Blockchain Project
Hashrate Derivatives
By: BRIAN WRIGHT | October 26, 2020
A Bitcoin miner’s revenue is heavily dependent on two hard-to-predict variables: bitcoin price and network hashrate. Miners produce hashrate. The probability a miner finds a Bitcoin block and receives the block reward and transaction fees is simply a function of the miner’s hashrate divided by the network’s total hashrate. When network hashrate increases, the miner’s likelihood of finding a block and receiving bitcoin therefore decreases. We are researching and experimenting with a range of novel difficulty and hashrate derivative contracts to learn how miners can incorporate the contracts into their strategies to reduce risks associated with unexpected increases in network hashrate.
Bitcoin
Mining
Hashrate

The Challenge

A Bitcoin miner’s revenue could decrease either when bitcoin price decreases or when network hashrate increases. Revenue could decrease when network hashrate increases because the miner’s total share of hashrate, and therefore probability of finding a Bitcoin block and receiving the bitcoin reward, decreases. Revenue could decline when bitcoin price decreases because the dollar-value of the bitcoin rewards have fallen. While vehicles exist for miners to hedge exposure to price, it is only recently that derivatives have emerged that allow miners to hedge against unexpected increases in hashrate. We are researching these contracts to learn which contracts are optimal for miners and how they can be incorporated into a miner’s strategy.

The Value

The learnings from this PoC have led to an improved understanding of the measures the Fidelity Bitcoin Mining team can take to reduce economic risks inherent to the industry.

What we Learned

We experimented with Bitcoin difficulty and hashrate derivative contracts with different contract settlement formulas and varying tenors, from less than two weeks to over six months. We believe that when used effectively these contracts can limit a miner’s downside while preserving much of the economic upside.

Team & Tech

The team includes experts on Bitcoin mining with a deep understanding of Bitcoin mining economics and data analysts.

Next Steps

We will continue researching the financialization of mining and experiment with new products that have potential to improve the risk/reward profile of Fidelity’s Bitcoin mining operation.

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The Deep Dive

Bitcoin miners are exposed to two hard-to-predict variables that have a large impact on revenue: bitcoin price and network hashrate. When bitcoin price decreases, the dollar value of the block reward and transaction fees that a miner receives when mining a block decrease. When network hashrate increases, a miner’s percent of total network hashrate decreases. This decrease in share of network hashrate means the miner has a lower probability of mining a block and generating revenue through the block reward and transaction fees. While there are a range of products on the market today that would allow a miner to hedge against an unexpected price drop, there are very few available options that allow miners to hedge against unexpected increases in network hashrate. Several new products have emerged within the last year that target this unmet demand for improved risk management in the mining industry. We are researching these new products and have engaged in discussions with some of the external firms that created them to discuss the specifics of the products. The intention is to create a Fidelity-perspective on how to best incorporate these products and which products are best suited to a miner’s needs. This initiative proves the merits of these derivatives and helps us form a strategy for how to best utilize the products as Fidelity continues to grow its mining operation.

 
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