Crypto mining giant Bitmain reveals heady growth as it files for IPO

might be a better title, though it is a little long.

(Generalizing here, but seems similar to California in 1849, Yukon in 1898, and several others)

Bitmain.

Maybe the most interesting thing about the initial public offering of Bitmain Technologies is its accounting. (Here is the preliminary offering document, here are articles about it from Bloomberg News and the Wall Street Journal, and here is an analysis from my Bloomberg Opinion colleague Tim Culpan.) Bitmain is a company that mostly sells cryptocurrency mining hardware; it also does some crypto mining itself. It seems to be quite profitable: In the first half of 2018, it had net income of $743 million, and profit from operations of $1.07 billion, on about $2.8 billion of revenue. (It seems to have had a loss in the second quarter though.) Its business seems fairly straightforward: Most of its revenue comes from selling mining hardware, most of its costs come from building the mining hardware, and the revenue greatly exceeds the costs.

But while Bitmain has over a billion dollars of operating profit, its cash flow from operations is very negative: It used $622 million of net cash in operating activities in the first half. That is unusual! But the explanation is simple:

"Our cash outflows from operations are principally payments for purchases of products and raw materials, selling and marketing expenses, administrative expenses, research and development expenses and other operating expenses. During the Track Record Period, we have accepted payment in the form of cryptocurrencies for sales of our cryptocurrencies mining hardware, and we also received cryptocurrencies from our proprietary mining and operation of mining pools, however, we do not recognize receipt of cryptocurrencies as operating cash inflows."

Oversimplifying slightly, Bitmain pays for parts and labor in fiat currency, uses those parts and labor to make stuff, and then sells the stuff for cryptocurrencies. The making-stuff part of this business is lucrative—it sells the stuff for much more than it costs to make it—but the currency mismatch is sort of muddling. Cash goes out to fund operations, but it does not come in as a result of operations.

Cash does come in, though: Sometimes Bitmain sells the cryptocurrencies. It sold $516.5 million worth in the first half of 2018. It just treats that as a cash flow from investing activities, not from operations. The normal operating cycle of paying cash to make stuff, making the stuff, selling the stuff for cash, and then using the cash to make more stuff, is completed here; there is just an extra step—and an extra timing decision, and an accounting move from operations to investing—in the middle, as Bitmain sells the stuff for crypto and then, later, optionally, converts the crypto into cash.

One could imagine a world in which Bitmain paid its workers and suppliers in crypto and the entire cycle stayed out of the fiat system, but—obviously—that is not the actual world. And one could imagine a world in which selling stuff and getting paid in crypto counted directly as operating cash flow, but that is also not the actual world (of accounting).

Anyway, between the time that Bitmain sells its stuff for crypto, and the time it converts that crypto into cash, something else a little weird happens to it:

"We account for cryptocurrencies at cost, instead of revaluing cryptocurrencies at their fair value on each accounting reference date, to avoid substantial volatility in the value of cryptocurrencies from time to time, which may distort our results of operation and financial condition. Gains or losses from the disposal of cryptocurrencies are determined as the difference between the net disposal proceeds and the carrying amount of the cryptocurrencies and are recognized in profit or loss on the date of disposal."

Is that right? I mean, it’s probably right as a matter of technical accounting; I am not an expert in the international financial reporting standards for cryptocurrency but I assume that Bitmain’s auditors are. But is it the right way to think about this business? It seems like the right way to think about a computer-hardware company; it isolates Bitmain’s ability to build hardware and selling it for more than it costs to build. And that is, operationally, a pretty good description of what Bitmain does.

On the other hand you could also think about Bitmain as an investment fund that invests in crypto assets, and whose value as a company rises and falls with the price of its crypto assets. This would not be fair to its operating business, and you can see why it says that it would “distort our results of operations.” But I am not sure it would distort Bitmain’s “financial condition.” It seems to me that shareholders might care about the value of Bitmain’s assets, and if that value swings wildly then possibly the financial statements should too.

I realize that this is an annoying and trivializing position; it reduces any real operating business that takes payment in crypto (and holds onto it) to a crypto hedge fund with an operating business attached. But that’s what using a wildly volatile currency will do for you!

One other accounting item I enjoyed is on page 197 of the offering document, under “Other Net Loss,” where there is a line item for “loss of cryptocurrencies incurred as a result of cyber-security incidents.” There are entries there for 2015 and 2017. They’re not huge—the 2017 one was “a loss of cryptocurrencies worth approximately US$27 million, which we suspect was caused by a hacker attack”—but I like the idea of “getting your Bitcoins stolen by hackers” as a recurring expense, and I expect to see a lot more of it as more crypto-related companies go public.