has grown substantially since our first article on the topic in September 2017. Adoption now approaches 50% and the growth has been reasonably consistent and gradual throughout the period.

Daily transaction volume

(Source: BitMEX Research, Bitcoin blockchain, Bitcoin Cash blockchain)

As the above chart indicates, Bitcoin Cash transaction volume declined from the c10% of Bitcoin level in March 2018, when we last commented on the topic, to around 6%. Then in the late summer of 2018 Bitcoin Cash volume picked up again, to around the 10% level. The Bitcoin Cash numbers are somewhat skewed by the “stress tests” which occurred in August 2018 and then September 2018. However, the median daily Bitcoin Cash percentage transaction volume compared to Bitcoin in the last six months is 9.0%, a recovery compared to earlier lows of around 5% or 6%.

Cumulative transaction volume since the launch of Bitcoin Cash

(Source: BitMEX Research, Bitcoin blockchain, Bitcoin Cash blockchain)

Since the launch of Bitcoin Cash, 22.1 million SegWit transactions have taken place, only 17.0% more than the cumulative number of Bitcoin Cash transactions, which stands at 18.9 million. Although, as the chart above illustrates, this appears to be skewed somewhat by the stress tests.

Prior to the start of the stress tests, in July 2017, there had been 15.5 million SegWit transaction, 95.1% more than the number of Bitcoin Cash transactions.

Coins moved for the first time since the fork

(Source: Forks.network, Original chart idea from BitMEX Research)

As for our investor flow analysis system, 9.1 million Bitcoin which existed prior to the spit has moved at least once since the fork, compared to 8.6 million Bitcoin Cash. As the chart above indicates, the gradient of the spend for the first time since the fork lines are flattening out on both sides of the split, potentially indicating further significant changes in the investor flow dynamics are unlikely.

Abstract: Bloomberg is reporting that Noble Bank, which back in February 2018 we speculated could be Tether’s primary reserve bank, may be facing financial difficulties. Tether is said to be diversifying away to other banks and this hypothesis is supported by Q2 financial data from Puerto Rico.

New Puerto Rico Financial Data for Q2 2018

Bank deposits in the International Financial Entities (IFE) category, which includes Noble Bank, were $2.9 billion, down 18.4% in the quarter. This is despite continuing growth of  Tether, which is illustrated in the below chart. In our view, this data supports the assertion that Tether is moving its reserves out of Noble and into other banks outside of Puerto Rico. BitMEX Research has also been informed by Tether insiders that the Tether funds have been diversified into other banks.

Puerto Rico’s IFE aggregate deposits versus the Tether balance in millions of USD. (Source: IFE Accounts, BitMEX Research, Coinmarketcap)

Bloomberg are also commenting on the financial data from Puerto Rico, stating:

Puerto Rico has seen a surge of cash related to cryptocurrencies. By the end of 2017, cash and equivalents held by so-called international financial entities, such as Noble, soared to $3.3 billion from $191 million a year earlier, according to data from Puerto Rico’s bank regulator. As of June 30 this year, the total had dropped to $2.6 billion. The majority of that money on the island was held by Noble, people familiar with the matter said earlier this year.

(Source: Bloomberg)

Bloomberg is also reporting that Bank of New York Mellon is no longer Noble’s custody bank.  Tether’s hunt for more reserve banks continues.

Abstract: Following on from our first piece on ICOs in September 2017, which focused on the team members and advisors, in this report we work with TokenAnalyst to track the Ethereum balances of the ICO projects over time. We look at the amount of Ethereum raised and the US$ value of the gains and losses caused by changes in the Ethereum price, for each project. We conclude that rather than suffering because of the recent fall in the value of Ethereum, at the macro level, the projects appear to have already sold almost as much Ethereum as they raised (in US$ terms). Of the Ethereum still held by the projects, even at the current c$230 price, projects are still sitting on unrealised gains, rather than losses.

