What China’s hydropower consumption parks mean for bitcoin mining

This year, in a move that has been applauded by the crypto industry, local governments in China have — for the first time — appeared to officially embrace bitcoin mining farms. 

The provincial government of Sichuan, a global bitcoin mining hub, opened a number of what it calls “Hydro-electricity Consumption Industrial Demonstration Zones” this year in an attempt to resolve a problem the province has every rainy summer: an excessive amount of hydroelectric power produced by its many dams. 

The zones are open to companies in select energy-intensive industries such as big data storage or electrolytic hydrogen production. One result of the new policy has been that bitcoin mining farm operators in China now have an option to reside legally in a government-approved industrial park where they can access a reliable supply of electricity. 

Out of the 99 local firms in the first batch of companies admitted to the demonstration zones, at least five of them were “big data” companies, according to a government document. That was notable because bitcoin mining farms in China typically categorize themselves as big data centers, cloud computing or server hosting service providers.

Indeed, at least one of the five, called Chengdu Wujilian, advertises bitcoin miner hosting and farm operation businesses on its website.

The second batch, which came in August, expanded the total number on the list by more than a dozen, according to multiple government notices. Within that batch there were at least three “big data” or “cloud computing” companies — and one of them was a subsidiary owned by Chengdu Wujilian.

According to Kevin Dejun Ge, a local bitcoin mining operator, the total power capacity approved for bitcoin mining farms this year in the demo zones was around 2 gigawatts. That's roughly equivalent to the capacity of a couple of large power plants. 

So what does Sichuan’s apparent embrace of bitcoin mining farms mean for the future of that industry in China? 

It’s probably too early to tell. “2020 was the first year. The policy [incentives] and the reaction time was not enough with limited construction leeway,” Ge said. “Plus there’s already an oversupply of bitcoin mining farms so it’s difficult to fulfill enough miners to consume all the provided electricity."

But the answer may ultimately hinge on whether Sichuan’s new demo zones actually disrupt the business-as-usual scenario for bitcoin mining — and that will depend on how an ongoing competition for profits plays out between miners, power plant operators, and the government.

Meanwhile, the economics of mining may favor the status quo. 

Grey areas

China’s Sichuan province has become a global bitcoin mining hub because it has a surplus of hydroelectricity in the summer. Historically, much of that hydropower has gone to waste.

According to Chinese government data, the total wasted hydroelectricity in Sichuan annually from 2012 and 2016 was 7.6 billion kilowatt-hours (kWh), 2.6 billion kWh, 9.7 billion kWh, 10.2 billion kWh, and 14.2 billion kWh. (For reference, an average home in the U.S. consumes 10,649 kWh per year.)

An effort to curb that waste is behind the Sichuan government’s decision to approve an initiative in July 2019 that set up the aforementioned demo zones in six prefectures within the province: Aba, Garze, Liangshan, Ya’an, Leshan, and Panzhihua.

Incidentally, the demo zones also appear to be a way for bitcoin mining farms to gain legitimacy in the eyes of the government.

Many bitcoin mining farm operators in China’s Southwestern region have traditionally relied on a power subscription model called Zhi Gong Dian. In general, it means that a hydropower generator that’s connected to the State Grid — China’s electricity distribution monopoly — supplies electricity directly to the bitcoin mining farm without first routing it to the State Grid. 

Although the power supply may be unstable at times, this can be a win-win deal: Farm operators can get a cheaper rate, and power station owners can bank on reliable purchases. But it also occupies a legal grey area if it is not outright illegal. 

China’s electricity system separates power generation businesses from power sales entities, and whether a power plant is allowed to directly sell electricity to a third party without going through a wholesale intermediary — in which case the local government and State Grid wouldn't get a cut — is a case-by-case matter.

A major perk of operating a mining farm inside a government-approved zone is being recognized as a legal entity. There's also access to a more stable electricity supply, via the State Grid.

Paying a premium

But participation in a demo zone comes at a cost. 

The composition of the basic electricity price offered at demo zones this year included a base rate of 0.075 yuan (around $0.011) per kWh, the State Grid’s cut of 0.04 yuan (around $0.0061) per kWh and a government cut of 0.02 yuan (around $0.003) per kWh.

All told, the starting point was 0.135 yuan (around $0.021) per kWh. Factoring in the sunk cost associated with the necessary administrative processes, Ge estimated the overall cost for a mining farm in the demo zones to be around $0.026 per kWh — and that is excluding construction costs. 

While the base rate for power supplied directly from the producer is higher than $0.011 per kWh, there are no middlemen involved. For a typical farm operator in Sichuan, the overall cost during the hydro season this year was around $0.021 per kWh.

Mining farms that host hardware owned by others typically charge clients an additional $0.01 per kWh. So for bitcoin miner owners looking to have a third party host their machines, the choice would be $0.036 per kWh for hosting inside a demo zone versus $0.031 per kWh at a farm with direct access to a power plant. And in bitcoin mining, even a seemingly negligible 0.01 yuan ($0.0014) per kWh translates into a huge difference in one’s monthly utility bill.

Ge added the base rate this year at the industrial parks was capped at 0.075 yuan (around $0.011) per kWh. But based on information he's received, he said next year $0.011 could be a just starting point.

An offer they can’t refuse?

Given the higher costs of operating in a sanctioned zone, mining farm operators may choose to stick to their conventional ways of doing business. That is, unless the government makes that too difficult or impossible.

Apparently, the State Grid can wield fairly strong administrative force over power generating firms. The State Grid’s subdivision in Tianquan county in Ya’an conducted a wide inspection in June of local power plants and ordered them to stop directly supplying electricity to bitcoin mining farms.

More recently, a document circulating on social media indicated that a Yunnan state-owned power plant has prohibited substations connected to the State Grid from directly supplying electricity to third-party big data customers. 

If this sort of thing continues, mining farm operators in China’s mining hub may be forced to make a decision sometime in the coming years: whether to pay a premium to be recognized as legal or continue operating as usual, but at the increased risk of getting their power cut.

Either way, Sichuan’s demo zone experiment has only just begun — and the government’s plan is to try this out until at least the end of 2022.