The fall of Bitmain: Canary in the crypto mine?

One year ago, Bitmain, which dominates the competitive Bitcoin mining industry, was the largest and most profitable player in the space. The world’s largest producer of ASIC miners, Bitmain also operates BTC.com and Antpool, two of the biggest Bitcoin mining pools. Together the two pools control almost 30% of the hash rate on the Bitcoin network. The 2017 crypto bull market saw the company make an unprecedented annual profit of between $3 and $4 billion.

As crypto asset prices surged, Bitmain were able to charge higher and higher premiums on mining equipment while also selling off crypto assets at much higher prices than they mined them at. The company was able to continue this strong performance in the first half of 2018, making a reported $742.7 million profit.

In an attempt to consolidate its strong position and raise additional capital for hardware production, in Q2 2018, Bitmain began preparations for an Initial Public Offering (IPO) on the Hong Kong Stock Exchange. The company completed its pre-IPO registration with the Hong Kong Stock Exchange in August and filed in September.

Less than 12 months later, Bitmain has fallen on hard times. The IPO appears unlikely to proceed and reports suggest the company may be in debt and running out of money. In February this year, Bitmain provided updated financial data to the Hong Kong Stock Exchange (as required for an IPO application). This data revealed that Bitmain made a net loss of $500 million in Q3 2018. While data for Q4 has not been released, an even larger loss is suspected, as the crypto market dropped to new lows in November and December.

The losses have forced the company to downsize rapidly. Multiple reports suggest that over 50% of Bitmain’s thousands strong workforce have been let go. Offices in Israel and Amsterdam have been closed, and co-founders and co-CEOs Jihan Wu and Zhan Ketuan have stepped down from their CEO roles. Once the face of Bitmain, Jihan Wu now seems to have removed himself from all Bitmain operations.

What went wrong?

Bitmain were hit with a perfect storm of both internal and external factors, that combined, have forced the company to take extreme measures to preserve capital. Bitmain is notoriously opaque about its business operations but analysts have been able to extrapolate from the IPO data filed in Hong Kong, and internal company leaks, to get an idea of the position the company finds itself in.

The number one external factor is the crypto bear market. This has adversely affected all crypto companies, but according to its critics, Bitmain has made strategic errors that have further exacerbated the situation. In 2017, a long running debate on the best path to scale Bitcoin led to a hard fork of the Bitcoin network, and the creation of Bitcoin Cash, a competitor to Bitcoin.

Along with Roger Ver, Bitmain’s Jihan Wu was one of the key supporters of Bitcoin Cash. Wu led several internal Bitmain groups dedicated to supporting the new cryptocurrency. Bitcoin Cash has since failed to win wide support, has itself been hard forked after community disagreement, and it has been one of the worst performing coins of the bear market. As a result, critics suspect that Bitmain hold a large number of Bitcoin Cash coins that are increasingly illiquid.

Samson Mow, CSO at Blockstream, and a Bitmain critic, believes the Bitmain IPO is doomed. "Highly unlikely for Bitmain to go public," he tweeted. "Their financials are weak, the Hong Kong Stock Exchange doesn’t like cryptocurrency related businesses, and too much of their prospectus relies on a pivot to a new business line (artificial intelligence) which alone could invalidate their IPO."

Mow also tweeted Chinese documents that suggest the company is being sued. He claimed, "Their assembly, component, production and repair companies are unpaid and losing patience." Mow also claims the company is selling their old generation S15 miners at 30% below cost. Further complicating the situation, the release of their next generation crypto miner was delayed, while consumer demand for new miners has continued to drop.

On Laura Shin’s Unconfirmed podcast, Mow said that with the IPO now unlikely to go ahead, Bitmain would be faced with having to pay back creditors with money it doesn’t have.

As for the inscrutable Jihan Wu, numerous reports suggest he is involved with a new cryptocurrency start-up, Matrix. Chinese media reports have stated that most of the Matrix team were previously part of Copernicus, Bitmain’s internal Bitcoin Cash team, before they were laid off from Bitmain.

Let’s zoom out. Is Bitmain’s fall from grace simply a high profile example of something more widespread across the sector? It appears so. In the third quarter of 2018, when the crypto bear market began to bite, across the industry, revenue and users went into sharp decline. As a result, cryptocurrency exchanges, who found themselves under-resourced and unable to cope with high user demand in 2017, now had the opposite problem. In September 2018, Kraken, a top twenty exchange by trading volume, announced that it would lay off 57 employees from its San Francisco based client services team.

