The Third Bitcoin Halving Just Happened: What Now?

Amanda Fabiano, director of Bitcoin mining at the Fidelity Center for Applied Technology, and Christopher Bendiksen, head of research at CoinShares, discuss the third Bitcoin halving, which occurred hours before the publication of this episode. They discuss:

• the significance of the halving
• what effect it could have on price and what Amanda and Christopher think of Dan Morehead’s projection that it could reach $115,000 next year
• how macroeconomic events like the coronavirus and quantitative easing could impact uptake of Bitcoin
• how the halving could affect miners and hash rate
• how the halving could influence the environmental impact of Bitcoin
• why mining was the first activity Fidelity pursued with Bitcoin
• what they think needs to happen in Bitcoin to foster more adoption
• why hash rate derivatives will be a crucial step
• what the outlook is for institutional adoption of Bitcoin
• plus, is it halving or halvening?

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Crypto.com: https://crypto.com/

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Episode links: 

Amanda Fabiano: https://twitter.com/_amanda_fab

Fidelity Center for Applied Technology: https://www.fidelitylabs.com

Christopher Bendiksen: https://twitter.com/C_Bendiksen

Coinshares: https://coinshares.com

Coinshares’ 5 Popular Bitcoin Halving Theories: https://coinshares.com/research/5-popular-btc-halving-theories

Coinshares’ December 2019 Bitcoin Mining Report: https://coinshares.com/assets/resources/Research/bitcoin-mining-network-december-2019.pdf

Unconfirmed episode with Dan Morehead: https://unchainedpodcast.com/a-bitcoin-price-of-115000-next-year/

Bitcoin stock-to-flow ratio: https://medium.com/@100trillionUSD/modeling-bitcoins-value-with-scarcity-91fa0fc03e25

Fidelity opens trading to institutional customers: https://www.bloomberg.com/news/articles/2019-05-06/fidelity-said-to-offer-cryptocurrency-trading-within-a-few-weeks

Fidelity Digital Assets signs first exchange: https://www.coindesk.com/fidelity-digital-assets-to-sign-up-its-first-crypto-exchange-by-end-of-the-year

Transcript:

Laura Shin:

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Laura Shin:

Today’s topic is the bitcoin halving. Here to discuss are Amanda Fabiano, Director of Bitcoin Mining at the Fidelity Center for Applied Technology, and Christopher Bendiksen, Head of Research at CoinShares. Welcome, Amanda and Christopher. 

Amanda Fabiano: 

Hey, Laura. Thank you for having me on the pod. I’m really excited to be here with Chris who is you know, one of the first researchers to publish reports on the state of the mining ecosystem, so we’re really happy to see some research back up some of what we’d been thinking internally about the Bitcoin mining network from him. 

Christopher Bendiksen: 

Yeah. Thank you for having me. It’s an honor and a pleasure. 

Laura Shin: 

So this is a momentous occasion in bitcoin’s 11-and-a-half year life so far. The third halving, it’s an event in which the rate at which new bitcoins being minted is cut in half. When the bitcoin network started up in January 2009 it was minting 50 new bitcoins per block, then in November 2012 that was dropped to 25 bitcoins, and July 2016 it dropped to 12.5 bitcoins, and when this podcast comes out, just a few hours before that will have dropped to 6.25 new bitcoins every 10 minutes. So all of this halvening and the new bitcoins being minted, this will happen in perpetuity every 210 thousand blocks until asymptotically bitcoin approaches a supply of 21 million bitcoins. 

So Amanda and Christopher, to you, what would you say is the significance of this third halving, why should people care about it? 

Amanda Fabiano: 

Chris, I can start. So I think the important thing to note about bitcoin halvening is it doesn’t change regardless of economic circumstances, right? So we don’t print more bitcoin. We all know the rules and the halving is expected and it’s fair and it’s what makes bitcoin scarcity real. When we think about the past two data points on halvening, there’s only two data points, right? We don’t have a ton of information on you know, what could potentially happen after the halvening. And you know, as the saying goes, past performance is not an indication of future results, right? And I think that really applies here, too. So I’m curious to see what will happen at the halvening and Chris, we can probably dive into this a little bit more but I don’t want to go too far without your input. 

Christopher Bendiksen: 

Yeah. No, I also think this is quite a momentous occasion and the timing couldn’t be more awesome, in my opinion. You have this event that happens every four years programmatically, automatically. It’s done without emotion by a bunch of computers that aren’t influenced by world events or charismatic politicians or anything like that, it just happens according to plan, and it just shows the credibility of the bitcoin monetary policy, especially in contrast to everything else that’s going on right now. 

