Mining digital gold
by Lisa Murray 7 July 2016 Australian Financial Review
In a bamboo hut at a restaurant in the middle of China’s Sichuan province an unlikely industry gathering is taking place.
A large sunken pot of spicy broth is bubbling away on the table which is cluttered with plates of food drowned in oil and chillis, cups of green tea and empty cans of Red Bull.
This restaurant in a small town, about an hour’s drive from Kangding city and not far from the Tibetan Plateau, is
surrounded by spectacular mountains, which are only just disappearing into the darkness around 9pm.
The only topic of conversation at dinner is the virtual currency Bitcoin.
That’s because Kangding has become one of the biggest Bitcoin mining hubs in the world and the five men around the table all depend on it for their livelihoods.
“We have tried Iceland, Georgia, Washington State, Inner Mongolia and now we are here,” says Melbourne-based Chinese businessman Ryan Xu.
Bitcoin is “mined” by supercomputers, which solve difficult mathematical formulas to generate the currency. Investors buy these machines by the thousands and store them in warehouses where there is cheap electricity and a relatively cool climate.
It turns out the area around Kangding, populated by tall mountains that are scattered with under-used hydro power plants, is an ideal place to mine the digital coins.
“Everyone says this is a virtual currency but in many ways it’s a traditional manufacturing business,” says Xu, who visits the area regularly. “You buy heavy equipment, you burn electricity and you are rewarded with Bitcoin.”
Apart from his advisory and investment business, Xu is chief strategy officer at Bitcoin Group, which tried to list on the Australian Stock Exchange in March but was rejected by the corporate regulator amid concern it would not have enough capital to last the year.
One of his fellow diners, Wang Ruixi, a fresh-faced 26-year-old, manages a nearby Bitcoin mining facility in partnership with Xu. The former software programmer is in charge of three long, blue sheds filled with just under 5000 supercomputers whirring away. Xu helps investors to buy machines, which are then kept at the site. Bitcoin Group, for example, owns 1700 of the machines. All up, the pair says the facility mines about $60,000 worth of Bitcoin every day.
The sheds are tacked on to a private hydro power plant about one hour’s drive away from the restaurant, up a bumpy mountain track out of site from the main road. Xu and Wang are also building another slightly more modern facility in the area, which will have around 8000 machines. Ten days ago it was not much more than a steel frame but both men insist it will be up and running by mid-month.
“It’s an industry that is changing very fast,” says Xu. “We keep searching around the world for the cheapest electricity and the lowest costs. In America and Europe, if I hired an electrician, they would get paid one hundred bucks an hour. In Kangding, you pay $100 a week.”
Also sitting around the table is investor Boris Shen, who is travelling with Xu and has ploughed more than $1 million into Bitcoin mining equipment in the past two weeks. Guo Hua, who manages a separate nearby facility with about 10,000 machines for the Beijing-based company HaoBTC, and his colleague, Guo Yongzhi, just 21 years old, round out the diners. There is camaraderie, not rivalry, among this group. They all have a stake in the industry’s future. They are in it together.
In a sign of their level of commitment, the elder Guo and Wang are even paid in Bitcoin.
Eight years ago, when Bitcoin was created, Wang was in his last year at school, Guo Hua was fixing cameras and Xu was an operator at a nuclear power plant. It was 2008 and the mysterious creator of Bitcoin had published a white paper under the pseudonym Satoshi Nakamato. It described a peer-to-peer electronic payment system in which transactions could be recorded without the need for a central authorising agency. As explained by a University of Melbourne report included in the Bitcoin Group prospectus “it achieves this by constructing a data structure, called the blockchain, which can be thought of as ledger that is maintained by a community of participants.”
The blockchain is public but the ownership of individual Bitcoin accounts, which are called “wallets”, are secret.
A network of computers maintains the system by verifying transaction records via the repeated solving of difficult cryptographic problems. This process is known as “mining” and these computers are rewarded with Bitcoin.
At first the virtual currency failed to catch on, apart from being used as a form of payment for the online drug market Silk Road. However, in 2013, the price surged to more than US$1000, at one point trading higher than the spot price for gold, which prompted Bitcoin exchanges and mining companies to set up around the world. Now it is the basis of a multibillion-dollar industry, albeit one that is still poorly understood and clouded by controversy as the hunt goes on for its creator and Bitcoin attempts to shake off its shady past. It is also hampered by a volatile trading price. Bitcoin tends to rally in times of uncertainty, such as during the Greek debt crisis and the aftermath of the Brexit vote – but can fall back sharply in between.
As he plucks a bright-yellow corn cake from the edge of the hot pot, Xu says Bitcoin will do to the finance sector what the internet did to the media and communications industry.
“People still use fax machines, but Facebook and Twitter have changed the way people talk and communicate. Bitcoin will gradually play a very important role in the financial system. It can really change the world.”