Please click here to download the pdf version of this report

Ethereum raised by 222 ICOs – Macro analysis

(Source: Ethereum Blockchain, BitMEX Research, TokenAnalyst, Token Data, Price data from Etherscan)

Overall profits & losses caused by changes in the price of Ethereum – US$ million

(Source: Ethereum Blockchain, BitMEX Research, TokenAnalyst, Token Data, Price data from Etherscan)

Notes:

1. This analysis only considers the Ethereum balances of the ICO projects, which we have tracked on the Ethereum blockchain. Funds raised in currencies other than Ethereum are not considered nor is the balance of the new token created by the project. Our reported totals are therefore lower than some other sources. Therefore while our figures may be an underestimate, one at least has a degree of assurance that the balance is calculated independently of the project. At the same time we are missing several projects such as Tron, as we have not identified a treasury address or an address cluster.
2. The estimate of the value of Ethereum raised is calculated by taking the highest value of Ethereum inside the address cluster of each project at any point in time (with the exception of EOS). This will result in some inaccuracies.
3. The estimate of the value of US$ raised is calculated by using the average ETH price during the ICO period. This should therefore be considered as a rough and unreliable estimate.
4. The estimate for the realised gains was calculated by taking the month end Ethereum balance for the address cluster of each project every month and then looking at the reduction in the Ethereum holdings. The average Ethereum price for each month was then used to estimate the US$ value of Ethereum that was sold. This is likely to be inaccurate and it is possible the project retains ownership of the Ethereum or that the Ethereum was not sold for US$.
5. While we believe our estimates at the macro level may be reliable, at the individual project level our figures are likely to be unreliable. We apologise for any errors or inappropriate assumptions.

Commentary on the overall Ethereum holdings and sales

The Ethereum price has fallen almost 85% from the US$1,400 peak price in around December 2017. As we mentioned back then, the value of Ethereum and the associated crypto-currencies was high and there was significant downside risk. The large fall in the value of Ethereum led some to question if there could be a “downward price spiral” due to the concentrated Ethereum holdings of the ICO projects. The theory being that many ICO projects were sitting on a large treasure trove of Ethereum and that as the price of Ethereum fell, these projects were going to “panic sell’, fearful of being the last project holding their Ethereum bags. Read more “Ethereum holdings in the ICO treasury accounts”

Abstract: Following on from our August 2018 piece on Bitmain’s IPO, in this note we look at new information made available in Bitmain’s IPO prospectus, which was published in the last few days. The new filing confirms our suspicion that Bitmain has been making large losses recently, with a net loss of US$395m in Q2 2018. The magnitude of wasted production costs is also revealed, with almost US$0.5 billion spent on failed chips in the last 18 months. However, the document also confirms that Bitmain successfully raised US$442m from investors in August 2018, significantly strengthening their balance sheet. At the same time, this brings the IPO closer, which is good news for Bitmain and something its rivals should be concerned about.

The Income Statement to June 2018

The prospectus discloses financials up to June 2018, one extra quarter compared to what had previously been available. The new income statement confirms our suspicion (driven primarily by lower sales prices) that Bitmain has been making losses recently. As the below table shows, the company lost US$395m in Q2 2018. The IPO prospectus document shows the company making a net profit of US$742m in the first half of 2018, however since we know from the “leaked” pre-IPO presentations that Bitmain made a $1,137m net profit in Q1, we can tell that Q2 was a loss making period.

(Source: Bitmain IPO prospectus, BitMEX Research)

However, the losses only relate to a period of one quarter and business conditions may change. One quarter of losses should not be a significant concern to long term investors, especially in a volatile business like crypto-currency mining. Although mining machine prices remain low and Q3 is also likely to be a loss making period, therefore moving back into the black may be challenging. Bitmain may need to raise prices to return to profitability, in our view.

In the document, Bitmain do acknowledge some potential strategic mistakes which may have contributed to the losses, and how they plan to address these issues going forwards:

Cash injections

The balance sheet position improved significantly in Q2 2018, mainly due to new cash injections from new investors. The net cash balance improved from US$104.9m to US$343m in Q2. Investors essentially rescued the company as it neared a cash crisis. As the table below shows, Bitmain raised even more money in Q3, which is likely to improve the cash position even further going forward.

Bitmain issuances of shares

(Source: Bitmain IPO prospectus, BitMEX Research)

Inventory

The inventory balance fell to $887.2m in Q2, compared to the $1,243.8m in Q1 2018. This reduction is likely to be primarily driven by impairments. In H1 2018 Bitmain suffered an inventory write-down of US$391.3m. Therefore a significant proportion of the pain related to the overproduction could have already occurred.