Amanda Fabriano:

And so like for miners it’s relatively simple to what happens. The revenue gets cut in half, right? And what that means is that the price has to stay above the level it cost that miner to mine a bitcoin in order for them to stay profitable. So because many miners  will be operating older machines, we could potentially see a drop after the halvening around 20 to 40 percent. 

Laura Shin:

Yeah. Well, that’s what I was wondering. In the first couple months coming out of the halving, what metrics will you guys be watching? 

Christopher Bendiksen:

I’ll be watching the hash rate first and foremost. It’s really the only way to gauge what’s going on and it’s not even in realtime, it’s pseudo realtime. So I’ll be watching the hash rate pretty closely and seeing you know, the magnitude with which it drops. If it does it is price dependent of course, and from the past now we can’t know exactly what the price is today so…

Laura Shin:

And when you say you know, the hash rate is really important, like why is that? That basically signifies kind of the security of the network, the amount of resources being put in by the different miners and the computers to keep the network running, so why is that so important to watch what happens to that metric?

Amanda Fabiano:

So one really interesting thing to consider is the different levers that you can pull when you’re thinking about the hash rate and how it could affect hash rate, so there’s like three different areas that I look into, so like Chris said if the price continues to rise when the halvening happens, miners could remain on because again, the whole basis of bitcoin mining is the price just has to stay above a miner’s level that it cost them to mine a bitcoin so that they can stay profitable. 

But there’s two other things that I think are pretty interesting to think about. So co-location and power contracts, right? So if the halvening is in the middle of the month, which it is, I just wonder if we’ll see an instant drop in hash rate, and we could argue that you could, but we could argue that maybe that won’t happen, and I think it all relates to how miners are billed, right? So I’ve seen a lot of different contracts for miners and is it you know, monthly? Do they have long-term contracts? Is it annually? Are they even able to shut off? So I think that’s like a really interesting fact to think about when people turn off their machines. 

Another data point…oh, Chris, did you want to jump in?

Christopher Bendiksen:

No, I was just going to contrast it a tiny bit to what we just saw about a month and a half ago at March 12 which was an unknown event beforehand which changed the dynamic a little bit. 

Laura Shin:

Are you talking about Black Thursday?

Christopher Bendiksen:

Yeah. So you know, there we had an effective halvening and not in every single possible way but in a lot of ways in that minor revenue was pretty much cut in half overnight, but that event was unknown whereas this one is well known and can be planned for well in advance. So all things other than that being equal, it should be less likely that we see disruption on that level, at least so rapidly.

Amanda Fabiano:

Yeah, and Chris, that whole point is really interesting, too, so it was a 16 percent drop, right? In hash rate which coincided with the price of bitcoin also dropping and then two weeks later we saw the hash rate bounce right back up, and the interesting thing that I think here is the delay of shipment due to coronavirus of new machines. So one hypothesis could be that miners were waiting to refresh their machines before the halvening happened because that’s something that they can predict, and so maybe they were just waiting for their new machines to come, and because of the delays of COVID machines weren’t really being shipped before March, but like between March and April, middle of March and April they’ve been regaining shipment. 

So you know, the dip on Black Thursday could have been you know, miners weren’t profitable with the old gen machines so then you know, when they got their new gen machines a couple weeks later we saw hash rate bounce back up.

Christopher Bendiksen:

I also heard anecdotally from a couple of lending sources that the March 12 drop kind of accelerated the reinvestment cycle and that a bunch of miners kind of had a fire lit under them a little bit and sped off with that process that they possibly would have waited some more weeks with in the absence of the March 12 drop.

Laura Shin:

So it sounds like what you guys are saying is just there are so many different factors here that could affect what happens to the bitcoin price in the wake of the halvening and some of it is that because of the way miners can be billed that there might be delays in terms of the impact that we see you know, depending on the kinds of contracts that they have they may not be able to really change much about what they’re doing, and yet on the other hand because of issues with like the supply chain or whatever it might be with the coronavirus or you know, on the other hand the massive drop in price we saw on March 12, even if obviously it did recover somewhat, that that’s now kind of hastening people getting new equipment which would help more of them to be profitable even after the halving.

So it sounds like there’s kind of like a lot of different mixed signals going on and we’ll sort of have to see how they all play out and impact each other after the halving. Is that a fair summary?

