Wired in-depth report | The survival story of China’s BTC mining tycoon

On April 8, the National Development and Reform Commission announced the “Guidelines for Industrial Structure Adjustment”, listing digital asset mining as an “eliminable” industry.

Miners have been earning valuable digital currencies from excess energy, but a ban could put an early end to the gold rush.

This article was originally published in the "In-depth Reading" column of Wired magazine and exclusively translated by Crypto Valley.

Mr. Gao told me: "In China, don't assume that something is legal just because it's not illegal." After saying this, he paused and took a breath.

Mr. Gao is a BTC miner who owns thousands of mining machines, some of which he rents out to others. He is very powerful and has plans to purchase 110,000 new machines to fully cover western provinces such as Sichuan and Yunnan and remote areas such as Xinjiang and Inner Mongolia.

Although the price of BTC has experienced a roller coaster-like sharp decline in the past period and has only recently begun to gradually recover, Mr. Gao's industrial expansion plan has never stopped.

China has 70% of the world's mining capacity, of which more than 70% comes from the mountainous areas of Sichuan, where abundant hydropower resources make mining the cheapest in the world. However, this "gold rush" is under threat.

While mining bosses of all kinds and backgrounds were making considerable profits through legal gray areas, the country's highest industrial guidance agency, the National Development and Reform Commission, published the "Guidelines for Industrial Structure Adjustment (2019 Edition, Draft for Comments)" on its official website on April 8, 2019. This seemingly insignificant news caused an uproar and triggered all kinds of speculation and interpretation.

Obviously, the Chinese government's official attitude towards the crypto economy has undergone a subtle change, from the previous total ban to: encouraging blockchain information services within the permitted scope and suppressing digital asset mining. This means that digital asset mining will be listed as an "eliminable" industry, and the future is unpredictable.

For those at the top of the cryptoeconomic food chain, this is a wake-up call to gather as much money as possible before the deadline.

Miners protect the network and maintain the infrastructure (called the "blockchain") by stringing transactions together into clusters (called "blocks"), which form a "chain". This makes the digital assets relatively decentralized and theoretically extremely unlikely to be attacked or hijacked. In the process, miners are rewarded in the form of digital assets.

In order to maintain the market stability of digital assets, the difficulty of mining will increase with the increase of computing power, and it will also consume more electricity. Therefore, a few years after the launch of BTC, mining machines began to gradually become specialized, from the initial desktop computers and small units to centralized operations with tens of thousands of machines, equipped with professional cooling equipment in large warehouses to prevent mining machines from overheating. Engineers in the mines work day and night to ensure that all mining machines are operating normally, and other management teams are responsible for operations and business work. One of the most important work contents is to maintain good relations with local governments and power suppliers.

Looking back, the price of BTC has experienced dramatic fluctuations. It soared to $20,000 in December 2017, but plummeted to $3,399 in February 2019. Since then, the price has stabilized in the range of $4,000 to $5,000. Of course, this has not had much impact on the existing miners' business. They believe that as long as the price of each BTC is not lower than the cost and tends to increase in value overall, their income will remain stable.

"In Q4 2018, the production-weighted cash cost of creating one BTC averaged around $4,060." This is the result of research by JPMorgan Chase. This means that as the price of BTC continues to hover around the $4,000 mark, it may fall to a level that is financially unable to cover the cost of mining.

But in China, this global rule does not apply very well. Studies have pointed out that China's abundant cheap electricity allows miners to keep the mining cost of each BTC at around $2,400.

“The reason why there are so many miners in China is simple,” Mr. Zhang, one of China’s first Bitcoin investors who requested anonymity, told me. “Machines are easily available, there is cheap labor to maintain them, and the cost of building mining facilities is low. Crucially, there is a lot of excess electricity here that needs to be used, so it makes sense to use it for mining.”

While people trading BTC are glued to their screens all day, checking the price of digital assets on various exchanges, miners are more interested in the price per kilowatt of electricity and where they can find a stable and continuous power supply that will not be cut off by the local government.

"Mining is what made me believe in Bitcoin," Gao told us, sitting in an upscale shopping mall in Chengdu, Sichuan. "Once you see the explicit costs, like the machines, the cooling facilities, and the labor, you realize: Bitcoin is not an intangible thing. It must have some kind of fixed value, otherwise why is it all here?" He pulled out his phone and showed us a photo of his mining farm: a series of huge warehouses nestled in the mountains of Sichuan.

