China’s underground bitcoin miners

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.

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.

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.

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.