Christopher Bendiksen:

Yeah. This is a very complex industry and it’s also quite opaque so the estimates that we can give are very often based on assumptions that we can’t fully prove. We can make reasonable assumptions and we can look at things like the hash rate and we can observe the way it behaved after March 12 to get an idea of you know, who was swimming naked at the bottom prices that we saw, but at the end of the day the halving is not coming as a surprise but the March 12 event did, so it might not be a fully fair comparison, either. 

Amanda Fabiano:

Yeah, and I would just add that that goes back to like a big key theme just overall that I’ve been seeing in mining that before from you know, 2009 to 2019 a miner was able to have this competitive edge by refreshing their hardware to the latest machine and now it’s really your electrical cost being the lowest is what will keep you above. So you know, the closer you get to the production of energy the lower your operational costs will be and so you’ll continue to be more profitable even during some of those bear markets like we saw, or that one day of a bear market that we saw in March, or just future bear markets in general. 

Laura Shin:

Yeah. So all of this is I think, it’s going to keep all of us even more on the edge of our seats to watch what happens, but I also was curious, so kind of what we’ve been discussing is maybe the more immediate impact on bitcoin, but what do you think will be the longer-term impact that the halving has on the price maybe say like a year or so out? 

Christopher Bendiksen:

Again, this is speculation but our chairman, Danny Masters, had a really interesting take on this. He compared it to the mechanics that he observed around 2016 which was that we have a market that is fairly in balance right now. You know, the price has been ranging, not going other than the rapid drop and recovery that we had recently which you could claim was an exogenous event, but if you disregard that we’ve had a market that’s fairly well balance which you know, all things else considered should mean that inflows are matching new production more or less. 

So if inflows continue at the levels that they are right now where the market is pretty much in balance but supply is cut in half, normal supply demand should indicate that there would be an upwards pressure on the price which is what we saw in 2016 you know, it laid the foundations for a long-term bull market. And on top of that we have some pretty interesting macroeconomic tail winds happening right now so it’s hard to give specific predictions but personally I think this will be positive. I’m not expecting some incredibly rapid jump in prices or anything, I think this is a mechanic that takes a while to sort of manifest and I think it’s like a long-term chugging more than a rapid jump so to speak.

Laura Shin:

And when you talk about the long-term macroeconomic factors are you just talking about things like quantitative easing that increases the money supply or are you also talking about you know, I don’t know, like some people are saying now that bitcoin is being perceived as digital gold which makes it seem less like a risky investment than people used to perceive it in the past. 

Christopher Bendiksen:

Well, it’s both and you know, we’ve observed more interest from people who are now getting increasingly worried about the fiat financial system, they’re getting worried about inflation. Every day that bitcoin keeps existing and doesn’t disappear magically is another day added to the certainty that people feel that bitcoin will remain here you know, a year from now, two years from now, so I think it’s actually a combination of both.

Laura Shin:

Yeah.

Amanda Fabiano:

And I would just say if we think about just…if we zoom out from the price of bitcoin and the future price of that, there’s a lot of people building on top of the bitcoin and investing in companies and bitcoin so we could argue that it’s not going anywhere anytime soon.

Laura Shin:

Dan Morehead of Pantera Capital was recently on Unconfirmed and he mentioned that Pantera projects that bitcoin could reach 115 thousand dollars next year due to the projections of something called the stock-to-flow model. What do you think of that projection, and Christopher, I think you’re also familiar with this model if you want to just explain a little bit about what that is.

Christopher Bendiksen:

Yeah. I’m not a statistician so I want to tread carefully here, but I am familiar with the model. It’s a supply-based model and it looks at their relationship between the bitcoin price and essentially the supply bands. And the model is predictive in that you can, at least the first version you can extrapolate. I saw that plan B has made a second version which is the S2FX model where you actually interpolate. 

I mean, on a personal level I really love this model because you know, it tickles my inner desires. I am skeptical to supply by itself being the singular driving factor behind price. I know that there were some initial outside peer review of the model that seemingly confirmed co-integration. I’ve seen that since that one of the authors of those confirmations have not had like second thoughts but had new realizations that the results might not hold. I really think that the supply constrictions are drivers of positive impact in the price market but I don’t think you could say that that by itself is fully predictive.

So I’m intrigued about this model and I like it on a personal level but I’m still a little bit skeptical because it leaves a lot of questions unanswered for me.

Laura Shin:

But I mean, according to that model…it’s kind of funny because with that model I did see two versions of price projections. One was the 115 thousand, another one was like more than 500k, like 420, 21 you know, so I mean, I think you’re right that it’s not you know, some kind of set in stone thing and that there is sort of a band in terms of the projections. But what do you think of that number?