Pre-payment to TSMC & the current mining industry outlook

Worryingly the TSMC pre-payment situation has not materially improved as a drain on working capital, with the balance as at Q2 being US$652.9m, only down slightly from US$666.0m in Q1. This could relate to Bitmain’s new 7nm mining product, which was recently announced. The fact that this was officially announced by the company is a positive, since the failed chips were not announced and therefore this product could finally be successful. This could rescue Bitmain from a difficult business enviroment. However, skeptics would point to the following:

• This new 7nm project could also be a failure, the company is only announcing it as they are under more pressure (in our view this is unlikely)
• Moving to 7nm is very challenging and it could take around 12 to 18 months until these devices are as reliable as the 14nm and 10nm products on the market
• Producing at the 7nm level is too expensive and Bitmain’s rivals, Innosilicon, Ebang, Bitfury have out-smarted Bitmain by selecting the cheaper and larger wafer size in their new products, which have also all been announced in the last few weeks.

Impairments related to failed chips

As we mentioned in our previous piece, “Bitmain has tried to release at least three new more efficient Bitcoin mining chips, one at 16nm, one at 12nm and more recently 10nm in March 2018. Each of these releases failed, costing Bitmain hundreds of millions of dollars”. The disclosure in these documents may reveal that our assessment may have been accurate and the scale of the cost of these failures can now be determined.

Provisions for impairments related to TSMC prepayments & inventory write-downs

(Source: Bitmain IPO prospectus, BitMEX Research)

The above illustrates just how risky and potentially financially costly it is to produce new chips. Bitmain have paid a high price for some of the failures.

Bitcoin Cash & the crypto-currency holdings

The prospectus does not reveal any significant new information compared to our previous report, individual holdings by coin were not disclosed. The value of crypto-currency on the balance sheet fell to US$886.9m in Q2, compared to US$1,172.4m in Q1. This is likely to be driven by a fall in value in Bitcoin Cash and the other coins. Bitmain disclosed an impairment of its crypto-currency holdings of US$102.7m in Q2, which is likely to have accelerated further into Q3.

Conclusion

The prospectus enables us to quantify the financial impact of mistakes we already suspected that Bitmain had made.

• Bitmain lost US$0.5 billion on production costs associated with mining chips that failed (or other inventory write-downs)
• The company was dependent on US$784.7m on new investment to retain a positive cash position
• Bitmain incurred a net loss of almost US$400m in the most recent quarter, due to having too much inventory and needing to lower sales prices

Obviously many of these mistakes could have been avoided, but all they really show is that Bitmain take risks. If Bitmain didn’t take such risks the company would not have built $1,617m of shareholder equity in the last few years and Bitmain would not have been the largest and most profitable mining company in 2017.

We now know the IPO is close and could occur within a few months. This could provide Bitmain a substantial cash war chest. Although Bitmain’s rivals have very recently successfully began releasing a wave of new more efficient mining products, Bitmain’s new large cash reserves is something they should worry about. Even though Bitmain obtained this money from investors, rather than generating it from free cash flow.

(The timeline of the IPO or number of shares which will be sold has not been disclosed in the filling)

Abstract: In this piece we review and analyse Bitmain’s financial data, which was made available (or leaked) as part of the pre-IPO process. The figures indicate Bitmain was highly profitable and cash generative in 2017, but may currently be loss making. Bitmain also spent the majority of its operating cash flow acquiring Bitcoin Cash and may have suffered mark to market losses of US$328 million as a result. We conclude that the IPO itself may go well, however going forwards the allocation of investor capital will be key and management may need to improve in this area.

Please click here to download the pdf version of this report

The IPO process

Bitmain expects to submit IPO documents to the Hong Kong Stock Exchange at the end of August 2018, with a public listing expected towards the end of 2018. The company has just conducted a pre-IPO round, raising several hundred million dollars at a valuation of around $14 billion. Therefore we believe the company is likely to attempt to raise several billion dollars at the IPO stage, with a valuation north of $20 billion.

Documents outlining this process, which also contain Bitmain financial data, have been leaked on Twitter. We have reason to believe the authenticity of these documents, which forms the basis for this report.

