How does Canaan address the "death spiral" in the mining industry with losses exceeding 700 million yuan?

In front of Canaan are two straws: cooperating with DJI and Ubitus to develop higher-performance AI chips and mining machines based on TSMC's 5nm technology.

Original Title: "The Three Spirals of Mining Death - What Happened to Jianan? (In-depth)"
Author: Wu Shuo Blockchain

A few months ago, the lively scene of Jianan celebrating its listing still seems fresh, but looking at the financial report just released by Jianan, one can only sigh at the "difficulties in the mining industry." Currently, Jianan's stock price is $3.2, nearly 60% lower than the $9 issuing price.

First, let's look at the first chart, which shows Jianan's revenue and profit for 2017-18-19. Revenue peaked in 2018 and fell back to the 2017 level in 2019. Meanwhile, net profit continued to decline, reaching a record loss in 2019.

Chart by: Wu Shuo Blockchain

Next, we look at the second chart, which illustrates Jianan's revenue and profit from Q1 to Q4 in 2019. The revenue surged in the third and fourth quarters of 2019, but the fourth quarter saw another record loss, indicating that the major losses in 2019 occurred in the fourth quarter.

Chart by: Wu Shuo Blockchain

The question arises, why did Jianan incur such significant losses in the fourth quarter of 2019? Jianan's financial report provides two explanations.

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

Jianan's financial report states that due to the significant drop in the price of Bitcoin during the entire financial reporting period, this led to a significant decrease in demand and selling prices, as well as an increase in Thash output.

From the trend of the coin price, it can be seen that Bitcoin's price fell in the fourth quarter of 2019, but Jianan had accumulated excessive inventory and had to clear it at a loss.

Bitcoin price trend in 2019

2) In 2019, Jianan incurred an additional RMB 240 million in stock-based compensation expenses.

In summary, Jianan went from having decent revenue and profit in 2017, to a large increase in revenue but decreased profit in 2018, and then to a significant revenue decrease and severe losses in 2019. What are the reasons behind this? It is worth noting that Jianan's operational status does not completely align with the price of coins. In fact, the market conditions in 2018 and 2019 were similar, with ups and downs, but Jianan's operational status was quite different.

There are two reasons:

1) The continuous growth of Bitcoin's network hash rate. Due to the re-balancing principle of Bitcoin mining, from the perspective of coin issuance, the quantity of Bitcoin produced is fixed; however, the Bitcoin hash rate keeps increasing, resulting in smaller returns per T, forcing the prices of mining machines to decrease, thereby reducing mining profitability.

According to Jianan's financial report, the total hash rate sold in 2019 increased by 86.6% from 1.6 million Thash/s in the same period of 2018 to 2.9 million Thash/s, but the revenue and profit were far below those of 2018. Selling more but earning less is truly challenging.

2) Intensified competition in the mining machine industry. Traditionally, Bitmain was the leader in Bitcoin mining machines, with Jianan in second place in 2017. However, in 2019, Shenma suddenly rose, especially with its high hash rate mining machines and price war strategies, challenging the market positions of Jianan and Bitmain, capturing a significant market share, and even lowering the industry's overall profitability.

A small detail reveals that in 2017, Jianan's largest accounts receivable came from Wu Gang of Bitmain, but Wu Gang later invested in Shenma mining machines himself.

Regarding the first quarter of 2020, Jianan stated that the first challenge was the outbreak of COVID-19, which lowered expectations for 2020 business, with estimated total revenue in the first quarter not less than RMB 60 million. However, this is still higher than the revenue in the first quarter of 2019.

The growth of hash rate and intensified competition represent the "death spiral" of the Bitcoin mining industry. Will Jianan sink deeper into this death spiral? Jianan's conference call and financial report provide two straws for hope.

Straw 1: AI chips. Zhang Nangong said that Jianan Technology has successively established strategic cooperation with top domestic clients, and has had preliminary contacts with DJI and UVify, receiving a warm welcome from North American clients. The company plans to launch the second-generation product this year with more features and performance several times better than the first generation.

For this, we need more detailed data to verify the revenue situation of Jianan's AI business. For comparison, the leading domestic AI chip company, Cambricon, had revenue of about RMB 400 million in 2019. But for this RMB 400 million, Cambricon's R&D expenditure in 2019 was RMB 540 million, while Jianan's overall R&D expenses in 2019 were RMB 169 million.

Straw 2: TSMC. Zhang Nangong stated that the R&D of new products in the first quarter was not affected by the epidemic and was completed in February. This product, compared to the previous generation mass-produced product, reduces costs while improving performance efficiency by about 20-30%, positioning it as a leader in the industry.

In addition, products based on TSMC's 5nm technology are also under intense development. Jianan Technology claims to have ample cash flow. As of December 31, 2019, Jianan Technology had RMB 516.6 million in cash and cash equivalents, which will meet the company's expected operating capital needs and capital expenditures in the next 12 months.

However, under the aforementioned two death spirals, 2020 welcomes a third vortex: the halving of Bitcoin, directly reducing output by half. Will the situation in the mining industry in 2020 be worse than in 2019? No one knows for sure, but Wu Jihan had already initiated layoffs at the end of 2019 to make early preparations. Product competition continues to intensify, with Bitmain's S19 and Shenma M30S being aggressively promoted. For Jianan, cost reduction in 2020 may be an inevitable choice. (On a side note, if the short report and collective lawsuits against Jianan had occurred after the Luckin incident, it would have been even worse, although the short report on Jianan was not professional.)

Mining is tough. Looking back in history, Zhang Pumpkin created an ASIC miner, and Jianan was the first blockchain/mining company listed on the US stock market, leaving their mark in history.

If the future of exchanges is monopolized by the top players and follows the Pareto principle, then the future of mining must undergo transformation. Zhang Nangong initiated AI early, possibly foreseeing this. Hopefully, Jianan can succeed in the transition from mining machines to AI and blockchain.

This article is reproduced with permission from ChainNews, article source: ChainNews (ID: chainnewscom)

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