Christopher Bendiksen:

Well, this is really hard to say. The model has the price go to infinity over time and at a certain point you know, the bitcoin issuance ratio is going to go negative as we reach zero issuance and non-zero permanent loss of coins, and so I mean, it’s hard to say how far ahead you can really look to these results as being predictive. We know that it’s going to break at some point, it has to.

Laura Shin:

Right, but for next year what would you say?

Christopher Bendiksen:

I really hope it’s right. 

Laura Shin:

Amanda, do you have anything to say about that projection, 115 thousand?

Amanda Fabiano:

No. I feel like I care more about like long-term bitcoin, so like the price in you know, a year from now doesn’t really excite me to think about. Yeah, there’s a lot of different ways that we can think about the direction that bitcoin price can go but I mean, I’m just here with my popcorn, waiting. 

Laura Shin:

Yeah. Yeah, me, too. So one other thing is I mean, we started to talk about this a little bit but you know, in terms of the mining industry you know, what we discussed was maybe more short-term impacts but I was wondering also where you thought especially now with the coronavirus, we will see the mining industry maybe like a year from now?

Amanda Fabiano:

So you know, I’m just going to shift your question a little bit to kind of what concerns me about mining now which I think is essentially what I focus on, so you know, we could look at the happy side of people building a lot more decentralized locations for mining, both in the US and you know, other locations around the world, but you know, there’s kind of like two things right now that I don’t lose sleep over but they worry me.

So one of them being the centralization of hardware, right? So like we talked about a little bit, COVID affected mining production of hardware and shipment, right? But when we think about bitcoin mining overall, the supply chain only has a handful of major mining manufacturers and all of them operating out of China so if something was to happen to that region that produces the machines, miners in the West might not have access, right? And if some other large events like a pandemic or something else shuts down this access, miners outside of China would never be able to compete without access to like the new gen machines. 

So you know, that’s a huge centralization risk for mining so one of the things I’d love to see happen over the next few years is more distribution of production of machines despite you know, the harsh reality that mining centralization will be a really hard thing to overcome.

Laura Shin:

Is there anything that you can do at Fidelity to incentivize that kind of production somewhere else? 

Amanda Fabiano:

So you know, we started out small with what we were doing. You know, I can give a little bit of background of what we’ve done. So you know, we’ve been mining bitcoin since 2013 and that started in one of our offices as a very small experiment. You know, the cost of electricity was certainly not a factor in this portion of our journey and you know, we just aimed to understand how this whole thing worked, like how this whole protocol worked.

And you know, we set it up there, let it run for a couple years, and we refreshed the machines in 2015. And then time passed and we began to see a decent amount of failure rate on the machines themselves, right? So we also realized that the mining industry evolved quite a bit and so we ordered machines from all the major manufacturers, looked into better operational setup both within the walls of Fidelity and also at like external hosting facilities.

And so you know, I think that we kind of follow this scan, try, scale methodology where we like scan the ecosystem which is what we’ve done, we try things out which is what we’ve been doing, and then hopefully we can scale. You know, I don’t know what the future will be for mining at Fidelity you know, in 10, 15 years but I hope that we’re able to help just generally secure bitcoins network and you know, secure this like future world where bitcoin could be the open network and open permission less network that financial services sits on top of. 

Laura Shin:

So one other thing before we…because I actually do want to ask you more about Fidelity’s role in all this but a bit later…

Amanda Fabiano:

Sure.

Laura Shin:

…but I wanted to ask a little bit more about like the hash rate and mining and stuff. There was something that I guess miners, or large-scale miners have which is called offtake agreements with utilities and I feel like maybe you did mention this but could you just describe a little bit more in depth what those are and how those could influence the behavior of miners after the halving?

Christopher Bendiksen:

It’s basically an agreement where…this is coming in a lot of power-demanding industry that you agree with the utility that you’re going to take off a certain amount of electricity from them per month no matter what. So what that means is that even if you as a miner sit on a bunch of unprofitable equipment, your contract with your utility doesn’t allow you to not take that power off them so you’re kind of forced to mine at a loss.

So I think situations like that are probably more relevant in episodes where the profitability is unexpected, like March 12, whereas going into the halving I think there’s at least a higher chance that miners would try to protect themselves by you know, doing specific contracts around that time or trying to come to an agreement since it is well known beforehand that this would happen. But at the same time you also do think that miners plan for the profitability loss.

