Sunday, 13 May 2018

Fintech: The cold, hard facts of bitcoin mining


In a furniture store outside Irkutsk in eastern Siberia, an anarchist in jackboots and a Che Guevara hat is showing Euromoney a bitcoin mining rig hooked up to a bathroom boiler and expressing a hope that it might one day be used to evaporate human waste.

That is not the strangest scene in this article and certainly not the craziest idea – in fact it’s a very good one. But it is illustrative of some of the unusual directions taken by the young, entrepreneurial industry of bitcoin mining.

Mining is the process by which new bitcoin is created and through which transactions among existing bitcoin are recorded and verified on the public ledger known as the blockchain. Miners use microprocessors to solve complex mathematical problems, and the first to do so gets to place the next block on the blockchain, for which they are rewarded with newly released bitcoin. 

In theory, anyone can be a miner. All you need is the right kind of processor, called an Asic (application-specific integrated circuit). If you have the most up-to-date equipment, then you can make money from mining, provided the revenue you generate is greater than the cost of the energy you consume in the process. Some consider it a far better model than investing in bitcoin itself. 

Today China dominates bitcoin mining, responsible for as much as 70% worldwide. That is partly because China also leads the world in manufacturing the most efficient and cost-effective Asics. Three companies in particular dominate the field; Bitmain Technologies, Beijing-based producer of the AntMiner processors, is pre-eminent. 

But China at a state level has become increasingly suspicious of bitcoin and last year began banning the many bitcoin exchanges that had sprung up in the country. 

Earlier this year it moved on to bitcoin miners too. This has taken a rather unclear form; provincial governments were told to: “Guide miners toward an orderly exit from the business”, as one source puts it, or “actively guide companies to exit the industry.” However, the outcome appears to be some bitcoin mining operations closing, a curb on new ones opening and others moving their operations overseas.

So, where is bitcoin mining going next?

Cold and cheap

There is a simple equation at the heart of bitcoin mining. To yield more revenue than you burn in electricity costs, you don’t just need the best processor you can find, you also need the cheapest electricity. 

On top of that, you also need to consider the heat that your bitcoin mining rig is giving off. These two dynamics will inform your choice of location: ideally a cold place with cheap electricity.

In China, bitcoin mining operations in the coal-rich states of Shaanxi and Inner Mongolia moved quickly to those with plentiful hydroelectricity, principally Sichuan, where the Himalayas start their descent towards the lower and flatter land to China’s east and the rivers feed numerous hydroelectric plants.

This is the heart of the modern bitcoin mining industry – or at least it was until the start of this year. 

Were you able to get near them, at many hydro plants you might find an innocuous blue-roofed building built on the site of the power station itself, often with cables drawing power straight from the station rather than the national grid. 

Within these humble buildings, often many miles from any form of public transportation, you would find two things: lines of microprocessors, cooled incessantly by dozens of fans, and basic dormitories where workers would stay for weeks at a time, working in the dark, getting through the boredom by reasoning that there is nothing to spend their wages on and that they are at least therefore saving money.

Since many of the power operators are themselves private-sector enterprises, the deals on electricity have been negotiated directly between power station and bitcoin miner. In cases where the plants have excess capacity that they cannot sell to the national grid, it has made sense to sell it at a discount to an on-site mining operation.  

Policemen and other administrative personalities do not like my outlook,” he adds. “I live in the system, but I protest against the system 

 – Dmitry Tolmachev

Generally the national grid takes from state-owned power stations before private-sector operators, so there has been a lot of capacity to sell. It has worked for both sides. 

There are a number of companies, venture capitalists and entrepreneurs that have driven growth in Chinese bit-mining plants, some not even formally registered as businesses. 

At the more formalized end have been companies such as HaoBTC, which runs (or at least ran) mines in both Sichuan and Xinjiang. Its former chief marketing officer, Eric Mu, gave the clearest picture of life inside these mines when he wrote an account for CoinDesk news site, including a recollection of a time an earthquake severed the only road connecting the power station in Tibetan Sichuan to the outside world and the workers had to eat potatoes for weeks until they were rescued. 

Then there are entrepreneurs like Ryan Xu, a Chinese-born Australian who worked as a reactor operator in a nuclear power plant before setting up bitcoin mines, including one in Kangding, Sichuan (others have apparently been set up in places including Iceland, the nation of Georgia and Washington State, as well as Inner Mongolia). 