Bitmain’s position in the mining industry

(Source: Bitmain pre-IPO documents, BitMEX Research)

Will there be demand for the IPO?

Bitmain has a strong or dominant position in most areas in cryptocurrency mining, as the table above illustrates. Bitmain is likely to be the largest and most profitable company in the blockchain space, which is likely to make the company attractive to many investors.

In the last few years and decades the key lesson many technology investors have learnt, rightly or wrongly, is to always invest in the number one company. The number one company typically benefits the most from network effects and as a result smaller rivals tend to fail. The below list of usual suspects illustrate this basic point:

Justified or not, the blockchain space is now regarded by many as one of the next big internet based technologies and Bitmain is the number one player in this space. Whether this network effect type logic can apply to ASIC design and distribution is not clear to us and the benefits of being big may be limited to the more traditional economies of scale. We think it is important to not only look at cryptocurrency mining through the technology lens, but also to look at it from the angle of an energy intensive industry, like mining for natural resources. In these sectors the benefits of scale are more limited than for internet based networks. Therefore we don’t completely agree that one should blindly invest in the largest cryptocurrency mining entity, we just think than some investors, perhaps naively, may think this way.  

Bitmain’s own mining operation declines

As we alluded to above, one of the most interesting discoveries in the Bitmain pre-IPO documents was the sharp decline in Bitmain’s own mining farm business. Although the share of revenue has dramatically fallen, in absolute terms own mining revenue still grew by 250% in 2017, its just that the 948% growth in equipment sales overshadowed this.

Bitmain – share of revenue from own mining operations

(Source: Bitmain pre-IPO documents, BitMEX Research)

We believe this decline represents a smart strategic decision by Bitmain to divest (relatively speaking), from an increasingly competitive and lower margin area. In our view, as one moves down the mining supply chain, the competition is likely to increase faster and Bitmain made a sensible move by trying to focus their efforts up the chain, where an increasingly large proportion of the value from mining may accrue. In some ways this is good news for Bitcoin decentralisation, as a dominant mining player has stepped back. We believe ASIC design and distribution is less critical to network security than mining farm operation, which in theory choose the pools who construct blocks and select which blocks to build on top of. Of course Bitmain’s power and dominance in the ASIC space still remains as a significant problem for Bitcoin.

Currently Bitmain are likely to be making losses 

In the documents, Bitmain disclosed the revenue, sales and crucially gross profit margin for each of the main mining products. We have displayed the relevant data in the table below. The data shows that Bitmain sold over a million S9’s in 2017 and then over 0.7 million in Q1 2018 alone.

Financial metrics by mining product

(Source: Bitmain pre-IPO documents, BitMEX Research, Bitmain website)

Using the disclosed gross profit margin from 2017, we calculated the implied cost price of each machine. Assuming these costs remain unchanged (which may be unrealistic), we were able to calculate gross profit margins based on the latest prices on the Bitmain store. This analysis implies Bitmain are currently loss-making, with a negative profit margin of 11.6% for the main S9 product and a margin of over negative 100% on the L3 product. In reality costs are likely to have declined so the situation may not be as bad, however we think it is likely Bitmain are currently making significant losses.

These low prices are likely to be a deliberate strategy by Bitmain, to squeeze out their competition by causing them to experience lower sales and therefore financial difficulties. In our view, herein lies the key to one of the main driving forces behind the decision to IPO. A successful IPO may increase the firepower available to continue this strategy and eliminate an advantage rivals could have by doing their IPOs first.  

Another reason for these low prices and apparent losses may be that Bitmain has too much inventory on the balance sheet. As at March 2018 Bitmain had $1.2 billion of inventory on the books, equal to 52% of 2017 sales. Bitmain may therefore have had to suffer inventory write downs, which could have generated further losses in addition to the loss making sales.

Use of operating cash flow and balance sheet

The documents contain summary balance sheet data. On the positive side is that Bitmain has no debt and the company was highly cash generative in 2017. The negatives include:

1. Large prepayments to TSMC, totalling almost $866m in 2017, which weaken Bitmain’s working capital situation;
2. A large inventory balance, of around $1.2bn (over 50% of peak annual sales) illustrating overproduction;
3. A large portfolio of altcoins, with a cost base of $1.2 billion which represents the primary use of Bitmain’s cash flow.

