• The move comes as such mining operations become increasingly difficult due to growing bans by individual countries, often worried about strains on their energy infrastructure
By Warren Yang
Why only sell cryptocurrency mining machines to others when you could just as easily use them to seek out your own new digital wealth? Canaan Inc. is doing exactly that with the recent addition of crypto mining to its activities, supplementing its core machine-making business. But it may be finding that profiting from crypto mining is easier said than done.
Last week, Canaan, one of the world’s largest bitcoin mining machine makers, said it signed agreements with multiple companies in Kazakhstan to jointly mine the virtual currency. As of the end of last year, Canaan ran a total of about 10,000 machines in the Central Asian country, where the Hangzhou-based company set up its first mining operations in June.
Bitcoin mining is the process for the creation of new units of the highly volatile but increasingly valuable cryptocurrency. That process sees miners race to solve complex equations generated by the blockchain network, with the first to do so rewarded with a certain amount of bitcoin. The process requires enormous computing power, creating demand for sophisticated specialty equipment made by Canaan and its rivals.
Starting a bitcoin mining business is a relatively easy, low-cost affair for Canaan because it can deploy its own machines without having to buy them at hefty prices from someone else. The new endeavor can also reduce Canaan’s inventory headaches.
Despite their status as hardware sellers, the fortunes of Canaan and other crypto mining machine makers are still closely tied to changes in volatile bitcoin prices, since falling values usually result in lower demand for mining machines and vice versa. That means that during a weak market, mining machine makers can get stuck with excess inventory that quickly loses value as newer, more powerful machines hit the market.
By using computers that would otherwise be sitting idle in warehouses, Canaan can kill two birds with one stone: Cut inventory and amass one of the hottest assets on earth right now. The company is doing just that, minting 23.86 units of bitcoin as of the end of September, its management said on a conference call in November to discuss third-quarter earnings with analysts.
But those holdings aren’t really adding much to Canaan’s bottom line, at least yet. For starters, Canaan’s bitcoin portfolio is worth just about $1 million based on the current market price – representing a fraction of its annual revenue or total assets.
And there are accounting technicalities. While there are no specific accounting rules on how to treat cryptocurrencies, in the U.S., where Canaan is listed, they are generally treated as “indefinite-lived” intangible assets. This means that while a company can record the value of its cryptocurrency holdings both as revenue on its income statement and assets on its balance sheet, it cannot book gains even if their price increases until it actually sells them. Put differently, there’s no such thing as unrealized gains for cryptocurrency assets, which are allowed for conventional financial instruments like stocks and bonds.
Crypto mining is also very costly, in large part because the computers required for such operations are big power guzzlers, resulting in huge electricity bills. For example, a look at the financials of Marathon Digital Holdings, one of the largest miners globally, reveals the difficulty of generating real-life cash from minting virtual money. In 2020, the company mined $4.4 million worth of cryptocurrencies. But that was easily overshadowed by $7 million in revenue costs, which includes electricity expenses.
Canaan’s decision to start mining operations in Kazakhstan, not in its home country, is the result of a swift regulatory crackdown on crypto mining in China. In the middle of last year, China, which at one point was home to more than three-quarters of bitcoin miners globally, banned crypto mining as it pursues carbon neutrality. The hardline action killed the cryptocurrency mining industry in China, sending surviving miners to overseas locations. A selloff in bitcoin ensued as well.
As China goes after the crypto industry, neighboring Kazakhstan, which provides easy access to cheap electricity, has emerged as the second-largest mining hub in the world after the U.S., hosting many refugee operators from China. Canaan’s own move into the country has been relatively easy, since it began selling into the country in 2020 and thus already had an established clientele there before the China crackdown.
However, Kazakhstan, or any other country for that matter, isn’t without a risk. That reality has been on prominent display recently after the Kazakh government last week cut off internet access to rein in massive protests initially sparked by high fuel prices. That, in turn, dealt a blow to crypto miners and sent bitcoin prices plunging. Even before the political instability, the sudden influx of Chinese miners into the country was already causing an energy shortage in Kazakhstan, straining miners’ operations.
Plus, a growing list of nations around the world are joining China in banning crypto mining because of the heavy toll it takes on power infrastructure and its environmental impact.
Canaan’s revenue sagged in 2019 and 2020, leading to net losses, as bitcoin prices slumped in 2019, followed by the Covid-19 pandemic the following year. While sales picked up in the first nine months of last year, Canaan is facing regulatory uncertainty that can hurt its business, on top of volatility in bitcoin prices.
Reflecting these difficulties, Canaan’s stock has nearly halved from its 2019 IPO price and is down more than 87% from a peak last March. Its plan to venture into mining has failed to excite investors. A share buyback plan has also done little to shore up the stock, perhaps because investors interpreted the move to mean the company lacks other good investment options.
Canaan shares are still trading at a relatively high trailing price-to-sales (P/S) ratio of more than 11. That compares with 9.4 for Ebang International Holdings Inc. (NASDAQ:EBON), a New York-listed peer, which is also trying to diversify its business with a plan to start a cryptocurrency exchange. Canaan’s lofty valuation can be best justified if it can continuously grow revenue and generate cash to be reinvested in new businesses. But at least at its current scale, the company’s young bitcoin mining operation appears to offer limited potential for such new growth.