But the status of these operations is now uncertain. Xu is understood to have run at least three such plants, but reported earlier this year that they had all been shut down; Euromoney was unable to reach him for comment through companies he is known to be linked with. And HaoBTC’s website in April carried only a message in Chinese saying that “due to the recent central government regulation,” they were not providing bitcoin transactions or client registration. 

There is a lot of uncertainty about the state of mining in China now. 

“I have not heard of a case where anybody has been ordered to shut down their mine or even had their miners confiscated,” says Leonhard Weese, president of the Bitcoin Association of Hong Kong. He says, though, that many are moving their mines out of the country.

“I think the more relevant point is that bitcoin mining in China may have reached a point where it is consuming all the electricity below two or three US cents per kilowatt hour (kWh),” he says. “They can’t grow anymore, and newly produced miners are deployed in Russia, Brazil, Canada, or anywhere with cheap electricity.”

Tunnel vision

The cold-plus-cheap electricity equation yields its most remarkable outcome in a cave in Kazakhstan – a former Soviet military bunker, in fact, which now houses the bitcoin mining operations of Ice Rock Mining.

Steeped in dank Cold War tunnels near a village 100 kilometres outside Almaty, it is perhaps the perfect place for a bitcoin mine. It has a constant temperature of around 12 degrees Celsius, low enough to absorb the heat from the processors without any need for additional cooling. 

It is owned outright by Ice Rock’s chief executive, Malik Murzashev, (how he comes to own a Soviet military facility in a cave is a question we never quite get to ask him) and so there is no rent. And he says he has negotiated a long-term electricity supply of just 3c/kWh, on a par with the very best known rates, in Sichuan hydro plants. This is apparently because the mine is located in what is technically an agricultural territory and is therefore subsidized. (How long this subsidy will remain in place when the authorities realize he is not rearing sheep but mining bitcoin, is another question we don’t get to ask him.)

Ice Rock Mining plans to have 5,000 Asics spread through seven tunnels in this facility and has conducted an initial coin offering linked to it.

Euromoney’s communications with Ice Rock Mining start well and go steadily downhill. The company’s executives, including Murzashev, are at first enthusiastic and invite us to visit the cave in Kazakhstan. Then the invitation is retracted, apparently on security grounds, to be replaced instead with a telephone or Skype interview. Shortly after that Amir Ness, a former equity trader who has been handling the group’s PR, leaves the firm. When Euromoney reaches him on the phone, he says that he is not comfortable that the right know-your-customer (KYC) processes have been established. 

“They [Ice Rock] are not bad people, they’re doing everything they said they would do,” he says. “They’re just doing it in a way I don’t agree with, both in terms of the language on the website and in having told me they were going to put KYC in place.” 

He insists, however, that the mining operation is legitimate. 

He then goes into more detail in a half-hour interview on YouTube published on March 19. “There wasn’t a strong focus on compliance, and I was OK with that in the beginning. But as things got bigger and bigger, I realized, no, we’ve got to have that in place,” he says.

He says things came to a head when he started speaking about the venture in the US, generating interest with investors there and bringing KYC and anti-money laundering (AML) standards to the foreground. “I saw that it wasn’t changing: that’s part of the management style, and I’m not going to be able to do anything about it.” 

He also expressed concern about apparent guarantees of returns on the website, which: “Put a number like 400% and come up with an answer that somehow seems to make sense but doesn’t.” He remains an investor in the project but no longer represents it.

Euromoney visits Almaty in March and makes a last attempt to contact Murzashev for an interview but in the end is unable to reach him, nor to verify anything the company claims to be doing. 

And so, to find the timezone’s new cutting edge in bitcoin mining, we must head further north – to Siberia.

Siberia: ‘crypto-capital’

Kazakhstan might have a location taken from a thriller movie, but for exotic characters there is only one place to be – Irkutsk, Siberia.

“We call it the crypto-capital of the Russian federation,” says Yuri Dromashko, who runs a bitcoin farm here having turned to the industry after running a bookkeeping office for more than 15 years and, at various stages, property investments and a karaoke bar. 

Irkutsk is another example of the perfect confluence of climate and energy availability. It has the cheapest electricity in Russia, much of it sourced from a hydroelectric dam between nearby Lake Baikal and the Angara river that links it to the city. 

Residents, as opposed to commercial businesses, pay around R1/kWh – less than two cents. And it is constantly cold. The average year-round temperature is zero Celsius; Baikal is frozen well into May.

Dromashko first heard about bitcoin over the radio in about 2011 and has regretted ever since that he didn’t jump right in. Instead he got started 18 months ago and now has two parts to his business: his own mining operation, using Chinese processors, and a farm that handles not just his own processors but those for other miners. 

