"Mining" the Future: A Report on the Differentiation and Financial Analysis of Canaan Technology's Mining Business

Written by: TaxDAO

Canaan Technology was founded in 2013 and went public on November 21, 2019. It is a technology company focused on the design of ASIC high-performance computing chips, chip research and development, computing device production, and software services. With the vision of "Supercomputing is what we do, societal enrichment is why we do it," Canaan Technology has extensive experience in ASIC chip design and streamlined production. In 2013, under the leadership of founder and CEO Zhang Nengeng, the founding team of Canaan Technology delivered the world's first batch of Bitcoin mining machines using ASIC technology, branded as Avalon. In 2019, Canaan Technology completed its initial public offering on the Nasdaq global market. Canaan Technology not only provides comprehensive artificial intelligence (AI) solutions globally, including AI chips, algorithm development and optimization, hardware modules, end products, and software services, but also offers supercomputing solutions through its proprietary high-performance computing ASICs (Application-Specific Integrated Circuits). As of 2022, Canaan Technology had 541 employees, with business covering Bitcoin mining machines, mining, and AI products, primarily distributed in countries and regions such as Indonesia, Malaysia, the United States, Australia, and Kazakhstan.

This report comprehensively analyzes the financial status of Canaan Technology since its expansion into the mining business in 2021, aiming to assess the impact of this business decision on the company's financial condition. By sorting through the financial data since the inception of the self-mining business and comparing the performance of the mining business over the last two quarters, this report reveals Canaan Technology's profitability and cost control in the mining sector, exploring the impact of the mining business on the company's overall financial health and strategic development direction. This analysis not only reflects the company's competitive position in the mining hardware market but also considers industry trends, changes in market demand, and the impact of the relevant policy environment on Canaan Technology's business expansion decisions.

2 Strategic Analysis of Canaan Technology's Mining Business Expansion

2.1 Canaan Technology Mining Activity Revenue Report

2.1.1 Mining Activity Revenue

Canaan Technology disclosed in its Q2 2023 report that the mining revenue for the second quarter of 2023 was $15.9 million, an increase of 43.3% compared to $11.1 million in Q1 2023, and a 105.1% increase compared to $7.8 million in the same period of 2022. The quarter-on-quarter growth was primarily driven by the rebound in Bitcoin prices and an increase in Bitcoin rewards on the network during the quarter. The year-on-year growth was mainly due to the increased computing power injected into mining.

Canaan Technology disclosed in its Q3 2023 report that the mining revenue for the third quarter of 2023 was $3.3 million, a decrease of 79.5% compared to $15.9 million in Q2 2023, and a decrease of 64.6% compared to $9.2 million in the same period of 2022. The quarter-on-quarter and year-on-year decrease was mainly due to the decline in mining computing power, which led to longer transaction confirmation times and reduced mining costs. The reason for the decline in computing power was the implementation of the "Digital Mining Activity Licensing Rules" in Kazakhstan in July 2023, which requires individuals engaged in cryptocurrency mining to obtain a professional license first. Subsequently, the company decided to temporarily shut down its mining computing power of approximately 2.0 Exahash/s in Kazakhstan to ensure legal compliance and has been actively working to obtain Class II licenses for mining hardware owners since early July, with its mining operations in Kazakhstan remaining suspended until Q3 2023.

2.1.2 Sales Activity Revenue

Canaan Technology disclosed in its Q2 2023 report that the product revenue for the second quarter of 2023 was $57.9 million, with mining machine sales revenue increasing from $43.7 million in Q1 2023 to $57.8 million. In comparison, Q1 2023 was $44.1 million, and the same period in 2022 was $238.1 million. The growth compared to Q1 2023 was mainly due to an increase in total computing power sales, although the overall purchasing power of the market demand side was weak, leading to lower sales prices. The decrease compared to Q2 2022 was mainly due to the decline in sales prices caused by the drop in Bitcoin prices. The AI product revenue for Q2 2023 was $1 million, while it was $4 million in Q1 2023 and $2 million in the same period of 2022.

