- China cracked down on its domestic crypto mining industry in May, but many miners have figured out ways to continue operations and evade detection.
- Experts estimate that as much as 20% of the worldwide bitcoin network remains in China.
- As hydropower dams dry up in the provinces of Sichuan and Yunnan, miners are newly contemplating taking their operations overseas.
Kirk is mining for bitcoin in the Chinese province of Sichuan, hoping every day that he doesn't get caught by the authorities.
Like other crypto miners who have gone underground since Beijing cracked down on the industry earlier this year, Kirk — who asked only to be identified by his nickname to ensure his safety — is getting creative to evade detection.
Kirk has spread his mining equipment across multiple sites so that no one operation stands out on the country's electrical grid. He has also gone "behind the meter," drawing electricity directly from small, local power sources that are not connected to the larger grid, such as dams. He's taken steps to conceal his geographic digital footprint, as well.
Kirk tells CNBC that he is used to "getting around things" when it comes to running a business in China, but the last six months have really raised the stakes.
"We never know to what extent our government will try to crack down…to wipe us out," Kirk said.
Tracking down outlaws
Kirk is not alone.
Although Beijing exiled its crypto miners in May and then doubled down on its mining ban in September and again in November, multiple sources tell CNBC that as much as 20% of all the world's bitcoin miners remain in China. This is well off its peak of around 65% to 75% of the global market, but it is substantially more than an official estimate from Cambridge University that puts China's current share at 0%.
Data from Chinese cybersecurity company Qihoo 360 shows that underground crypto mining appears to be alive and well in China. In a November report, the research group estimated that there are an average of 109,000 active crypto mining IP addresses in China on a daily basis. Most of those addresses, according to the report, are in the provinces of Guangdong, Jiangsu, Zhejiang, and Shandong.
Crypto mining has survived in China, in part, because lot of miners weren't sure whether Beijing was actually serious about the ban.
China has repeatedly lashed out against digital currencies, but each time, the sting wore off, and the rules eventually softened. The country's announcement this spring that it would be cracking down on crypto mining dovetailed with the centennial of the founding of the Chinese Communist Party, a time when there was pressure on lawmakers to show strength. Some miners – especially smaller-scale operators who didn't have the resources or the connections to migrate abroad – figured a lot of the crypto talk by the government was bravado, so they powered down, laid low for a few weeks, and then came back online, taking a few extra precautions when they did.
But this crypto crackdown appears to be different for a few big reasons.
For one, China is short on power, a resource vital to the process of bitcoin mining. The country has been dealing with its worst energy shortage in a decade, resulting in power cuts.
Beijing has also made it clear that crypto mining stands in the way of its aggressive climate targets, as it pushes to achieve carbon neutrality by 2060. In November, government spokesperson Meng Wei slammed bitcoin mining, calling it an "extremely harmful" practice and vowing stricter enforcement measures.
There's looming competition from the digital yuan, as well. The country is testing its own central bank digital currency, which could grant the government greater power to track spending in real time. Making it harder to transact in rival cryptocurrencies could be part of a larger plan to ensure adoption of this new central bank digital currency, according to Fred Thiel, CEO of Marathon Digital Holdings and a member of the Bitcoin Mining Council.
"China's government is doing everything they can to ensure that bitcoin and other cryptocurrencies disappear from the Chinese financial systems and economy," speculated Thiel. "Part of this is to ensure the adoption of China's central bank digital currency, and part of this is most probably to ensure financial surveillance activities are able to see all economic activity."
Whatever the impetus, the government's growing hostility toward crypto-related endeavors is apparent.
In the provinces of Zhejiang, Jiangxi, Hebei, and Inner Mongolia, for example, the government has taken varying degrees of action, such as asking local officials to run their own self-compliance checks, screening IP addresses for illicit mining activity, raiding illegal underground crypto mines, and arresting and expelling party members suspected of participating in crypto mining schemes.
Authorities appear to be paying special attention to mining happening at research institutions, community centers, and schools, where electricity prices sometimes cost less than the going rate. In November, the government vowed to hike energy prices for institutions that use subsidized power to mine.
Authorities are also zeroing in on state-owned businesses taking part in the trade.
This week, China's Central Commission for Discipline Inspection, the country's anti-corruption watchdog, said it had identified dozens of state-owned entities in the eastern province of Zhejiang that were using public resources to mine for twelve cryptocurrencies, including bitcoin, ether, litecoin, and monero. Of the nearly 50 people who were penalized, 21 worked at state-owned enterprises or Communist Party agencies.
