The list of Bitcoin mining operations that have had to shut their doors due to poor risk management is longer than many in our industry would like. However, with the introduction of hash rate derivatives, mining companies have a new risk management tool in their arsenal that can mitigate hashrate volatility risk and increase cashflow stability.
Read on to learn about hashrate derivatives and their impact on the Bitcoin mining industry.
What Are Hashrate Derivatives?
Hashrate derivatives are financial contracts between a buyer and a seller that use hash rate, the computing power required to mine bitcoin, as the underlying asset.
To understand hashrate derivatives, imagine buying a new mining rig to mine bitcoin. But then, for a moment, you are scared of the risk that more people will start to mine, and the network’s hashrate will increase, making it harder for you to profitable mine from home.
So, instead, you decide to buy hashrate derivatives instead of buying an actual mining rig. By doing so, you are entering a contract to profit when the hashrate goes up, speculating on the growth of Bitcoin mining.
Alternatively, a Bitcoin mining company can use hashrate derivatives to hedge against falling bitcoin prices in a time of rising total network hashing power, thus stabilizing their revenues.
Types of Hashrate Derivatives
Currently, there are three main types of hashrate derivatives: network hashrate futures, OTC hashrate derivatives, and fee swaps. (In most cases, OTC derivatives and fee swaps are combined into one.)
Network Hashrate Futures
A network hashrate future is an agreement between participants to buy or sell hashrates at a future date for an agreed-upon price.
The instrument is settled in cash, meaning instead of the hashrate exchanging hands (which would be pretty difficult), it’s executed using the Hashprice Index, which is the cash value of the hashrate.
OTC and Fees Swaps Hashrate Derivatives
Since the market for hashrate derivatives is in its infancy, prominent platforms have developed hashrate derivative instruments based on an Over-the-Counter (OTC) model.
These platforms facilitate an OTC hashrate derivatives contract and act as brokers between two counterparties. In many cases, the broker combines hashrate and fees to create a contract for hashrate derivatives and fees swaps.
The fee swap here provides the counterparties with exposure to exchange fees where one of them receives a fixed payment, and the other party receives payment on the basis of the network’s average transaction fee. Such an agreement for fees helps insulate against potentially high fees in the future and favors miners and mining pool operators who require fixed revenue to cover operating costs.
How Can Hashrate Derivatives Help Reduce Miner’s Risk
Hashrate is the measurement used to show a crypto miner’s computational power. Measured in hashes per second, it shows how fast a miner can execute the calculations required to solve the algorithms that make up blocks in a blockchain.
A miner with more computational power has more significant potential to become more successful in creating blocks and earn more rewards.
Mining difficulty adjusts based on hashrate in order to roughly contain the block time target, which should constantly be at 10 minutes. The network adjusts to maintain a steady block generation rate, requiring more miners and more difficulty, leading to the need for more computational power. The higher the computation power, the more effort you need to generate Bitcoin, which will also eventually affect BTC’s market price once the miners sell their holdings to cover operating costs.The result is that miners cannot predict or maintain a consistent revenue stream as the value of mining rewards fluctuates radically within short periods. The introduction of hashrate futures empowers miners with a tool that helps them navigate the existing uncertainties and leads to a more sustainable, predictable, and resilient mining ecosystem.
Here’s how hashrate derivatives help miners.
- Revenue predictability: The ability to lock in a specific hashrate can give miners a more predictable revenue stream. As a result, miners can make informed decisions and plan for their expenses and future investments.
- Enhanced liquidity: Derivative trading can improve liquidity in the mining market as miners have a new way to monetize their efforts. This could attract more miners, increase competition, and help reduce mining costs.
- Greater transparency: Hashrate derivatives can increase mining transparency by enabling miners to demonstrate the value of their efforts. This could attract new investors by increasing trust in the market.
- Better risk management: Hashrate trading provides a hedge against bitcoin price fluctuation and helps miners manage risk more effectively.
From Mining 1.0 to Mining 3.0: The Road to Hashrate Derivatives Trading as a Commodity
Following the launch of Bitcoin in 2009, bitcoin mining only required a simple PC with solo miners competing against each other until the end of 2010. However, individual mining soon became unreliable.
Between 2010 and 2018, miners began creating alliances (Mining 1.0) and combined their efforts to find more blocks faster and share rewards equitably, giving birth to crypto mining pools. With mining pools, individual miners pooled their resources to finance operational costs in return for smaller, more frequent rewards.
As the market matured, professional mining pools emerged between 2019 and 2023, offering pooling as a service (Mining 2.0). The professional pools introduced several advantages, including mobile apps and fast payouts, with participants choosing mainly based on payable fees.
As profit margins continued reducing, pool operators, beginning in mid-2023 and into 2024, sought new ways to introduce the concept of working with hashrates to generate more significant income.
In this emerging system, pool operators are increasingly becoming hashrate traders, where hashrates are the new commodity to make greater profits and derisk otherwise risky mining operations.
The prospect of trading hashrates as mining commodities introduces the possibility of trading hashrate futures, which would be a new financial product that would take crypto mining to a new level Mining 3.0).
Moreover, as far as hashrate futures go, a daily settlement means a regular cash flow for miners who can now easily finance their operational expenses like investing in new mining equipment, maintenance and electricity costs, etc.
The Hash Away
Hashrate derivatives bring more stability into the mining industry by enabling miners to manage their hashrate risk better and stabilize their cash flows. Moreover, they are creating a new market for speculators to bet on the success of Bitcoin mining.