So again this is a mechanic that’s very hard for us to sit and watch from the outside. Individual miners are the ones that know which agreements they have with their local utility, but yes, it is the case that sometimes miners don’t have a choice. They have to keep mining, they have to take that electricity off the hands of the utility. 

Amanda Fabiano: 

And that also works in the opposite direction, too, right? So sometimes if there’s a load, like too much of the load they will turn off specific areas or specific like access to power, and so we’ve seen that happen before in certain locations where like say you know, energy becomes increasingly a demand, then you know, in every power contract it will say like we might have the ability to turn off up to X amount of days, so it goes both ways with power contracts.

Laura Shin:

And one other thing I wanted to ask about is you know, Christopher, you I think have done quite a bit of calculation on various things and I know you published this pretty extensive report in December where you looked at you know, kind of all the different types of miners and you said, “The current market average, all in marginal cost of creation at 4 cents per kilowatt hour, 15 percent non electricity OPEX, and 30 months depreciation schedules is approximately 6 thousand 300 dollars,” and I wondered, is that still your basic estimate and so like around the time of recording bitcoin is like roughly 9 thousand, is it fair to assume that some percentage of bitcoin miners will drop out and if so do you have a sense of like what percentage that might be?

Christopher Bendiksen:

So that estimate is a little higher right now, so right now that estimate is around 7 and a half, but it’s not the all in ROI estimate that’s actually important for when miners shut off their machines, it’s the cash cost estimate and so the cash flow estimate right now for 4 cents with 15 percent additional OPEX is around 5 thousand, but there’s a very important thing to remember here is that these figures are market average but there’s a big split in the market between the previous and the new generation hardware. 

So the best thing would probably be to estimate these bands separately because the new generation hardware probably had a much lower…no, they definitely have a much lower cash cost than that, and the older generation hardware might have a higher one, and individual miners could have both generations of hardware in their operation as well. 

So I think it’s likely that at the price that it is at the time of recording we see some drop off of gear that is just made obsolete but this gear could come back again later if either the price increases or if they get sold off to miners that have access to cheaper electricity. But around you know, the 95 hundred band…I made an estimate for this the other day, let me see if I can find it for you. 

Laura Shin:

So 95 hundred is a newer miner?

Christopher Bendiksen:

No, 95 hundred being the bitcoin price. 

Laura Shin:

Oh, the price. Oh, oh, oh.

Christopher Bendiksen:

Yeah. So let me see here, I made an internal estimate for this and I have to caveat that these are a little rough, but I think in between 9 and 10 thousand bitcoin price my estimate would be that we could see a hash rate drop of around 10 to 20 percent. 

Laura Shin:

Oh, okay. 

Amanda Fabiano:

A really interesting research report that came out, I think it was a couple weeks ago, is Coin Metrics. They researched into the distribution and so they’re estimating that about 23 percent of hash rate online is coming from old gen S9 hardware, so if we think about you know, if old gen equipment becomes unprofitable to run unless the price of bitcoin is where it is today or you have really low electricity, it seems like that band of 20 to 40 percent of hash rate drop, or even 10 percent like Chris is quoting with the price where it is, doesn’t seem that far off.

Laura Shin: 

Yeah, so actually that isn’t a huge drop. I mean, hash rate is kind of…so I didn’t research this right for this show but I seemed to have looked at this somewhere recently, I think it’s like near all-time highs. Can either of you correct me on that? 

Christopher Bendiksen:

It is definitely near all-time highs. 

Laura Shin:

Okay, so it doesn’t sound like the security of the network would suddenly drop a significant amount from where it was you know, like a year ago or whatever.

Christopher Bendiksen:

Right, and the other thing to keep in mind there is that you know, how much security is enough? We don’t really know, so you know, at 10 percent drop it’s significant yes, but you know, we don’t know if 80 percent lower than this was “enough” or you know, if we need more it really comes down to individual transaction sizes and how many confirmations transactors want to accept before being comfortable with having fully received a batch of money. 

Laura Shin:

Okay. Well, speaking of whether or not the hash rate is “enough,” or too much maybe is the more important direction to go, as I’m sure you both know there’s been a lot of concern about the environmental impact of bitcoin and I was curious to know how you expected the halving to affect that, the environmental impact?

Christopher Bendiksen:

I don’t know that it will have much, I mean, of course a 15 percent reduction in hash rate is a 15 percent reduction in you know, I guess the current environmental impact of whatever that is, but you know, it’s mainly price that is the driver of that. If the price doubled then the hash rate would go up you know, past where it was before. 