State-owned entities have been tied up in crypto mining schemes elsewhere, too.
In the coastal region of Jiangsu, the communication watchdog for the province found that 21% of the IP addresses participating in crypto mining were from state-owned institutions.
Despite the government's significant and growing efforts to weed out all crypto miners, many, like Kirk, have found ways to survive undetected.
When China began its crypto mining takedown in May, most of the industry went dark virtually overnight, as miners waited for the dust to settle.
CNBC spoke to multiple participants in China's illicit crypto mining market, some of whom have spent time on the ground in China and others who have direct knowledge of how these operations continue to exist under the ever-increasing scrutiny of regulators.
The biggest players in the business, who already had connections overseas and cash to spare, got out fast. Many shipped their gear and moved their teams to Kazakhstan, the U.S., and other international destinations with low-cost power and available hosting capacity.
Some heavy hitters left their gear sitting in warehouses in Asia and headed to greener pastures empty-handed, instead placing orders for the latest-generation machines to be delivered to their new homes abroad.
But smaller miners with limited disposable income and fewer international connections found it hard to relocate thanks to pandemic-related travel restrictions, supply chain and shipping bottlenecks, and trade war headwinds between China and the U.S.
Selling gear wasn't all that effective as an off-ramp either, as the flood of inventory into the resale market tanked the going rate for mining rigs.
Medium-sized miners were "100% screwed" in this year's crackdown, according to one expert speaking to CNBC. They couldn't offload their equipment to recoup their losses, nor could they mine at full capacity again, because their electrical footprint is easy to pick out.
But for the smaller mines, like the ones Kirk runs, it's been easier to fly under the radar. Some divided their mining operations into multiple farms across the country that the authorities were less likely to notice. Others piggybacked off small, local power sources, like tiny dams in rural areas that are not connected to the main electric grid.
"Mining is no longer a big business," said one bitcoin miner who has spent years minting crypto all over the world, including in China, and asked to remain anonymous for fear of the authorities. Instead, the industry has turned into more of a piecemeal operation, with "a couple thousand miners here, a couple thousand miners there."
"It's more like a sort of band-aid to make money to help move the miners out of the country."
Running an illegal crypto mine
Kirk – who has been mining cryptocurrencies since 2015 – has one thousand mining rigs that are powered by grid electricity and another five thousand units tethered to hydropower, direct from the source in the southern province of Sichuan.
For the hundreds of miners running on grid power, Kirk tells CNBC that he has spread them out across the country, in order to evade detection by authorities.
"They're everywhere. You won't find a pattern," Kirk said of the mining gear that he has plugged into industrial power lines wherever his friends will let him grab a bit of extra power.
This is now common practice for many miners, according to Marshall Long, who has been mining for cryptocurrencies for over a decade in places like Sweden, Iceland, and China.
"They are drawing from the grid, and they are smaller scale now, so they are fragmented," Long said, referring to his many friends who are mining in China under the radar. "They're usually doing it in chunks of 20 megawatts or smaller, so they're kind of like home-buying their way to allow them to small-scale mine."
To put that into context, downtown Dallas uses 200 megawatts, and once the build-out is complete, America's largest mine will have a total power capacity of 750 megawatts.
But Kirk says the problem with this technique is that grid pricing is "really expensive." Using off-grid power allows for much better profit margins, and it is easier to operate on the sly.
The wet season in China runs from May into the late fall, and monsoon-level rainfall translates to an abundance of hydropower, which is more easily captured from behind the meter.
Beijing's crypto bans came as miners were already heading to Sichuan and Yunnan, two of the main provinces for crypto mining, thanks to their decentralized constellation of thousands of dams. Compared to the coal plants in the northern provinces of Xinjiang and Inner Mongolia, which were once bastions of the crypto mining network, these dams are less trackable and harder to identify – and therefore less accountable to government regulation.
"There is definitely a lot of miners attached to hundreds upon thousands of hydro dams within Sichuan," said Kevin Zhang of digital currency company Foundry, which helped bring over $400 million of mining equipment from China into North America.
In Kirk's case, most of his rigs run on hydropower. He has two sites in Sichuan. One is 12 megawatts and the second is eight megawatts. Kirk tells CNBC that in China, a mine that is above one megawatt at a single location is now considered sizable.