He is far from alone. 

“My farm is not the biggest in Irkutsk, I should note,” he says. “Mining is really accessible to every circle of society here.” His farm consumes about 2 megawatts an hour, he says. “It’s a really profitable business. It’s amazing how fast it can bring money in.

“The situation for small-scale businesses in the Russian federation is not so positive,” he says, speaking from experience. “It’s very hard to do business in Russia now and very hard to gain rewards. But for mining, people are very happy. They have huge revenues: you can gain back all the money you have invested in a mining firm within three months.”

Dmitry Tolmachev. Photos here and
below by Chris Wright

The most memorable people we meet in the whole industry are the interesting combination of a Che Guevara-styled furniture magnate called Dmitry Tolmachev – described earlier – and a computer-minded businessman called Ilya Frolov.

The two knew each other at school in Irkutsk but led different lives. Tolmachev, a self-styled anarchist but with a clear entrepreneurial zest, started out in business after the collapse of the Soviet Union, importing goods from Turkey, China and anywhere else he could find something the country needed. Then for 20 years he specialized in furniture production, still his main business. He has a multi-floor furniture showroom outside Irkutsk that is unremarkable except for the Che iconography all over it and the art gallery next door, where local artists can exhibit for free. 

Frolov, meanwhile, worked for multinationals all over the world, from Coca-Cola to Caterpillar, involved in everything from the pump industry to Spanish olive oil. He spent three years in China working for Ikea before coming back to Irkutsk in 2013, where he set up a consultancy and really began to study bitcoin and blockchain technologies.

The two were brought together by a simple idea. Why not use the heat generated by bitcoin mining to warm homes? That way the heat emissions, considered a problem in most bitcoin mining, serve a purpose and further reduce costs. Why not connect the bitcoin rigs to a boiler (a crypto-boiler, Tolmachev calls it) so that in addition to gaining revenue from mining, the heating bill is taken care of?

Tolmachev shows Euromoney a number of demonstration homes. They are small – some so small as to be portable – but well made, with room for bitcoin processors in areas such as bathroom cupboards, linked to a central heating system. “In our Siberian climate, we decided to use the heat for our houses, not to just waste it as a by-product,” he says. 

In one modest 16 square metre room, the processor that heats it brings in about $350 of revenue a month when bitcoin’s price is around the $9,000 level (it was obviously a lot more when it was worth $20,000 a coin). 

“Normally you spend money when you have to heat your house,” he says. “In this case you spend no money, but you gain money.” The set up is linked to an app showing the progress of mining, revenue, electricity use and supply, strength of internet connection and so on. 

Tolmachev outside a house he designed
to be heated by bitcoin computers

Customers can buy a house with a processor or just the house and put their own processor in it. Some house models he shows us cost as little as $5,000 to $8,000. These are portable homes, which sounds strange, but is actually quite common in this part of Russia, where people will put a cabin on the back of a truck and transport it to the Baikal lakeside, one of the world’s most beautiful places.

The strong environmental agenda around the pristine Lake Baikal has led Tolmachev to some more far-sighted ideas for what one might do with bitcoin. Anyone who takes their house to Baikal is going to produce waste; Tolmachev thinks mining heat could be used to evaporate and ignite it.

“You can use bitcoin to sort out your excrement,” he says.

There is also the question what to do with the heat during the warm season, which most people in Irkutsk are at pains to point out barely even exists. “Our heating season [when heating is necessary] is nine months,” says Tolmachev. “In the summer, we can use [the heat] for greenhouses and swimming pools.”

One of the reasons the model works and is gaining traction is because it enables the individual to take part in mining. Indeed, the lack of corporate standing is essential, since industry pays up to four times more for electricity than private citizens. 

“There is a simple business model,” says Frolov. “You buy the home [and processor] yourself using your own money, and get the heat as a complement. You mine some bitcoins, which give you investment returns to pay the house and the equipment. We promote the idea that the house will pay the mortgage by itself: there’s no need to be a slave to the bank for 10 years, like I am right now.”

That individualist model will also help if Russia decides to crack down on bitcoin miners as China has done. A home is much harder for the state to intrude upon on than a big farm, says Frolov. He knows Dromashko and says he told him: “Don’t mine in one place, because you don’t know what will happen tomorrow. They can visit you and unplug you or whatever.

“But when you have private houses, it’s my business, I’m just using it to heat my house. This computer? It’s a heater.

“First they have to get into your house and to do that they have to find it, and they have to prove it is not a heater.”

