MinerMovements #12
FTX Launches Hash Rate Futures
Welcome to the fourth epoch of Bitcoin mining.
The transition to miners earning a 6.25 BTC subsidy per block was accompanied by lower network hash rate, longer block times, and larger transaction fees.
Lower hash rate deployed leads to longer block times and fewer blocks make block space more valuable by default.
Many were enthusiastic to see transaction fees as a percentage of total block reward raise to over 20% post-halving but the state of transaction fees will not be clear until two difficulty adjustments take place post-halving.
The first took place two days ago with the difficulty recording a downward adjustment of 6%.
However, this difficulty adjustment also takes into accounts blocks which were produced from the last adjustment to the halving at block 630,000.
This means that the new difficulty level of 15.14 trillion does not fully adapt to the new level of computing power deployed since the halving.
The next adjustment will be entirely based on the computing power which miners deploy at the current difficulty level and block subsidy of 6.25 BTC.
The next difficulty adjustment will alter the network to the hash rate deployed over the next ~2 weeks and it will afterwards become clear whether users are paying higher transaction fees post halving.
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FTX Launch Hash Rate Futures
The dominant theme in our recent MineBlown event was the financialization of mining.
Developments in derivatives to hedge risk, lending facilities, and the procurement of markets to trade hash rate have long been the subject of lengthy discussion among miners.
Hash rate and difficulty-based futures contracts are often at the forefront of this discussion.
Miners are inherently long the value of their hash rate, long the price of Bitcoin, and short difficulty.
If a miner establishes a 100 PH mining farm at a given difficulty level, any rise in the difficulty level will result in the mining farm claiming less of the rewards pool.
To achieve the same percentage of rewards as when they set up, the miner will either have to upgrade their equipment, deploy more mining rigs, and/or overclock their machines.
The idea behind difficulty-based contracts is to give miners an option to hedge their exposure to difficulty.
By longing such a contract, the theory is that the financial gain from longing the contract will balance out the financial loss which the mining operation incurs when difficulty increases.
How to design such contracts has been the subject of lengthy discussion.
Last week, crypto derivatives exchange FTX pushed ahead with listing three hash rate futures contracts.
FTX launched contracts for Q3 2020, Q4 2020, and Q1 2021.
The expiration value of each contract will be based on the average difficulty of all blocks in a quarter.
The average difficulty of all blocks over the quarter is divided by 1 trillion to get the value of each contract.
The Q3 contract is currently trading at 17.2 indicating that the market is anticipating an average difficulty of 17.2 trillion over Q3.
For comparison, the previous difficulty level was 16.1 trillion.
The 14-day moving average of hash rate on the day of the recent difficulty adjustment was 108EH/s indicating that the previous difficulty level of 16.1 trillion roughly represents a hash rate of 108 EH/s deployed on Bitcoin during this difficulty phase.
With the Q3 contract trading at an anticipated average difficulty level ~6.8% higher, the market is currently anticipating that around an additional 7.3 EH/s will be deployed on average throughout Q3.
That would equate to roughly 66 thousand of the latest gen Antminer S19 Pros.
The Q4 contract and Q1 2021 contract are currently trading at 14.78% and 24% premiums to the 16.1 trillion difficulty level respectively.
This would suggest an additional 15.96 EH/s (~145k Antminer S19 Pros) on average throughout Q4 and an additional 25.92 EH/s (~234k Antminer S19 Pros) on average throughout Q1 2021.
Market Dynamics
While the contracts are designed to give miners a way to decrease their risk to upside difficulty movements, the instruments have naturally attracted speculators.
In terms of natural sellers of the contract, ASIC manufacturers may be one.
Assuming they can maintain their respective market shares, ASIC manufacturers benefit from an increase in difficulty as the fresh rigs arriving on the market will be supplied by their businesses.
They may be willing to take a short position on difficulty as declining difficulty could represent falling demand for mining rigs in some cases.
Professionals involved in the ASIC rig supply chain will also hold information which will have a material impact on the prices of the hash rate futures.
Increased volatility would be expected around rig releases as the market prices in the impact of new rigs being delivered to miners.
It would be unsurprising to see increased volume and volatility ahead of such announcements as those in the supply chain may position themselves to capitalize on information not known to the wider market.
How Effective Are The Contracts for Hedging?
In terms of miners hedging their exposure to difficulty, the contracts leave a lot to be desired.
In fact, taking a long difficulty contract could leave miners doubly exposed.
Let’s take the March 12th-13th Bitcoin price crash for example.
In this case, miner margins were extremely squeezed as BTC price dropped roughly 50%.
Inefficient miners were pushed into the red and huge amounts of hash rate went offline.
What proceeded was the largest downward difficulty adjustment since ASIC miners began dominating the Bitcoin network.
In this case, a miner who had hedged their mining operation with a long difficulty contract would have been negatively impacted by both the drop in price and the drop in difficulty.
Nonetheless, after lengthy discussion on how to design a difficulty based contract, it is refreshing to see FTX push ahead with listing a product.
Future iterations and releases by other exchanges can improve upon the design.
Thanks to Juri Bulovic for feedback on this piece.
Miner Insights;
Miners Face Capitulation Post Halving - With many mining rigs unprofitable even at lower electricity rates, a large portion of miners have already turned offline or are facing capitulation. Data highlights that miners are currently selling more BTC than they’re generating. This suggests that the more inefficient miners are currently depleting their treasury reserves.
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