Techniques to stay undetected
Even before the ban, it was increasingly standard practice for miners of means to rent (or build) their own transformers and substations, in order to provide power to mining sites directly from power plants. Transformers take the power from a substation and convert it to a lower voltage that can then be used to power bitcoin miners.
At one of his locations in Sichuan, Kirk paid a one-time fee to lease an entire power plant that operates off the grid, which is one way he lowers his chance of being found out.
While Kirk has taken steps to hide his activity, he's not totally immune to detection. He says that China Telecom, one of the country's biggest telecommunications companies, doubles as the mining police in China by looking out for suspicious electricity usage.
Once identified, the chain of command becomes a game of telephone — China Telecom refers the activity to the central government, who then relays this information to the specific province or town where the alleged mining is happening. From there, according to Kirk, the local government calls the power plant directly to investigate the allegation.
This recently happened to Kirk, but he says he was lucky because the power plant owner likes him. When the government contacted the power plant about suspicious activity, the owner covered for Kirk. After the call, Kirk shut off the mine for a few days, took some extra steps to mask his network traffic, then powered back on.
This kind of IT hygiene is critical to keeping miners off the radar.
Miners conceal their IP address by using a virtual private network, or VPN, to mask their geographic digital footprint. But Beijing is wise to the use of VPNs as a tool to evade government censorship and has cracked down on their use.
Most underground miners are now turning to mining pools as another way to hide their tracks, joining cryptocurrency miners from around the planet to combine their computing power. Even though many mining pools have announced a suspension of services inside China, multiple sources tell CNBC that some foreign pools are still signing up Chinese miners.
"They hide their hashrate," explained Kirk. Hashrate is an industry term used to describe the collective computing power of all miners in the bitcoin network.
Typically, when a block of transactions is "mined" and added to the digital ledger of transactions known as the blockchain, the pool that won it signs its name to the block. Multiple sources tell CNBC that now, when Chinese miners contribute their computing power to solving a block, pools opt to not sign their name, which is a departure from past protocol.
"A pool doesn't have to reveal any data," continued Kirk. "You're basically telling the world that my revenue is only half of what I actually have. You don't brag about it."
This could help to explain why China's share of the global bitcoin market went to zero practically overnight, since the bitcoin mining index is based upon data voluntarily shared by mining pools.
Though pools are quiet about working with Chinese miners, they have been very helpful to many of these underground operations behind the scenes, according to multiple sources.
"There are some larger pools who still care. They actually provide a lot of technical support to help you, in case your own people don't have the technical ability to set it up," Kirk said.
Long tells CNBC that many of these foreign pools provide them with technology that disguises what they're doing.
"They are encrypting their packets as it leaves the data center, so it just looks like ordinary web traffic," Long said.
As Kirk describes it, one pool that he works with helped him to set up a server that made his mine look as though it had fewer "connection points." When one IP address has thousands of connection points, each of which is submitting massive amounts of data, that looks suspicious to authorities, especially in a rural area like Sichuan. But Kirk says that pools help miners get around that.
"After they do their magic, you're only going to see five machines, which then does not look suspicious, because any household can have that," Kirk said.
The 'dry season' migration
But China's underground miners have a new and very big problem: The wet season is over.
In years past, miners would pack up their gear and truck it to either Xinjiang or Inner Mongolia to tap into the electricity generated by coal-powered plants. Both those regions are now closed off to miners.
"It's going to get really interesting," said Zhang, who estimates that China's share of the global bitcoin market will plummet to 5% as hydro dams dry up. "A lot of miners will have to capitulate and send gear abroad."
Zhang tells CNBC that it's "very painful" when you have to unplug and re-route your miners over and over again, so he suspects that many will look to North America, where they can sign longer-term agreements. "It's a more stable framework, and it's not going to change on you overnight," he said.
Kirk is weighing that option right now.
But until he strikes a deal with an American host, Kirk is in a bit of a holding pattern. Although he says he is selling some of his S19 series Antminer ASICs, for the most part, he's hanging on to a lot of his machines until he figures out next steps.
"These are essentially money printers," explained Zhang, who made the point that these machines grant virtually instant access to bitcoin, or U.S. dollars if you liquidate your crypto stake. In a country with very tight capital controls, that kind of insurance policy is pretty valuable.
"It's a big reason why a lot of miners haven't capitulated and sold their equipment, because for them, it's access to capital overseas…once they get it plugged in," said Zhang.
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