A worker is checking mining equipment in Kongyu Township, Ganzi, Sichuan. Image source: The Washington Post

Before the NDRC’s “blockbuster” was officially released, the legal status of BTC in China remained unclear.

In 2016 and 2017, there was a lot of speculation about BTC and other digital assets, and the number of token financings and exchanges surged. Many of them were scams.

According to rumors, China's earliest blockchain financing project can be traced back to 2012. Since then, there have been many strange stories. For example, Jiang Xinyu, a genius teenager who called himself "Baked Cat" and graduated from the University of Science and Technology of China, launched a dedicated mining hardware "butterfly mining rigs", but lost in the fierce market competition and then disappeared.

The Chinese government, concerned about the rapid development of the crypto industry, stepped in and launched a comprehensive reform. After the "94 ban", most early adopters closed their businesses, and some left the mainland and set up new locations in Singapore, Malta, etc. Binance's Zhao Changpeng is an example. But if their behavior of making money from Chinese citizens is exposed, they will still be subject to Chinese legal sanctions.

Similar regulatory reforms have caused the global share of BTC trading denominated in yuan to fall from 90% at its peak to just 1% today, according to statistics from the US library of Congress.

It is not illegal to own or trade BTC in China. However, you cannot buy BTC with RMB or exchange RMB for BTC. Given the very limited ways to use digital assets, this means that BTC in China can only be used as a store of value - and intangible value stored in cryptographic form.

The crypto asset craze will not cool down naturally because of a ban, and profit-seeking is human nature. In actual operations, a considerable number of OTC (over-the-counter) transactions are not conducted through exchanges, but through channels such as WeChat or Alipay. Using Alipay, users transfer money to a middleman, and the other party confirms the payment and sends the corresponding amount of the required digital assets to the designated address. This requires a high degree of trust between each other, because such transactions are "fraudulent" offers without any right of recovery and are not protected by law.

Of course, compared with the frequent collapse of P2P or other forms of illegal financing, this is just a drop in the ocean. But because blockchain is naturally close to "money", it has aroused the vigilance of regulators.

From a regulatory perspective, digital assets are a headache. The government has extremely strict controls on citizens' money transfers. "In China, money is like a shrimp trap," said Dr. GM Bell, a researcher based in Shanghai. "It's easy to get money into the country, but it's hard to get it out." Distributed digital assets pose a serious challenge to the authority of governments that intend to control citizens' wallets, which is why the central government has taken tough measures against exchanges.

However, given the huge technological potential of BTC and blockchain in the future, the government is unwilling to completely ban related activities. Therefore, the official discourse of "blockchain serving the real economy" has emerged. In a sense, this is a hedge between risks and opportunities, and a typical "Chinese wisdom".

Considering the lack of legal trading channels and the huge risks of over-the-counter transactions, mining is the best and safest way to obtain digital assets in China. Although Chinese miners are clearly different from crypto-anarchists in other countries, these tokens are indeed legally created, which makes mining behavior naturally political.

When I asked this question to a well-known mining tycoon, he was dismissive.

"I'm not an anarchist or a libertarian. I don't even know what's the point of talking about these 'high-end words'. Strictly speaking, I'm a nationalist and I love my country. I just think it gives people a new asset selection channel and it can make me rich. That's all."

Since exchanges and token financing channels have been completely closed, and there is currently no legal way to exchange digital assets for RMB, mining has become the last pillar supporting this "invisible building."

If the government decides to completely destroy China's crypto industry, it only needs to ban mining. The industry guidance statement issued by the National Development and Reform Commission shows that this possibility exists, but when the shoe will fall, everyone is still waiting to see.

The document suggests that mining could be outlawed entirely as part of an economic activity that “wastes resources, pollutes the environment, is unsafe, or does not comply with the law.” However, the miners I spoke with did not seem surprised or overly discouraged by the news.

Some people pointed out that the bill is still in the public consultation stage, and even if it is finally passed and becomes a real law, the directive will not be implemented immediately and the initial inspection will be quite lax. This is a common practice in China.

But others don't think so. They have already started looking for a way out overseas.

Mining has a unique meaning in China. In some circles, crypto mining is seen as an efficient way to clear excess power capacity.

The Hobbit Mine is located in a remote mountainous area of ​​the Qinghai-Tibet Plateau bordering Sichuan, with a superior geographical location. It is close to a hydroelectric generator, which ensures a reliable power supply at a very low cost. Image source: The Washington Post

From the United States to Canada, Europe and China, critics often claim that digital assets are an environmental disaster. They point to a set of data, saying that in 2017, global BTC mining activities consumed as much energy as the electricity consumption of Denmark. This is true, but it is also true that in 2016, Yunnan Province in China wasted 32 billion kilowatt-hours of electricity - which is roughly equivalent to Denmark's electricity consumption that year.