China has embraced the virtual currency wholeheartedly despite an early central bank decision to ban payment companies from accepting Bitcoin transactions. It is home to the world’s biggest Bitcoin mining companies and the bulk of trading is now done in Chinese yuan. This is partly because Chinese exchanges generally don’t charge commissions, making them attractive for high-frequency traders. There are also those speculative investors who have been driven out of China’s sluggish stock markets and some people who may be looking to get money out of the country and need to circumvent Beijing’s strict capital controls.
Li Lin, founder and chief executive of one of China’s biggest exchanges, Huobi.com, says the number of traders has grown from less than one million in 2013 to “several million” while the value of daily transactions has jumped more than five times to over 1 billion yuan.
In mining, too, Chinese players dominate.
Wu, a 30-year-old former investment analyst who describes himself as a Bitcoin “evangelist”, was actually the first person to translate Satoshi Nakamato’s white paper into Mandarin. He says taking into account labour and equipment, the set-up costs in China are a fifth of what they are in the US.
Wu’s company, Bitmain, currently mines between US$200,000 and US$300,000 in Bitcoins every day and is also one of the biggest manufacturers of the mining machines, which vary widely in price but are now selling for around US$2400.
“Mining Bitcoin has been a risky investment over the last three years so the investor wants to have a very short period to get their investment paid back,” says Wu via phone from Beijing.
“In the US, you need to spend three to six months building a mining facility but in China it’s just one month.”
Still, he thinks that situation might reverse over the next three years as the Bitcoin price rises and technology improvements slow down so that mining machines last longer.
Back in Kangding, Wang concedes that when the mountain peaks are once again covered in snow during winter he will have to move some of his machines out of his facility to another location because of the unreliability of the hydro power supply.
Guo Hua is less concerned about the weather and more concerned about the “explosive growth” in mining facilities around Kangding. He says the number has jumped from two to more than 10 in the past 14 months.
And this rapid development comes ahead of an uncertain period for the Bitcoin price.
In order to protect the value of the digital currency, the new supply of Bitcoin halves roughly every four years.
That’s the way the system was designed. There is a finite supply of 21 million Bitcoins, with more than two thirds of that already in circulation. In order to slowdown the release of new Bitcoins, regular “halvings” are required.
The next “halving” is predicted to occur close to midnight on July 9, which means that the reward for miners in solving each of those difficult mathematical formulas drops to just 12.5 Bitcoins from the current 25.
“Nobody really knows what will happen,” says Xu. “If the price doesn’t go up, half the machines will need to shut down but it’s a dynamic industry.”
Xu points out the last time Bitcoin experienced a “halving”, in November 2012, its price surged tenfold over the next six months. Still, it will be a difficult time for the industry as investors who have piled money into new machines could be left with a smaller return than anticipated, at least in the short term.
Xu is optimistic by nature. His enthusiasm for the industry’s prospects is catching but he has had his fair share of setbacks – the latest of which was the decision by the Australian Securities and Investments Commission to stop Bitcoin Group from listing on the ASX.
In March this year, the company was forced to withdraw its initial public offering and return the $5.9 million it had already raised to investors. That amount had fallen well short of the $20 million it was targeting.
ASIC was concerned the group’s forecasts for an increase in the Bitcoin price after the halving were too bullish and it would not have enough working capital to see out the year.
“It comes down to what the regulator thinks about the industry,” says Xu. “ASIC is afraid of change and new technology.”
Xu notes that scepticism is not just confined to Australia. He says the Winklevoss brothers, famous for suing Facebook’s Mark Zuckerberg claiming the social media platform was their idea, have been trying to list their Bitcoin company in the US for the past three years.
Regardless, Bitcoin Group wants to try to list again this year but Xu says it will place less emphasis on its mining activities and focus more on what it can do with other applications of blockchain technology.
That’s not to say Xu will stop investing in the mining industry. Grinning, he points out that just down the road from his Bitcoin mining facility is a gold mine.
“It’s the same business,” he says. “We mine digital gold. They mine real gold.”
Xu’s arguments are compelling but there is no doubt Bitcoin mining is a frontier industry that is changing every day while Kangding is still adjusting to its newfound hub status.
There are many challenges ahead. Not the least of which is the city’s remote location. At almost 4300 metres, its airport is the third highest commercial airport in the world.
Our plane was forced to abandon its first landing attempt and return to the Sichuan capital of Chengdu because the pilot couldn’t make out the runway, something that happens regularly according to flight staff.
And on leaving the hot pot restaurant after a day of touring Bitcoin mining sites, we were stopped by three police cars and eight officers who insisted we had broken the rules by not reporting to the local station. After two hours, during which dozens of photos were deleted from mobile phones, we were released.
In the end the local policemen were more curious about the outlook for the Bitcoin price than they were about our tour of the area.
with translation by Lucy Gao
Original article here