Published: May 22nd, 2020
It may be time to ditch the old stereotype of bitcoin miners. If once they were mainly a disparate group of enthusiasts, earning new coins by solving complex math problems in their bedrooms, today they’re more likely to be savvy startups, using the latest financial instruments to minimise their risk.
Crypto derivatives exchange FTX has become the first notable platform to answer that demand with the launch of bitcoin hashrate futures. The new crypto-specific instruments are designed to help miners hedge against volatility arising from bitcoin’s mining difficulty adjustments.
Until now miners have mainly been at the mercy of sudden changes in bitcoin’s ‘hashrate’, a measure of the processing power spread across bitcoin’s entire blockchain-based network. It can fluctuate wildly and dictates how much electricity miners need to generate new coins.
Having access to derivatives that enable mining startups to hedge against the hashrate would, in theory, provide them with more transparent cashflow projections – a minimum requirement to secure VC finance.
FTX's bitcoin hashrate futures re based on a measure of the average mining difficulty over a set timescale, representing the total hashrate being used for bitcoin mining in that period.
The company said in a statement that while it's impossible to measure hashrate precisely, over longer periods, it can be approximated with calculations based on block times and difficulty.
The exchange revealed plans to launch a bitcoin hashrate future last August. The product finally went live this week.
Sam Bankman-Fried, CEO of FTX, told analysts that miners and startups had expressed significant interest in hashrate futures.
“We've been expanding relationships with mining firms and individuals, and now have enough of a network to support flow into these futures,” he said.
Bitcoin miners and their high-powered ASICS machines have to draw on increasingly large amounts of computing power as they compete to solve the complicated math riddles that build the BTC blockchain. Miners receive rewards for their efforts – which help ensure the legitimacy of transactions on the network – in the form of new bitcoins.
The hashrate refers to the volume of computing power miners are using at any given time to validate bitcoin’s blockchain. The more power being put to work by miners, the assumption goes, more secure bitcoin’s blockchain is.
But all that processing power consumes a lot of electricity. The most recent Bitcoin Energy Consumption Index shows annual global energy usage from bitcoin mining alone is equal to annual electricity consumption in the Czech Republic (Pop. 10.5 million).
The first contract on offer from FTX is for Q3 2020 and will settle to the average mining difficulty calculated within the quarter. FTX has also launched futures for Q4 of this year and Q1 2021.
It is worth noting that bitcoin hashrate futures aren’t an entirely new idea. Earlier this year, crypto brokerage BitOoda launched its Hashpower futures contract, while Interhash and mining risk management firm GSR also announced plans to develop a hashrate derivatives product for miners.
If the market for hash rate hedging tools takes off, it could spark more investor interest in crypto mining startups. Mining has traditionally been for lone enthusiasts with access to high-powered ASICS but its rapidly transforming into a capital-intensive industry that's addressing the growing demand for digital coins.
Any spike in the mining hashrate pushes up the miner’s electricity requirements, increasing production costs and eating into eventual profits of coins sold. In that sense hashrate is a volatile risk variable that needs to be addressed – otherwise, it could become a sticking point for startups as they aim to attract investment from institutions and VCs.
For investors hunting higher returns in a time of ultra-low interest rates, crypto minoring firms could be a tempting target.
The evidence of interest is there if you look. Last month Chinese giant crypto mining Canaan went public with a USD 90-million Nasdaq IPO, giving the firm a valuation of around USD 2 billion.
While others like BitOoda have taken important but tentative steps into the nascent hashrate futures market, analysts believe an exchange like FTX will have a natural advantage as it can offer access to retail investors and, crucially, more liquidity.
FTX addressed liquidity issues specifically in its launch announcement, telling journalists that the exchange has numerous liquidity providers, with more will likely to sign up in the near future.
The timing of the launch – just days after bitcoin's third halving – means it arrives in the midst of an intensive transition in the bitcoin ecosystem. Bitcoin revenue reached a high of $20.6 million in early May but then began to trend downward as the halving’s drop date grew nearer.
The halving has cut the bonus paid to miners by 50 per cent, which has naturally shrunk the rate of new coin creation. In addition to the bonus, miners also receive a fee each time they confirm a bitcoin transaction. Of the post-halving miners’ income, roughly 13% is made up of transaction fees.
If mining revenues decline over the long term and companies shut down, analysts say transaction fees could be the best revenue option to help miners stay afloat.
Higher fees in future could accommodate the growing demand for processing transactions while keeping the network secure. After the latest halving, transaction costs leapt upward by 400 per cent.
Longer-term, miners hope the halving will lead to reduced hashrate and mining difficulty.