Amanda Fabiano: 

The energy consumption question, right, is something that we often hear and so you know, when you think about is bitcoin ruining the world with its energy consumption, we think it’s not? Clearly Fidelity wouldn’t be doing this whole thing with mining if they believed that it was ruining the world. So the energy consumption question is interesting but I think you have to zoom out a little bit. So when we think about the mining network energy spend, right? The first reaction I’ve had was to try to compare it to something, some other type of energy spend that already exists today. 

But the reality is it’s really difficult to find a comparison because there’s no benchmark. So bitcoin gets in trouble for the transparency, right? Because you can check the network at any time to see the bitcoin energy spend but it’s really difficult to determine for example how much energy is expended for any type of other transaction including financial transactions and just you know, how much energy is expended to secure the entire financial industry as a whole, right? 

So bitcoin is truthful to a fault and people see this energy spend and think it’s really, really bad, but the thing to remember is this energy spend is being used to secure the entire bitcoin network.

Laura Shin:

Yeah, I agree with you. It’s one of those things where bitcoin can be criticized because the environment…or maybe not environmental impact but the energy expense is known whereas with other financial systems. I mean, does Visa let us know what the energy costs are for you know, running the Visa network? Christopher, did you want to add something?

Christopher Bendiksen:

Well, and you know, that comparison isn’t quite fair, either, because you know, Visa is a payments network and bitcoin is a monetary system and so you know, if you want to compare Visa to anything you’d have to compare it to something like lightening because you know, you can bake an incredible amount of economic weight into a single bitcoin transaction so I mean, we’ve been using the bitcoin payments network as if it was like a straight-up payments network but in my opinion it’s more akin to a settlement network and it gets more efficient with increasing settlement value. 

So you know, you can transfer as much money as you want in a single bitcoin transaction and it doesn’t have any impact on how much energy the network uses.

Laura Shin:

All right, so we’re going to talk a little bit more about where bitcoin goes from here, but first a quick word from the sponsors who make this show possible. 

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Laura Shin:

Back to my conversation with Amanda Fabiano and Christopher Bendiksen. So Amanda, you started to go into this a little bit where you talked about how Fidelity began mining bitcoin in 2014, but I was curious, why was that one of the first things that Fidelity tried to do with cryptocurrency, mining? That’s like a pretty unusual step for a financial institution.

Amanda Fabiano:

Yeah, so that’s a really great question and it is a interesting project that we worked on pretty early on. So you know, Fidelity right now cares about bitcoin mining for a few reasons and it’s important to stress that our operation has always been research first, but learning about how this underlying bitcoin mining network works we think is essential when you’re trying to do things like building businesses on top of it, right? Or investing in bitcoin companies, and so mining is critical to this ecosystem so you know, it’s critical that we understand mining. And being plugged in is important and we don’t just mean like physically plugging in the machines, but more you know, understanding this opaque space that secures the network, so that’s what we aim to do with that experiment. 

We have a group in FCAT called the blockchain incubator and we do a lot of different experiments with bitcoin and this was one of many. 

Laura Shin:

And so what does Fidelity do with the bitcoin it mines?

Amanda Fabiano:

So we don’t disclose any of that information, I’m sorry. It’s you know, a proprietary information so we can’t talk about that, sadly. But you know, it does allow us to…I think the thing that matters most is it allows us to understand how this all works versus like the profit that we make off of it.

Laura Shin:

Being very secretive, it’s like maybe you guys are hanging out with Satoshi Nakamoto.

Amanda Fabiano:

One could dream, right?

Laura Shin:

And I also wanted to ask, and this is going to take us down a slight tangent but I was also curious, Fidelity has also mined ether. When did you guys start doing that and do you still do that and if so what would you say is different about mining ether versus bitcoin?

Amanda Fabiano:

Yeah, so we explore all different types of projects and products, right? And when we were mining bitcoin we said hey, we have some servers that could also mine ether so we explored that for a little bit. We have about 45 different POCs that we’ve put on a shelf and said like maybe this is something that we’ll explore later but it just doesn’t make sense for us right now, so we could move back into the ether you know, mining, but right now what I focus on is mining bitcoin for Fidelity.

Laura Shin:

And was that just because of the kind of specific characteristics of bitcoin due to its monetary policy or did it have something to do with the actual mining of the cryptocurrency itself?

