Bitcoin mining hardware manufacturer Canaan finished its fourth quarter with a steep net loss despite an increase in revenue, as the industry faces its most challenging environment yet due to rapidly falling crypto prices along with an anticipated decrease in mining rewards after next month’s Bitcoin “halving” event.
The company reported on Thursday, April 9, that it posted a $114.7 million net loss for its fourth quarter. Canaan ended its 2019 fiscal year deep in the red with a net loss of 148.6 million compared to $17.3 million in net income for 2018. The losses were sustained despite revenues rising 66% for the quarter, to $66.5 million, and hitting $204.3 million for the year.
China-based Canaan, not the largest bitcoin mining manufacturer but the only one that is publicly traded, measures its sales in computing power sold — a total of the collective processing power versus individual miner units. The company reports that it increased sales by 86.6%, to 2.9 million Thash/s for the quarter, and 47.1% to 10.5 million Thash/s for the year.
These earnings reports come as the company is faced with a class-action lawsuit alleging that it made “false and/or misleading statements” to generate interest in its IPO. The suit says that Canaan executives claimed that they had secured a deal to sell $150 million in mining equipment to Hangzhou-based Grandshores Weicheng Technology. However, it turns out that this wasn’t a deal struck with an independent company; Grandshores Weicheng Technology owns almost 10% of Canaan. The day before the earnings announcement, the firm representing the aggrieved investors said in a statement that the case was going ahead and more investors had joined the suit.
Due diligence research firms have also had a field day with the company. Marcus Aurelius Value (MAV) recently put out a report titled “Canaan Fodder,” claiming that Canaan’s largest customer identified in SEC filings, Chen Jian, is the same Chen Jian that ran some of China’s more prominent ICO scams, the now-defunct 3ico.com, that brought disgruntled investors to the streets, protesting outside the company’s former office. MAV also identified that one of Canaan’s top distributors was controlled by a Canaan executive, and seven of the other distributors on the SEC filings are “small, defunct, or otherwise incapable of buying material amounts of product from Canaan” (some of which have since been removed from the company’s disclosures with the SEC).
According to 13F filings (a quarterly report filed by fund managers, in accordance with U.S. securities regulations) reviewed by Forkast News, Canaan’s shares are not widely held by institutional shareholders. Company executives own between 350 million and 8 million shares, the largest shareholder outside this core group is Bank of America with 607,000 shares, followed by a New York-based wealth management fund, Millennium Management with 379,579 shares.
Canaan’s challenges extend beyond weak earnings and lawsuits from investors who feel they’ve been misled. The entire bitcoin mining industry is going through a structural crisis on multiple fronts: a perception that it is a massive emitter of greenhouse gases, the Bitcoin halving event in May that will greatly reduce incentives for mining, and the broader decline in the value of crypto assets as Covid macroeconomic uncertainties drag things down.
See related article: Bitcoin’s ‘black swan event’ — should investors worry?
Greenhouse gases and Bitcoin halving
A common criticism of the bitcoin mining industry is its carbon footprint. “98% of bitcoin mining machines will fail to produce a block during their lifetime,” Alex de Vries, a blockchain specialist at PwC, was quoted as saying earlier this year. That was the quote that sent the crypto community into a tizzy last month, spawning conversations and soul-searching about the efficiency of cryptocurrency mining and the broader network itself. All those miners consumer electricity, with little to show for it. The consensus was that crypto mining had an efficiency problem: it’s an electricity-heavy process to mine new tokens and maintain the network, so the chances of it crypto scaling to the point of being mainstream are nil if every transaction requires significantly more electricity than, say, the MasterCard network.
While there are problems lingering with the crypto mining industry, its carbon footprint perhaps isn’t it. According to a report by CoinShares Research, the biggest mining facilities are typically placed in regions with the cheapest power— which happens to be hydroelectricity. Per CoinShares’ analysis, China’s Sichuan produces 54% of the world’s hash rate and has a renewables (primarily hydropower) penetration of 90%. The next 35% of the world’s hashrate is split between Washington state, New York, British Columbia, Quebec and Sweden, which have renewables penetration ranging from 45% (New York) to 100% (Quebec). The majority of the remaining 11% comes from Kazakhstan and Iran, and miners in both countries are connected to a grid powered by coal.
“Our current approximate percentage of renewable power generation in the Bitcoin mining energy mix stands at 73%, around four times the global average,” writes CoinShares. They estimate that the entire industry uses 61 TWh on an annualized basis as of 2019.
Talk of the mining industry’s greenhouse gas problem could be a distraction from the cliff’s edge the industry is approaching with the Bitcoin halving in May and the impact it will have on major suppliers of miners — Canaan and others, like BitMain, that once considered an IPO but decided against it.
Bitcoin halving is the periodic reduction of the block subsidy provided to miners that allows the issuance of bitcoin (or any other crypto token) to remain constant until the maximum supply is reached. Although this is not the first time a Bitcoin halving has happened, and the event is expected to take place every four years, the problem with the 2020 halving is it is coming at a time when the price of crypto assets have been unexpectedly dropping in concert with the broader equities and commodities market that has been roiled by the coronavirus pandemic.
With the dollar value of crypto being dragged down, appetite for mining is at an all time low. It’s no longer the profitable endeavor that it once was. Canaan at its core is a silicon designer, but will it be able to shift focus to more profitable markets?
Canaan it pivot?
For Canaan, the writing is on the wall. In its initial prospectus, it mentioned that it planned to use the capital raised in the IPO to pivot its business away from just making silicon for bitcoin mining. During its April 9 earnings call, executives spent considerable time outlining their plan to move into the artificial intelligence and automotive technology market.
But the company is spending less than $10 million a quarter on research and development. For the fourth quarter, it spent $9.1 million on R&D and ended the year with only $24 million in total spend — a decrease of 11%.
On their earnings call, Canaan executives did not mention a plan to increase their R&D spend, which would certainly be a must if the company is seriously considering pivoting to new markets. For a point of comparison, rival mining manufacturer BitMain, which did not follow through with an IPO, disclosed that it spent $86.9 million in R&D for only the first half of 2019.
In its report, MAV also notes that Canaan’s IPO on the NASDAQ followed three prior failed attempts at completing a listing. In 2016 it suspended its listing on the Shenzhen Stock Exchange because of a “hostile regulatory environment” in China. In 2017 it attempted to list on China’s NEEQ exchange, but that process was suspended. Its third attempt to create a listing, in 2018 in Hong Kong, triggered a remark from the Hong Kong Stock Exchange’s CEO Charles Li: “cryptocurrency mining machines fail to meet the Hong Kong Stock Exchange’s listing principle of ‘suitability.’”
What Canaan it do?
For now, not much. The firm is weighed down on so many fronts with the mining market softening and a pending investor lawsuit. It all comes back to a question of runway. Its IPO was much softer than expected, raising just $90 million when it expected $400 million. With a raise of $400 million it would have a war chest to devote to R&D, pivoting towards new markets and opportunities to soften the blow of bitcoin’s decline. But that’s not its reality, so it will need to do more with less as its main market continues to dwindle in the foreseeable near future.