Chief Executive Officer Jesse Powell told Bloomberg that the exchange was reducing staff after trading volumes had dropped. "The cost-saving measure will have zero impact on the quality of our service," Powell said. "No other teams are affected, and we are still aggressively hiring in all areas."

In October, Coinfloor, one of the UK’s longest running crypto exchanges laid off 20 staff, or half of their total workforce. Coinfloor CEO Obi Nwosu told Financial News the staff cuts were a response to a change in the market environment.

Even Coinbase, who were signing up to 50,000 new customers per day at the end of 2017, have laid off staff, though at a smaller scale than most. In October, Yahoo Finance reported that the American exchange cut 15 people from its remote support team. Coinbase, in a statement to Yahoo Finance, said, "We’ve learned that certain teams who are co-located are more efficient, effective, and happier in their roles. So moving forward, some teams—including Support, Fraud, and Compliance—will only hire employees into Coinbase offices."

In January this year, popular exchange Shapeshift was forced to let 37 employees go, a reduction in the size of their team by a third. Shapeshift founder Erick Voorhees published a blog post to explain the situation. In his uniquely frank and honest style, Erick explained, "Crypto, like the moon we strive toward, is a harsh mistress. We ride high and fast during the ascents, growing at rates unseen almost anywhere else in the business world (ShapeShift grew 3,000% in 2017).

And when the markets turn, the crypto recession is similarly dramatic and severe. None of it surprises those who have been through these cycles. But even with that experience, navigating these tumultuous seas is a continual lesson in humility." Voorhees goes on to explain that Shapeshift made several key mistakes — hiring too many people too quickly, diversifying its product offering too soon, and neglecting its core business. These problems were hard to identify in the rush of a bull market but soon came home to roost in the crypto winter.

Voorhees continues, "As a company, our greatest and worst financial decision is the same: to embrace substantial exposure to crypto assets. Much of our balance sheet is comprised of them. We accept the volatility, we accept the risk. And our proclivity to attach our own fate to that of the crypto market is not altered by the recent pain. Booms and busts are intrinsic to any frontier. And while comfort out here is elusive, passion and opportunity are abundant."

As noted by Voorhees, this boom and bust cycle is indeed the nature of markets, but the highs and lows in crypto are an order of magnitude more extreme than any other market in history. It’s this inherent volatility that exists at the beginning of all new markets that is the leading cause for the current downsizing of crypto businesses. Growth rates of 3000% per year are not sustainable across an industry.

Thining the herd

From this perspective, the current crypto winter should be seen as an unavoidable but vital part of the industry’s growth. Equally unavoidable are the inevitable casualties. It’s not just the exchanges that have cut staff. Dash, Steemit, SpankChain and ConsenSys are just some of the high profile names that have made significant reductions to their teams. Many other ICOs, exchanges and businesses have shut their doors for good. As we’ve seen above, the common thread is that all crypto companies have had to confront a similar set of problems.

There are external factors such as; plummeting asset prices, a lack of users, and falling exchange volumes. Each company has likely also made internal decisions that haven’t played out in the way intended, (ie. Bitmain backing Bitcoin Cash, Coinbase outsourcing its support, Shapeshift diversifying its product line too early). That is simply the nature of the beast. In high growth, emerging technology markets, it’s difficult to predict what will happen in six month timeframes, let alone 18 months or more.

Companies will get things wrong. This is expected. That’s why many start-ups adopt a strategy of "fail fast and often". This strategy recognises the fact that over 80% of all start-ups will fail. So if you do fail, fail fast, pivot and start again with a new approach. The key is to learn from mistakes, and apply these learnings iteratively. Adapt or die.

What’s next then, for Bitmain, crypto exchanges and the sector as a whole? Bitmain still own the two largest mining pools in the space. Coinbase remain the largest fiat on-ramp in crypto. In one sense, their fate may be the same as the stoic holders – if they can survive until the next bull market, they’ll be okay. In the meantime, the longer the bear market goes on, the more downsizing we’ll see. Smaller companies with poor fundamentals, no products and no customer base will continue to fall away, as they should.

This is simply part of the market cycle. The same thing happened with the Dotcom boom in the early 2000s which washed out countless smaller, weaker companies whose products didn’t exist or weren’t ready for mainstream use. The few major players who survived, improved their product offering, learnt from the washout and grew into some of today’s largest tech titans. The same is likely to happen in crypto. Those that survive today’s harsh crypto winter will help build the infrastructure for the next wave of crypto’s global adoption.