Amanda Fabiano:

You know, I think it’s a little broader than that. For every project that we bring in the door, which is a lot, we have a lot of ideas, we kind of almost have to get rid of one project, right? So because something doesn’t make sense for us to work on right now doesn’t mean that you know, it doesn’t make sense for everyone or it doesn’t make sense for us to re-pick that up in the future. So basically we just had to shift what we wanted to do and you know, we just thought it was something that we didn’t pursue at the time but it could potentially come back, you never know. 

Laura Shin:

And can you also fill out what the other initiatives are that Fidelity is working on? Obviously I know you guys have Fidelity Digital Assets which does custody, you also have trading for institutional investors. Can you just sort of fill out everything going on under that…

Amanda Fabiano:

Yeah, sure. So you know, we’re a large company. There’s often some confusion on the different names and initiatives within the Fidelity walls. So there’s like three main areas, so there’s Fidelity Center for Applied Technology, the group that I work on, there’s Fidelity Digital Assets, and then Avon Ventures. So we covered you know, what FCAT does, but Fidelity Digital Assets, we also covered that a little bit. You know, the interesting story here is the research group in FCAT you know, we build and test these different ideas and when we started mining, I mention this, too, we had this like how do we custody this asset question, right? 

And so that led to us exploring how you know, how custody works, and that service blossomed into what is known now as Fidelity Digital Assets, and Fidelity Digital Assets is our commercialized business unit, building projects for institutions who want exposure to bitcoin.

And then I also mention Avon Ventures and so we have an affiliated venture fund and that focuses on the crypto landscape and investing in early stage crypto companies. 

Laura Shin:

All right, and now let’s turn to Christopher. Can you give us a background on what CoinShares does and why it regularly publishes these extensive bitcoin mining reports?

Christopher Bendiksen:

Sure. So CoinShares is a digital asset manager and our business is to offer customers a wide range of investment products that are all related digital asset  industry, so we have a suite of eight passive exchange traded trackers for bitcoin, ether, XOP, and litecoin that trade on Nasdaq in Stockholm and Nordic Growth Market and Boerse Stuttgart. We also have some passive products you know, one of them being Meltem’s  VC Fund, and we recently launched a physically-backed gold token.

So the reason we’re into bitcoin mining is as a part of our research effort. You know, we believe that education is a huge open gap that needs to be further filled in this space and we believe that if investors are fully informed they will come to the right decisions on their own without having to be influenced by you know, others. So this is just part of our comprehensive effort to track everything that concerns the bitcoin space and you know, the supply side of the equation there is extremely important, so that’s basically why we’re in there.

Laura Shin:

And so at this point in bitcoin’s history as we’ve been talking about we’re at this inflection point of the third halving, and I imagine you know, you could look at each period of bitcoin’s history in between the halvings and kind of put a narrative on how bitcoin developed during that period, and so I wondered you know, for this phase what do you two feel needs to happen in bitcoin to kind of further promote its adoption?

Christopher Bendiksen:

A few different things, and some things are already happening. For example, the rise of proper institutional level custody like Amanda and them are doing at Fidelity is a huge thing. I think one of the other things that needs to happen is the proliferation of financial product for miners. Miners are currently unable to fully hedge their production the way that normal commodities producers can which again sort of hinders the flow of capital into this whole space.

I mean, those are some of the things that I hope can happen. I think that if we do get proper hedging products for miners we can dampen the volatility of the market a little bit by getting some more certainty on part of miners as to what their incomes are going to be over time which will allow for professionalization of that sector. 

Amanda Fabiano:

And yeah, Chris, there’s a lot of momentum in that space right now, right? With several companies designing those financial products to help miners reduce their risk so you know, like Chris was saying with the network hash rate how it fluctuates like we’ve been talking about all day, miners have exposure to these swings of difficulty adjustments resulting in a lower than expected bitcoin return from you know, their mining operation. 

So things like hash rate derivatives with the difficulty swab can be used to hedge against this risk.

Christopher Bendiksen:

Yeah, you know, for potential listeners who are not quite familiar with why that’s important, I mean, say that you’re a normal commodities producer like an oil producer, you have a really good idea of how many barrels you’re going to pump out of the ground over a certain time and you know, as an oil producer you can hedge by selling that production forward using deliverable futures contracts. If you’re a bitcoin miner you don’t have that luxury right now because you don’t actually know how many coins you’re going to produce and that is because of the difficulty. 

You know how much hash rate you’re going to produce over a certain time but without having somebody to hedge your exposure to the difficulty you don’t actually know how many coins that hash rate is going to produce and that’s a problem.

