Bitcoin Extraction

China’s Digital Goldmines

  • Why it matters

    Why it matters

    China is the world leader in mining the crypto-currency bitcoin. While Chinese authorities are now cracking down on citizens using bitcoin as an investment tool, they are still allowing miners to make a living.

  • Facts

    Facts

    • In mid-January, police, together with employees of the Chinese central bank, raided the offices of two large bitcoin transaction platforms in Beijing and Shanghai.
    • Chinese bitcoin farms mine more bitcoin than all other countries combined.
    • In the beginning of 2017, 1 bitcoin fetched $1,150 and was close to breaking the all-time record of $1165 from 2013.
  • Audio

    Audio

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Newly planted trees line a new street in front of residential buildings under construction in the Kangbashi district of the town of Ordos in China’s Inner Mongolia Autonomous Region
The Inner Mongolian city of Ordos is home to many Bitcoin mines. Source: Reuters

In a mine in the northern Chinese city of Ordos, some 3,000 employees work 24-hours a day, 7 days a week, 365 days a year, without taking so much as a lunch break. But they don’t need one. Because these employees aren’t people, but computers. And the material they’re sifting through is data, not coal. They are mining the crypto-currency bitcoin, which has become a sizeable industry in China due to cheap computers, low electricity costs and entrepreneurial moxy.

The white factory building which houses the hard-working hard drives sticks out like a sore thumb in the middle of the desert. Its windows are covered with plastic wrap and the plaster is coming off the walls. The buzz of thousands of ventilators can be heard from far away. The factory’s superintendent, Liu Yunfeng, is standing in front of the entrance wearing a dark, washed-out jacket and black leather shoes covered in dust. A black and white terrier runs between his legs as he invites us inside.

It’s the first time a journalist has been allowed on the premises, which represents an industry as shrouded in mystery as the crypto-currency itself.

Bitcoin has been in circulation since 2009, and is not pegged to any other world currency. While it operates independently of governments and banks, it can be bought with conventional currencies – and the greater the demand, the higher the value. There has been much speculation about bitcoin’s origins and its alleged creator Satoshi Nakamoto. To this day, it is unclear whether one or a team of computer scientists are behind the Japanese pseudonym. What is clear, however, is that the amount of bitcoin in circulation has been limited to 21 million and that the currency is founded on blockchain technology.

Blockchain is a kind of database in which all transactions are saved and given a specific digital signature or time stamp. New data is attached to previous “chains” of transactions, also known as a ledger, which can then no longer be modified. Computing operations involved in blockchain technology can be carried out by essentially any computer, be it a home PC or thousands of computers operating in Chinese bitcoin farms, like the one in Ordos. There, computers are set up without chassis with exposed wires and circuit boards. As Mr. Yunfeng explains, this makes it easier to replace parts. “It only takes a couple of minutes,” he said. Mr. Yunfeng is paid in bitcoin.

The contrast to Western data processing centers, where employees wear protective clothing to enter sealed computing rooms, could hardly be starker. However, this is also what has led to China’s success in bitcoin mining, said Li Qiyuan, chief executive of the bitcoin trading platform BTC China. “In China, you have a large number of cheap computers being used to mine,” he explained. Quantity wins over quality, with cheap computers beating their high-powered counterparts. China is said to possess – and utilize – more bitcoin mining power than the rest of the world combined.

“If anything changes in Ordos, we’ll just set up our computers elsewhere.”

Xie Jinming, Owner of the Chinese bitcoin mine in Ordos

At the moment, factory supervisor Mr. Yunfeng is cheerful about the extremely cold winter. “This is good – it will mean less electricity costs for our cooling system.” The factory in Ordos is surrounded by a grid of paved roads in an otherwise barren landscape. A bent metal sign advertises a future “Cloud Computing Center”, though it’s hard to believe that this rural autonomous region is operating at the cutting edge of a burgeoning crypto-currency industry.

A few years ago, the discovery of coal deposits in the area had many people anticipating a mining boom. But the necessary investments never arrived and the millions of dollars and laborers expected to help establish a city in the desert stayed away. Instead, a different kind of mining arrived – one which rode in on the coat tails of an energy infrastructure designed for a metropolis but only serving a few thousand people. For Xie Jinming, owner of the bitcoin mining factory in Ordos, the city was an obvious choice because of cheap electricity.