Canaan Technology disclosed in its Q3 2023 report that the product revenue for the third quarter of 2023 was $29.9 million, with mining machine sales revenue amounting to $29.755 million. In comparison, Q2 2023 was $57.9 million, and the same period in 2022 was $136.3 million. The decrease compared to Q2 2023 was mainly due to a reduction in total computing power sales and lower sales prices, which were caused by the overall slowdown in market demand. The decrease compared to Q3 2022 was mainly due to lower sales prices, although Bitcoin prices gradually recovered and total computing power sales increased, the overall market demand slowed down. The AI product revenue for Q3 2023 was $2 million, while it was $1 million in Q2 2023 and $4 million in the same period of 2022.

2.1.3 Proportion of Mining Activity Revenue

• Canaan Technology's total revenue for Q2 2023 was $73.85 million, with mining revenue accounting for approximately 21.5% of total revenue;
• Canaan Technology's total revenue for Q3 2023 was $33.32 million, with mining revenue accounting for approximately 9.8% of total revenue.

Currently, Canaan Technology's mining business revenue accounts for a small proportion, and the decline in computing power under legal compliance requirements has led to higher mining costs and a reduction in mining revenue. However, the company will implement an inventory reduction strategy for a longer period to mitigate risks and improve operational efficiency. The balance between the mining business and mining machine business needs to be further adjusted based on future market performance and company strategy.

2.2 Mining Costs and Profits for Q2-Q3 2023

2.2.1 Direct Costs of Mining Activities

Canaan Technology's mining costs for Q2 2023 were $30.6 million, an increase from $27.3 million in Q1 2023 and $11.5 million in the same period of 2022. The mining costs here include direct costs of mining production (including electricity and hosting fees), as well as depreciation and amortization expenses. The depreciation expense for the deployed mining machines in this quarter was $16.2 million, while it was $16.3 million in Q1 2023 and $10.1 million in the same period of 2022. The year-on-year growth was mainly due to the increase in mining capacity. Therefore, the direct costs of mining activities for Q2 2023 were $14.4 million. The direct costs accounted for 47.1% of total costs.

Canaan Technology's mining costs for Q3 2023 were $18.7 million, a decrease from $30.6 million in Q2 2023 and $15.8 million in the same period of 2022. The mining costs here include direct costs of mining production, including electricity and hosting fees, as well as depreciation. The depreciation expense for the deployed mining machines in this quarter was $15.8 million, while it was $16.2 million in Q2 2023 and $7.7 million in the same period of 2022. The year-on-year growth was mainly due to the increase in computing power deployed in the company's mining business. Therefore, the direct costs of mining activities for Q3 2023 were $2.9 million. The direct costs accounted for 15.5% of total costs. The proportion of direct costs has decreased.

Canaan Technology's product costs for Q3 2023 were $83.7 million, while it was $113.3 million in Q2 2023 and $97.1 million in the same period of 2022. The continuous and year-on-year decline is consistent with the decrease in the sold computing power. The accrued inventory write-down, prepaid expense write-down, and inventory purchase commitment reserves for this quarter amounted to $53.9 million, while it was $45.9 million in Q2 2023 and $33.1 million in the same period of 2022. Product costs include direct production costs and indirect costs related to the production of mining machines and AI products, as well as inventory write-downs, prepaid expense write-downs, and inventory purchase commitment reserves.

From the above data related to the mining business and mining machine sales business, it can be concluded that the gross profit margin for the mining business in Q2 2023 was -0.92%, while the gross profit margin for the mining business in Q3 2023 was -68.47%. At this stage, Canaan Technology's mining business has not brought significant profits to the company.

2.2.2 Profit Analysis

The net loss for Q2 2023 was $110.7 million, while the net profit for the same period in 2022 was $6.3 million. By Q3, the net loss was $80.1 million, which includes $53.9 million in inventory write-downs, prepaid expense write-downs, and accrued inventory purchase commitment reserves for the quarter. These actions align with the company's proactive inventory reduction strategy to cope with the challenging market environment and should be viewed as non-cash items. To improve its financial situation, Canaan Technology has implemented strict expenditure control measures, including layoffs to enhance operational efficiency. In the near future, Canaan Technology will continue to maintain cash reserves through diversified sales efforts and prudent expense management to ensure operational continuity and position itself to seize future opportunities.