(Source: Bitmain pre-IPO documents, BitMEX Research, Prices from Bitfinex)

(Notes: Projections based on prices as at 28 August 2018, coin holdings as at 31 March 2018)

One of the key assets of the company is its portfolio of cryptocurrencies, valued (on a cost basis) at almost $1.2bn as at March 2018. As at March 2018 this consisted of over 1 million Bitcoin Cash. The market value of the altcoin portfolio has fallen in value since Bitmain invested, with almost all the losses attributable to Bitcoin Cash, as the chart below shows.

Bitmains investment in cryptocurrency – change in value vs cost price – $ million

(Source: Bitmain pre-IPO documents, BitMEX Research, Prices from Bitfinex)

(Notes: Prices as at 28 August 2018, coin holdings as at 31 March 2018. Chart assumes coin holding do not change)

As the following chart below illustrates, the Bitcoin Cash investment itself is very significant, to the extent that the company spent around 69% of its 2017 operating cash flow on purchasing Bitcoin Cash. Although this could be an exaggeration, some of the Bitcoin Cash would have been inherited from pre-fork Bitcoin. The figures imply that around 71,560 of the 1,021,316 Bitcoin Cash coins could have been inherited in this way. 

Bitmain use of 2017 cashflow – $m

(Source: Bitmain pre-IPO documents, BitMEX Research)

The situation is even worse than the above indicates. Not only did Bitmain spend a majority of the 2017 cash flow into Bitcoin Cash, they also spent a majority of cash flow from their entire history of operations, into Bitcoin Cash. The documents show that Bitmain generated no cash flow in in 2016 and then only $25m in Q1 2018 (perhaps due to large TSMC prepayments).

Bitmain operating cashflow – $m

(Source: Bitmain pre-IPO documents, BitMEX Research)

In a sense of course none of this matters. Bitmain spent their own funds on risky assets and they knew the risks. For a public company the situation could be a different, with investors expecting the company to invest in core operations or return money to investors. Although perhaps our expectations for governance here are too high for Hong Kong.

Why are Bitmain doing the IPO?

In our view the primary motivating factor for the IPO is simply that Bitmain’s competitors are also planning on doing them and the industry is fiercely competitive, as Bitmain’s loss making prices indicate. Rival Canaan Creative are planning on an IPO and Bitmain are unlikely to let them obtain such a funding advantage. Bitmain’s IPO should deduct money from the pool of capital that could otherwise be invested in Canaan as well as the other miners and it is therefore a good complement to the strategy of lowering prices.

The other reason for the IPO may be to strengthen the balance sheet after investing the majority of the operating cash flow into Bitcoin Cash. Bitmain only had around $105 million of cash on the balance sheet as at March 2018, when this figure could have been nearer a billion dollars if the company hadn’t acquired so much Bitcoin Cash. At the same time the business does require a lot of cash, for example the large advance cash payments TSMC require, which reached a peak of $866m in 2017.

The debate over Bitmain’s technological advantage

The narrative surrounding Bitmain’s technical capabilities can be spun in either direction and as ever the truth may lie somewhere in the middle. However, one thing is clear, if these mining companies do go public, the picture should be far less murky going forwards and we think that could be a significant positive for the cryptocurrency community.

Conclusion

In a way some of Bitmain’s biggest mistakes, such as producing too many units and buying too many speculative altcoins in a bull market, are somewhat analogous to the typical behaviour of mining company management teams.  For instance gold mining firms often invest in high cost assets in bull markets and then fail to invest in quality low cost assets in bear markets. Perhaps it is not totally fair to blame these companies, the hedge funds and institutional investors who own the shares are often just as, if not more, at fault. Greed, fear and the emotions of market moves can affect us all. Therefore although Bitmain has made mistakes, in many ways they are not unusual or unexpected.

We are sure you have heard it before, but “cryptocurrency is here to stay”. In that environment we think Bitmain has the ingredients to be one of the great companies in the space. Bitmain can be a legendary crypto company, generating strong shareholder returns for decades to come, but in order to achieve this (and it’s a lot harder than it sounds) the Bitmain management team may need to improve their management of company resources. Once the company goes public, capital allocation decisions in this volatile and unpredictable market will be difficult enough, letting emotions impact too many investment decisions may not be tolerated.