As economic growth slows, China's development pace has shifted from focusing on infrastructure construction to service industries represented by consumption upgrades and e-commerce. On the other hand, unbalanced regional development and the suffocating elimination of backward production capacity have also led to a serious oversupply of electricity.

This is especially true in places like Inner Mongolia and Xinjiang, where coal-fired power plants spew toxic gases into the arid desert day and night; while in Sichuan and Yunnan, where hydropower dominates, dams have flooded countless villages and displaced millions of people. It can be described as "ice and fire". There are more than 6,600 hydropower stations in Sichuan alone, and the provincial government has had to strictly prohibit more small dams built specifically for BTC mining.

In Inner Mongolia, coal-fired power drove economic growth until 2012, when coal prices began to fall sharply, and to make matters worse, the government began to tighten environmental protection policies, causing coal prices to fall further.

In 2014, Beijing was enveloped in thick black smog, forcing schools and airports in the northeast to close for days. The Chinese government's attempt to wean the country off coal has devastated the economies of regions such as Inner Mongolia, where cities that were expected to grow are now largely empty, with famous "ghost towns" such as Ordos.

The emergence of digital assets came at the right time and seemed to have re-injected vitality into the above-mentioned areas. Ordos's Kangbashi offers preferential electricity prices to BTC miners within its administrative area. They once quoted a low price of $0.04 per kilowatt-hour to Bitmain, a leading supplier of mining equipment. This fee is about 30% lower than the electricity price paid by most companies in the region.

Interestingly, in the suburbs of Ordos, 200 kilometers away from Bitmain’s main mine, lies China’s largest open-pit coal mine, Harwusu. It can be seen that people are pinning their hopes on BTC mining to reap wealth again.

The Library of Congress report states that “In January 2018, China’s Internet Finance Risk Rectification Leading Group asked local governments to cancel preferential policies for BTC mining companies.” However, local governments have not strictly implemented this instruction. Several miners I spoke to said that double trading is still common. Of course, provincial government inspections have indeed increased. Some mining equipment in Inner Mongolia and Xinjiang has been seized and operating sites have been forced to close.

China’s massive infrastructure projects have created a massive energy surplus, which in turn has driven down the cost of energy-intensive Bitcoin mining. Image credit: Adrian Greeman/Construction Photography

In China, there are roughly three types of people mining BTC. The first are those who follow the trend and hope to get rich returns; the second are those who enter the industry by chance and have privileged access to cheap electricity (either their own or through connections); and the third are those who truly believe in BTC and its related industries.

There is a very vivid phrase in the Chinese world, "cutting leeks", which is often associated with those who blindly enter a certain industry in pursuit of wealth, because leeks grow very fast, and after one bunch is harvested, another will soon grow out.

The underlying trading volume of digital assets is notoriously dubious. Chainalysis, a blockchain research company, estimates that the real trading volume of BTC is about $812 billion, which is four times lower than the $3.3 trillion total trading volume issued by institutions such as Satoshi Capital Research. This means that wash trading is very prevalent in this industry, which is essentially no different from the "pump and dump" in regulated traditional financial markets.

Investing in digital assets is difficult due to the lack of reliable knowledge and the influencers driving the market. Research by Credit Suisse shows that 97% of BTC is held by only 4% of market participants, a tiny group that has huge financial influence.

In 2017, Xu Xiaoping, one of China's most famous angel investors and founder of Zhen Fund, said at a private meeting that blockchain is a great technological revolution that will prosper if you follow it and perish if you go against it. Although he had requested confidentiality when he gave his speech, his remarks were undoubtedly leaked. The next day, domestic blockchain concept stocks rose 5.7%.

Even today, with exchanges shut down and token fundraising banned, there are still countless BTC crypto groups active on WeChat, and once registration is open, they fill up quickly. They exchange information about coin prices and OTC transactions, discuss which VPN is the best, and where there is exciting mining action. It is almost impossible to verify the authenticity of this information.

Many miners who entered the market in 2017 were particularly hard hit by the BTC depreciation. They entered the market when the machines were expensive. One mining tycoon told me that he bought a lot of D9 mining machines at 40,000 yuan each during the boom, only to see them fall along with the price of BTC. In the end, he sold the equipment for a few hundred yuan and reduced the number of mining machines from 30,000 to less than 7,000.

