Three major death spirals in the mining industry: two charts to understand what happened to Canaan? (In-depth)

A few months ago, Canaan's grand celebration of its IPO seemed to be still before our eyes. However, after seeing the financial report just released by Canaan, we can only sigh that "mining is difficult." Currently, Canaan's stock price is $3.2, which is nearly 60% lower than the issue price of $9.

First, let's look at the first picture, which is Canaan's revenue and profit from 2017 to 2018 to 2019. Revenue peaked in 2018 and fell back to the level of 2017 in 2019. At the same time, net profit continued to decline, and in 2019 it even set a record of losses.

(Chart: Wu Talks about Blockchain)

Then let's look at the second picture, which is Canaan's revenue and profit from Q1 to Q4 in 2019. Revenue soared in the third and fourth quarters of 2019, but the loss in the fourth quarter set a record again. It can be said that the main losses in 2019 were caused by the fourth quarter.

(Chart: Wu Talks about Blockchain)

The question is, why did Canaan incur such a huge loss in the fourth quarter of 2019? Canaan's financial report gave two explanations.

1: Mainly due to the write-down of RMB 729 million in inventory and prepayments, indicating that Canaan is dumping inventory products at low prices. Another data also shows that the inventory was RMB 585 million at the end of 2018 and RMB 196 million at the end of 2019.

Canaan's financial report stated that this was the result of a sharp drop in Bitcoin prices throughout the period of financial statement issuance, which led to a significant decrease in both demand and selling prices, as well as an increase in Thash sales.

It can also be seen from the trend of currency prices that the price of Bitcoin fell in the fourth quarter of 2019, but Canaan had accumulated too much inventory and had to clear it at the risk of losses.

(Bitcoin price trend in 2019)

2: In 2019, Canaan spent an additional RMB 240 million on equity incentives.

In summary, Canaan's revenue and profit were good in 2017, but in 2018, revenue increased significantly and profit decreased, and in 2019, revenue decreased and suffered serious losses. What is the reason behind this? It is also worth noting that Canaan's operating conditions are not completely in line with the price of the currency. In fact, the market conditions in 2018 and 2019 are similar, with both ups and downs, but Canaan's operating conditions are very different.

There are two reasons

1: The computing power of the entire Bitcoin network continues to grow. Because of the rebalancing principle of Bitcoin mining, from the perspective of currency standard, the number of Bitcoins produced is fixed; however, the computing power of Bitcoin is constantly growing, and the income per T is getting smaller, so the price of mining machines can only be reduced, which in turn leads to a decrease in the profit of mining machines.

According to Canaan's financial report, the total computing power sold in 2019 increased by 86.6% to 2.9 million Thash/s from 1.6 million Thash/s in the same period of 2018, but the revenue and profit were far less than that in 2018. The more they sell, the less they earn. It's really difficult.

2: Competition in the mining machine industry has intensified. Traditionally, Bitmain ranked first and Canaan ranked second in mining machines, which should have been relatively stable in 2017. However, the sudden rise of Shenma in 2019, especially Shenma's high-computing mining machines and price war strategy, challenged the market position of Canaan and Bitmain, seized a lot of market share, and even reduced the profits of the entire industry.

A small detail shows that Canaan's largest accounts receivable in 2017 came from Wu Gang of BiXin, but Wu Gang later invested in Shenma Mining Machine himself.

For the first quarter of 2020, Canaan said that the first challenge was the outbreak of COVID-19 (new crown pneumonia), so it lowered its expectations for 2020 business, and the total revenue in the first quarter is expected to be no less than RMB 60 million. But this is still higher than the revenue in the first quarter of 2019.

The growth of computing power and the intensification of competition are the "death spiral" of Bitcoin mining. Will Canaan fall deeper and deeper into this death spiral? Canaan's conference call and financial report gave two straws.

Straw 1: AI chips. Zhang Nangeng said that Canaan Technology has established strategic cooperation with leading domestic customers, established initial contacts with DJI and UBTECH, and is widely welcomed by North American customers. The second-generation product that the company plans to launch this year will have more functions and performance several times that of the first generation.

In this regard, we need to verify the revenue of Canaan's AI business from more detailed data. For comparison, the revenue of Cambrian, the leading domestic AI chip company, was about 400 million yuan in 2019. But for this 400 million yuan, Cambrian's R&D expenditure in 2019 was 540 million yuan. Canaan's overall R&D expenses in 2019 were 169 million yuan.

Straw 2: TSMC. Zhang Nangeng said that the research and development of new products in the first quarter was not affected by the epidemic and had been completed in February. Compared with the previous generation of mass-produced products, this product has reduced costs and improved the performance-to-power ratio by about 20-30%, making it a leader in the industry.

In addition, products based on TSMC's 5nm technology are also being intensively developed. Canaan Technology said it has sufficient cash flow. As of December 31, 2019, Canaan Technology had 516.6 million in cash and cash equivalents, which will meet the company's expected working capital needs and capital expenditures in the normal course of business in the next 12 months.

However, under the above two death vortices, 2020 also ushered in a third vortex: Bitcoin halving, which directly reduced output by half. Will the mining industry be worse in 2020 than in 2019? No one knows, anyway, Wu Jihan had already laid off employees at the end of 2019 to make early arrangements. Product competition is still intensifying, and Bitmain's S19 and Shenma M30S are being promoted in a high-profile manner. For Canaan, cost reduction in 2020 may be an inevitable choice. (Off topic, the previous short-selling report and class action lawsuit against Canaan would have been even worse if it happened after Luckin Coffee, although the short-selling report on Canaan was not professional)

Mining is a difficult industry. Looking back at history, Pumpkin Zhang created an ASIC mining machine, and Canaan was the first blockchain/mining machine company to be listed on the U.S. stock market. They have always made a significant mark in history.

If the future of exchanges is head monopoly and Matthew effect, the future of mining must be transformation. Zhang Nangeng started AI early, and he may have seen through this. I hope Canaan can succeed in the transformation of mining machines to AI and blockchain.