2.3 Impact of Mining Business Expansion on Canaan Technology's Debt-to-Asset Ratio

2.3.1 Current Number and Value of Canaan Technology's Mining Machines

In Q2 2023, Canaan Technology's inventory was $272 million, while its fixed assets, including software equipment, were $50.48 million, and its right-of-use assets were $289.6 thousand. In Q3, Canaan Technology's inventory was $217 million, its fixed assets, including software equipment, were $34.02 million, and its right-of-use assets were $230 thousand. This indicates that Canaan Technology is focusing its business on more profitable mining machine sales, with a median selling price of 14 million RMB (approximately $1,946) for its mining machines, maintaining a stable number of around 140,000 units (for sale and mining).

2.3.2 Impact of Previous Mining Business Expansion

Canaan Technology had previously operated a mining business, starting in Q2 2021. By expanding into global markets, the company's relationship with customers evolved from purely selling mining machines to joint mining, creating tighter profit ties. At the same time, mining was also listed as an independent financial item in the reports. Therefore, a comparison of key indicators from the Q1 2021 and Q2 2021 reports can be made to analyze the impact of mining activities on the company's asset ratios, which can be visually represented in the following table to show the differences in Canaan Technology's financial performance before and after the start of this business.

The data indicates that Canaan Technology's total asset turnover and return on equity have significantly improved after expanding its mining business, reflecting good financial performance as a company that has traditionally expanded its business downstream in the supply chain. The increase in the current ratio and quick ratio, along with the decrease in the debt-to-asset ratio, reflects an improvement in the company's financial condition, while the increase in return on equity indicates enhanced profitability and effective capital utilization. Specific analyses are as follows:

(1) Increase in current ratio and quick ratio: The current ratio refers to the ratio of a company's current assets to its current liabilities, while the quick ratio excludes inventory, which is relatively less liquid. An increased current ratio and quick ratio indicate that the company is better able to meet short-term debt obligations and respond to unexpected liabilities. The introduction of the mining business may have improved the company's cash inflows and reduced the capital tied up in inventory, thereby increasing these two ratios.

(2) Decrease in debt-to-asset ratio: The debt-to-asset ratio is the ratio of a company's assets to its liabilities, and a decreased debt-to-asset ratio indicates that the company's assets are healthier relative to its liabilities. This may mean that the company has obtained more funds through its mining business to pay off debts or invest in more profitable projects, or that it has reduced liabilities through more efficient asset management.

(3) Increase in return on equity: Return on equity is the ratio of a company's net profit to its net assets, and an increased return on equity indicates that the profit generated per unit of net assets has increased. This may be due to the introduction of the mining business bringing in additional revenue, or the company's cost management being optimized, thereby improving profit levels. It may also reflect that the company has utilized capital more effectively, enhancing profitability.

In summary, these improvements in financial indicators suggest that Canaan Technology has achieved an improvement in financial condition, optimized debt-to-asset ratios, enhanced profitability, and better met investor expectations through the introduction of the mining business.

Based on past experience, the mining machine business is linked to cryptocurrency prices; when prices rise, performance improves, and when prices fall, performance declines. In 2021, cryptocurrency prices dipped to around $30,000 per coin at their lowest and exceeded $60,000 per coin at their highest, showing significant volatility; meanwhile, challenges from various sources were numerous. However, Canaan Technology's performance in 2021 showed a continuous increase over four quarters, ultimately achieving a year-on-year growth of over ten times, far outpacing the price trends of cryptocurrencies. This demonstrates that innovative and flexible business strategies, stable supply chain capacity, expansion of mining business, increasing R&D investment, team building, and improving management levels were beneficial to Canaan Technology at that time.