Mining farms take time to get up and running, so miners that intend to enter the market at a specific price often find themselves caught off guard when the market rebounds.

Coinbase data shows that 600,000 mining farms around the world have closed during the recession, most of them in China.

With the deepening of economic reform, China has experienced two huge booms in the past 20 years. The first was real estate, and the second was the stock market boom.

BTC unexpectedly gained global attention when the stock market crashed in 2015. For those who failed to benefit from the first two waves, the upcoming crypto-economic wave is extremely tempting, exuding an inexplicable aura that makes them unable to extricate themselves.

In addition, stories of ordinary people making huge fortunes also strike a chord with people, such as how Alibaba founder Jack Ma rose from an ordinary English teacher to China's richest man in 20 years. The government promotes this case as a positive example - when you work hard, everything is possible. This is the "Chinese Dream" of the new era, the Asian version of "The Great Gatsby".

If they can, why can’t I? If a farmer from Guizhou — Tao Huabi, founder of Lao Gan Ma — can build a billion-dollar sauce empire, is investing in a token mined from the ether using mathematical principles really that absurd?

My friend “小米鸽子” (net name), whom I met when I attended a blockchain meetup called Crypto-Monday in Chengdu, introduced me to some miners who are the source of information for this article.

On the way to the party, I asked him, "Have you ever invested in BTC?" "Yes, I lost ten years' salary," he told me calmly. Later, when I asked him if he would like to share a ride home, he told me that he had moved to a suburb outside the outer ring of Chengdu, which took two hours by subway and bus. Strictly speaking, it was no longer in Chengdu.

However, for miners who remain in the industry and have access to electricity or confidence in the market, they will keep their operations stable and pray.

These people who once had huge investments, physical mines, and complex business logic, can only wait now, just like the protagonist of Ha Jin's novel of the same name. However, deep down, they actually have great expectations. Because they have experienced similar storms in the past, this is just a new obstacle on the road to wealth.

Before the NDRC’s announcement, most miners I spoke to believed that the market situation after last year’s BTC crash was similar to the Internet bubble at the turn of the century - it eliminated speculators, and those who remained would be the important figures who could lead the crypto industry towards professionalization and maturity.

It sounds a bit ironic. The dot-com bubble burst, healthy competition gave birth to giants, and then came huge technology monopolies. They have the power to ignore the government and complete privacy monitoring tools. The Internet is fragmenting, and China is isolating itself behind a wall.

Later, utopian technological ideals emerged to transform and innovate the Internet, or to rebuild a decentralized global space. The reshuffle of BTC miners will only leave strong players, and amateurs will be eliminated.

In 2011, when BTC did not yet have a Chinese name, Zhang Jingyang began investing in this industry. He is a believer of Bitcoin founder Satoshi Nakamoto and is part of his great distributed ideal, connecting mining machines and PCs as a hobby.

When I asked him if he still mines, he laughed. “It’s too complicated, there’s the risk of local regulation, and the cost is too high. I only invest in cloud-based mining now.”

If China does ban mining completely, the market could be fragmented again, but this seems unlikely. In anticipation of regulatory changes, a large number of Chinese miners are looking overseas.

The Financial Times said that in digital assets, Bitmain's machines are equivalent to shovels during the "gold rush". The mining machine giant previously announced plans to deploy 200,000 machines in Sichuan to make full use of cheap hydropower during the rainy season.

I spoke to an investor who holds a large stake in the company and he casually mentioned that he was helping Bitmain expand into the Middle East. There is no doubt that if the NDRC really decides to "cut it off", these miners will immediately go elsewhere.

Mr. Gao briefly talked about his plans to move his business. It could be to the United States, where he feels the regulatory environment is more relaxed. But he also believes it will take some time for the regulations to take effect. For now, he has more pressing things to do - moving the machines, negotiating with the local government to ensure that his mine will not be closed, and finding a place with stable electricity and good prices.

In his view, BTC, like everything else in China, is subject to petty local politics.

When I asked him why he was willing to do this, was it just for the money? His eyes lit up and he said:

“BTC is the future. I want to tell my son one day that I didn’t just watch history pass me by, I was a part of it.”

Author: BARCLAY BRAM; Translator: DUANNI YI; Editor: Sonny Sun; Typesetter: Roy

Source: Crypto Valley

The content is for reference only and is not intended as investment advice. Please assume all risks