“They built power stations in Ordos for a major city, but they miscalculated,” he explained. While he wouldn’t give exact numbers, Mr. Jinming said bitcoin mining is a lucrative business. “And if anything changes in Ordos, we’ll just set up our computers elsewhere.”

Mr. Jinming rarely makes the trip to his bitcoin farm, relying instead on superintendent Mr. Yunfeng to take care of daily operations. “In winter it gets very cold here,” said Mr. Yunfeng, huddling next to an electric heater. He is surrounded by bunk-bed frames, which are attached to the walls and packed full of computers.

In one corner, a young employee named Liu Fei spoons rice out of a plastic bowl. “I’m from the area, and this is my first job,” said the 26-year-old, who says that he has always enjoyed tooling with computers. “But life here is tough. There’s no supermarket, no restaurant. I don’t even have any neighbors.” And yet Mr. Fei is convinced that bitcoin mining is a promising industry. “I bought bitcoin myself. The value has fluctuated quite a bit, but I do know people who have made good money with it.”

While the mining business is growing, the bitcoin system is not without its flaws. The network only allows for a few transactions per second, while companies like Visa allow for some 24,000 transactions per second. In 2016, constant transfer delays slowed the system down significantly. To fix the problem, computer scientists conceived a redesign, using a protocol known as “Segregated Witness”, which helped traders through transfer bottlenecks. The redesign could help increase the size of the network, but in order to do so, some 95 percent of the world’s bitcoin mines would need to readapt to the new system. To date, only a quarter have done so.

This is mostly due to resistance by Chinese bitcoin miners. Xie Jinming was one of the few bitcoin mine operators in China to support the reforms. He criticized his business rivals who blocked the reforms in order to continue making a profit in the short run. Nevertheless, bitcoin mining will almost certainly become less lucrative due to the limited number of bitcoin in circulation. The more bitcoin is mined, the less mine operators can earn.

“They will allow the mining, but the trade and use of bitcoin is a step too far.”

James Chang, Financial consultant at auditing firm PwC

In the beginning, miners received 50 bitcoins for every data block logged into the central accounting book of the blockchain. Eventually, that number was reduced by half. Since July, it’s become 12.5, and by the summer of 2020, it’s expected to sink to around 6. But this trend appears inversely proportional to the bitcoin’s popularity.

This is partially because less pay for mine operators has resulted in a slowing rate of bitcoin inflation. In the beginning of 2017, the price for 1 bitcoin fetched $1,150 and was close to breaking the all-time record of $1,165 from 2013. But just like a few years ago, it fell back down to slightly below $900.

In 2013, the drop was attributed to the bankruptcy of the Tokyo-based bitcoin exchange Mt. Gox. Today, the Chinese central bank seems to have played a key role.

Aside from being the center of currency mining, China also boasts the largest demand. This is partially because the People’s Republic has shielded its financial system from the rest of the world, and Chinese citizens have difficulty investing their money outside of the country. Since the deceleration of the country’s formerly turbo-powered economy, Chinese investors have been looking for new lucrative financial instruments.

Bitcoin had been a kind of escape hatch in this regard, with Chinese authorities long looking the other way. Until now.

In mid-January, police, together with employees of the Chinese central bank, raided the offices of two large bitcoin transaction platforms in Beijing and Shanghai. Their goal was to better understand the flow of bitcoin business transactions: who was investing how much into bitcoin at what time, and what happened to the money they put in. Shortly thereafter, global bitcoin prices fell sharply.

For James Chang, a financial consultant at auditing firm PwC, following the money is one of the Chinese government’s main interests. “Beijing will never allow its agencies to give up control over this area,” he said. January’s raids could be just the beginning, though as Mr. Chang explained, “They will allow the mining, but the trade and use of bitcoin is a step too far.” In other words: mine operators should continue to be able to make a living, but Chinese citizens should avoid purchasing the currency themselves.

Back in Ordos, bitcoin farm owner Mr. Xie is considering closing down his factory in anticipation of an increase in electricity prices. However, he has found a plan B in the form of a hydroelectric power station located in Tibet. Mr. Xie has already set up a cluster of computers there to mine bitcoin, powered by cheap electricity. For the Chinese entrepreneur, flexibility is key: “We’re mobile. If Ordos stops being the right place to operate, we’ll simply pack up and leave.” It’s this kind of pragmatism that has been the key to success in China’s bitcoin mining industry.

 

Stephan Scheuer covers China’s economy and politics for Handelsblatt. To contact the author: scheuer@handelsblatt.com

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