In Q4 2021, despite significant fluctuations in cryptocurrency prices, Canaan Technology further expanded into overseas markets, such as Southeast Asia and South America, establishing partnerships with customers in emerging markets like Malaysia, the UAE, Argentina, and Peru. New customers accounted for 41% of the computing power purchased; at the same time, demand from traditional overseas markets such as Central Asia, North America, and Europe remained strong, with repeat customers accounting for 59% of the computing power purchased. Strong market demand drove the company to sell 7.74 million T of computing power in Q4, a 15% increase from Q3, setting a new historical record for the best single-quarter performance.

2.4 Impact of Mining Business Expansion on Canaan Technology's Inventory

In Q1 2021, Canaan Technology's inventory was $376 million, and in Q2 2021, the inventory was $587 million, a year-on-year increase of 56.12%. This can be visually represented in the following table to show the impact of this business on Canaan Technology's inventory ratio.

After the implementation of this business decision, the shortened operating cycle and increased inventory turnover reflect the following points: First, the addition of the mining business may have brought in an additional source of revenue, increasing the company's total income. Second, because mining activities typically require less time to convert into cash or other liquid assets, the company's cash flow has improved, thereby shortening the operating cycle. Additionally, the increase in inventory turnover means that the company can convert inventory into sales revenue more quickly, reducing the risk of inventory backlog and improving the efficiency of capital utilization.

Overall, these improvements in indicators suggest that the company's operational efficiency has increased, profitability has enhanced, and market demand has been better met.

In summary, based on its main business of mining machine production and sales, Canaan Technology has expanded its self-mining business to extend coverage downstream in the industry chain, aiming to enhance competitive barriers, increase revenue sources, and gradually reduce the risks associated with a single business model. Although the development speed of the mining business is rapid, its proportion in the company's total revenue remains low. According to the company's plan, a certain proportion of production capacity will be deployed for self-mining each month, with the specific deployment quantity flexibly adjusted based on the situation of cooperative mining farms and market demand, primarily located in overseas regions such as Kazakhstan. However, the mining market in Kazakhstan is undergoing further adjustments due to compliance requirements, which may increase the company's mining costs.

While self-mining can superficially reduce risks, the high correlation with the main business and the significant regulatory risks faced by the mining business may lead to an expansion of risks. If the mining business is treated as an important asset investment, it may pose severe challenges to Canaan Technology's revenue and cash flow during unfavorable market conditions or tightening regulatory policies. Although the mining business provides a certain source of income for the company, its risk factors must be carefully considered to ensure that the company can maintain stable operations in different market environments.

3 Comprehensive Conclusion

Since Canaan Technology expanded its mining business in 2021, its strategic decisions and financial performance reveal the company's efforts to seek growth and competitive advantages in the global mining hardware market. By vertically integrating upstream and downstream businesses in the industry chain, Canaan Technology has not only enhanced its control within the Bitcoin ecosystem but also diversified certain market risks, further consolidating its market position. However, since the growth of both the mining machine sales and mining businesses heavily relies on the cyclical and volatile nature of Bitcoin, this decision has limited effectiveness in diversifying market risks.

Despite the negative gross profit margins for the mining business in Q2 and Q3 2023, the short-term financial challenges do not completely offset the long-term value of the strategic decision to expand the mining business. Considering the growth potential of Bitcoin as a long-term investment target, the Bitcoin held by Canaan Technology may achieve capital appreciation in the future, compensating for short-term operational losses. Therefore, the mining business can serve not only as an immediate source of income for Canaan Technology but also as a foundation for long-term asset appreciation. Thus, despite facing challenges with negative gross profit margins in the short term, the expansion of Canaan Technology's mining business remains strategic and forward-looking, with the potential to bring continuous growth and profit maximization opportunities to the company amidst the ongoing changes in the digital currency market.

In conclusion, Canaan Technology's mining business expansion strategy is a strategic decision that comprehensively considers market trends, technological advantages, and long-term investment value. By continuously optimizing its business model, strengthening cost control and risk management, and flexibly adapting to market changes, Canaan Technology is expected to find opportunities amidst challenges, achieving long-term success and growth in the fields of mining hardware and mining business.