Irkutsk’s quirky bitcoin mining industry attracts a confrontational, free-thinking, libertarian crowd. Tolmachev wears his attitudes on his sleeve in his Che hat, long hair and head-to-toe black clothing. 

“Che was a person who didn’t want to have money but had everything,” he says. “He was not a Communist, he was a Marxist. His image helped me in Putin’s Russia. 

“Policemen and other administrative personalities do not like my outlook,” he adds. “I live in the system, but I protest against the system. That is why Che Guevara said life is a fight.”

It really has been a fight. In 2011, people burned his shop to the ground. And last November he spent five days in jail after inviting Russian opposition leader Alexey Navelny to his home. 

So for someone like Tolmachev, the original libertarian ideals of bitcoin clearly strike a chord. 

“I am like this too: an anarchist. All nations are the same,” he says.

Computer-minded businessman Ilya Frolov; and how a bitcoin processor is linked to the heating


Frolov is less of a revolutionary but a great believer in the possibilities of cryptocurrencies

“I see the potential. I really like the people involved. I’m so excited by what I see, how the horizons are opening,” he says.

He is also practical: “I don’t know what the future of bitcoin mining is, but I know what the future of heating is. I’m 100% sure that the need for heating in Siberia will be for ever.”

Dromashko, too, is a big believer in bitcoin’s ideals. 

“Bitcoin will take its place in the global economic system,” he says. “And if bitcoin has a future, then mining has a future too. 

“The idea of a decentralized system is great. I’m a citizen and I do not like it when government or other authorities control my money transactions and try to limit my freedoms.”

Corporatized approach

Naturally, alongside this individual opportunism is a more corporatized approach to bitcoin mining, and this finds its clearest expression outside the Asia-Pacific region, where Canada and Sweden are among the leaders. 

Miner One, for example, is a crowdfunded cryptocurrency mining company that has set up its mining operations in Luleå, Sweden, close to the Arctic Circle. 

Luleå is also home to the so-called Node Pole, a hub built specifically to support the cloud industry and data centres but also a natural home for bitcoin mining operations. Just like Irkutsk, it has a cold climate and plentiful green energy. Pranas Slusnys, chief executive of Miner One, tells Euromoney he is already seeing Chinese bitcoin mining companies setting up nearby.

Slusnys believes that bitcoin mining is getting a lot harder to make money from and is calculating that this will be to the advantage of professional operations like his as more players drop out.

There are clear arguments supporting his view that mining is becoming tougher. For a start, there are conditions hardwired into bitcoin that limit the number of tokens that can ever be mined – a maximum of just under 21 million, of which about 16.7 million are already in circulation. Additionally, roughly every four years, the rewards for bitcoin mining halve: where originally mining a block of bitcoin yielded 50 bitcoins, today it yields 12.5 bitcoins. 

And the calculations required to mine bitcoins are getting steadily harder, increasing the level of energy consumption per coin gained. 

This difficulty level adjusts itself according to the amount of computational power that is being employed, in order to keep the rate of new block discovery constant. It adjusts after every 2,016 blocks, which is roughly every two weeks. 

“That all means you are getting less profit for the same equipment,” says Slusnys. “So we can expect that when the bitcoin price is decreasing and the difficulty is increasing, only the best mining operations from the most efficient operators will stay in the business. 

“For the rest of them, it will no longer be profitable to stay in the business.”

A company like Miner One benefits from the fact that Sweden seems to be right on board with promoting itself as a centre, if not for bitcoin mining explicitly, then certainly for data centres. This contrasts with China, which is clearly moving against bitcoin miners, and Russia, which operators fear may do so. 

Slusnys says companies like his receive a discount on tax as a data-centre operation. Node Pole is not some out-of-nowhere hipster startup, but is owned by Sweden’s utility companies Vattenfall and Skellefteå Kraft.

Sweden is also quite happy to accept Chinese investment. 

Magnus Wikman, chief executive of Node Pole, points to Chinese tech company Canaan Creative, which has set up in the Boden Business Park, part of a cluster. 

Canaan’s chief executive NG Zhang says in a statement that: “We came to the conclusion that Boden is the best location for us to drive blockchain technology to the next level.”

“Sweden seems very open to bitcoin mining and in general is rolling out the red carpet,” says Slusnys. “Facebook is up there, Hydro66 [a data-centre provider]. I think Sweden is one of the leading countries in its support of data centres and of cryptocurrencies.” 

That is probably true. But it doesn’t have the Soviet bunkers or the plumbing-rigged processors. Bitcoin mining, for the moment, has room for many different approaches. 


No comments:

Post a Comment