Digging for clues

Bitcoin miners are not the first to leverage their own government’s inefficiencies and turn them into entrepreneurial opportunities. As expected, China has a long tradition of local interests challenging the rule of law of the Communist Party to improve their economic situation and use the abundant resources of their land. Xiaogang farmers ignored threats of capital punishment to improve their living conditions by dividing farm land in order to increase productivity and the rewards of their harvest. Their decision left an indelible mark on the future economic direction of their homeland and their capitalist spirit carries through to current generations.

Today, China’s dominance in terms of supplying the world with resources is unparalleled. Their monopoly position might not be more obvious than in the rare earth metals industry. These minerals being a significant component of modern consumer electronics, they are in ever increasing demand. China is currently responsible for 89% of the world’s supply.

Government enforced quotas have resulted in significant incentives for black market actors to satisfy the market’s demand. In the presence of a regulatory patchwork with lax incentives to enforce crackdowns, illegal miners have ballooned the supply line and put heavy pressure on international prices as well as the rest of the industry.

This situation has obviously led to significant backlash from other industry participants, international competitors as well as global commerce agencies. In spite of this and the increased regulatory oversight, some reports suggest that the efficiency of artisanal, grey market producers is such that 90% of legal miners are operating at a loss.

“Unequivocally the illegal mining of rare earths in China is the biggest issue facing the industry.” “In essence China has been damned by its success; such that rare earth production is almost a cottage industry which is proving impossible to control.” — Dudley Kingsnorth, Curtin University professor and rare earths expert

A digital analog?

Satire reflects reality

When taking into account the conditions mentioned above, it is not hard to rationalize the rise and subsequent domination of Bitcoin mining in China. A recently released report on the rare earth industry posits two applicable observations:

“Rare earths are not rare” “Low labour & lax environmental standards made it much cheaper to mine & process rare earth ores in China”

Similarly, from a mining standpoint, bitcoins are not so much rare as they are incredibly hard to unearth and come at the expense of vast amounts of energy in the form of Proof-of-Work. Reports from industry insiders points to two main factors driving the growth of the Bitcoin mining ecosystem: significantly subsidized electricity cost and an hands-off approach from regulators.

An infrastructure behemoth

When representatives from the Chinese Bitcoin industry gathered with various developers in California over the summer, one of the most insightful piece of information to come out from the transcripts, for me, was the importance of the CAPEX advantage for eastern miners. Unlike what circulating knowledge professes, the discussion between participants challenged the memes of “free energy” and pointed to infrastructure expenditures as their main competitive edge. Bitcoin mining is a race against time. Chinese leverage a mixture of regulatory largesse to optimize the ROI of their mining equipment. Small ones take advantage of the existing industrial grey markets. Not unlike off grid aluminium smelting shops, they maximize their efficiency by limiting their exposure to the regulated system and use established back channels to provide them with power. The largest most professional miners achieve this by applying the same functional and scalable construction engineering displayed in the video above to state-of-the-art data center standards. The sooner they’re up, the quicker they can start hashing.

The security tradeoff

Hashrate distribution according to blocktrail.com

Today about 70% of the Bitcoin hashing power can be attributed to pools in China. The market, to a lot of users, looks dominated by a few powerful actors that have shown themselves increasingly willing to attempt to sway the direction of the protocol through political posturing. Such a large discrepancy between geographic concentration of mining and non-mining nodes has led to communication and education gaps between the two main infrastructure providers of the ecosystem.

Nevertheless, as counter-intuitive as it may seem, the market forces that led to this dynamic are favourable to Bitcoin’s decentralization, at least in the short term. The proliferation of informal mining installations provides an interesting counter-balance to their geographical concentration. One can readily imagine western located miners being a phone call away from being shut or slowed down by inquiring authorities. The extra-legal nature of the current network of sweatshop-style farms is certainly less vulnerable to such regulatory outreach.

This insight, in my opinion, invites the introduction of an alternative frame of reference from which we can study the evolution of the mining ecosystem. In order to define the decentralization of the latter, we ought to account for the regulatory forces that provide the context within which the various actors operate. In that respect, geography and political framework can often lead to hasty conclusions.

https://twitter.com/TuurDemeester/status/793911813784027136

The market conditions in places like China reward investors with an appetite for risk. The influence of local officials and incentives put before them promote a grassroots emergence of disjoint entrepreneurial initiatives that effectively present a much more permissionless environment than what you may find in more regulated countries. The ensuing economic benefits then serve to strengthen the reliance and therefore bias of local interests to preserve its activities despite potential external pressures.

These observations explain the popularity of mining investment schemes over there. After news of the Xinjiang data center leaked, Bitmain was quick to point out on Twitter that they were only minority owners of the farm:

This provides some encouraging perspective: decentralization of investors is another nuanced aspect that is easily forgotten. An increase in competitive investments will necessarily introduce conflicting agendas that may mitigate the collusive forces of their physical colocation.