Amanda Fabiano: 

Yeah, there’s a lot of things that you don’t know in bitcoin mining and two of the biggest ones being the price of bitcoin and the rate of hash rate, so it’s fun. These future products like hash rate derivatives would be super helpful for miners to hedge out that risk.

Laura Shin:

So how does that work? Like if I’m a miner, just walk me through the steps of how it is that a hash rate derivative helps me you know, hedge my risk when it comes to mining.

Amanda Fabiano:

Yeah, so a miner would be like long difficulty in the contract so the miner receives a payout in bitcoin if the difficulty increases more than expected so it would make up for the lower than expected bitcoin revenue from the mining operation.

Laura Shin:

Oh, I see. 

Christopher Bendiksen:

And every mining operation sets up with a certain set of assumptions for where the price and difficulty will be in the future. But having access to these types of derivatives would allow them to protect themselves if you know, the difficulty increases by more than what they thought it would.

Laura Shin:

And what is the cost of purchasing something like that? Is it nominal?

Amanda Fabiano:

Right now…it has a long way to go. This is like I think very beginning stages of you know, this type of product being delivered. So our team has been exploring some of these contracts and just their structures overall and we’ve even conducted some paper trades which has been an interesting learning experience for us, but ultimately I think there’s just a long way to go to figure out exactly how these would work.

Christopher Bendiksen:

Yeah, pricing is a big open question there and so most of the current products that are out there have been OTC and bilateral for the most part and they rarely extend past one single difficulty period, and for these products to be fully functional in terms of what the miners need they would have to have a much longer range than that. So pricing is a big, big open question here and I don’t think anyone has the answer yet.

Amanda Fabiano: 

Another really interesting product that is coming out that we see is fund-like structures, so this is allowing exposure to bitcoin mining without some of the operational headaches. So if you can mine a bitcoin for a lower cost than you could buy it on the open market, and you could take on this like long bitcoin mentality, funds are an alternative way to diversify your exposure to bitcoin because with the right operational setup you can mine a bitcoin at a discount rate. 

Laura Shin:

Boy. So how does that work?

Amanda Fabiano:

So it’s similar to like traditional funds, so say if an investor invests money into you know, this type of operation they give money to the operation and then they would just get out bitcoin or US dollar in the end, depending on how it’s set up. So you know, we’ve seen some companies exploring this type of structure which should be really interesting. 

Some of our research has also backed up that there is institutional demand for this for just generally, not funds but just generally structuring products around bitcoin mining, so in 2019 and again in 2020 we held a survey for institutional customers and we asked them if they would be interested in a product focusing on crypto mining. In both years we saw about a 20 percent group of people that said yes they would be, so you know, this gives us hope that there’s a demand for an institutional-grade mining product, however I think there’s still quite a bit of work that needs to be done on the mining side if we want an inflow of institutional investors.

Christopher Bendiksen:

I for one cannot wait to have Western capital markets unleashed on the mining space. That is going to be awesome.

Laura Shin:

And when you say that like what would that look like to you? What would be exciting to you?

Christopher Bendiksen:

I mean, just having the ability to create products that look and feel like current investment products that proliferate in the Western capital market space. I just think that would lower the cost of capital for Western miners which you know, could hopefully at least act as a bit of a balance against the advantages that Chinese miners currently have by proximity and lower setup costs and so forth, and I just think that would be you know, one way to level out the playing field, at least a little bit.

Now what it would exactly look like is hard to say but if we do get these types of difficulty and hash rate derivatives in place, you could start to imagine structures like Amanda talking about, like funds or even fixed income products. 

Laura Shin:

Wait, and just so I’m clear, like essentially what you’re saying is kind of the more robust hash rate derivatives that we have, that could even foster more mining outside of China. Is that where you were going with that?

Christopher Bendiksen:

Well, at least I think if you have these types of products in place you can start building financial products that you could sell in Western capital markets which tend to be you know, more efficient and are much larger, and I think that could help…and I also don’t think that the investors that would be buying these products would want to have the operations outside of their either home jurisdictions or similar jurisdictions to their own where they can feel confident in you know, rule of law and…

Amanda Fabiano:

Yeah, and I would just add here that like with mining is this really weird, opaque industry, right? Even some of the experiences that we’ve had has been really interesting from the institutional perspective so you know, one of the manufacturers that we ordered machines from, 50 percent of our hardware arrived broken and when we reached out to them we said hey, how do we fix this, and they told us use duct tape. So I think that there’s like quite a bit of work that needs to be done on the mining side that you know, from an institutional investor perspective if we can figure out all those operational complexities for them and you know, offer them a product where they can you know, have access to bitcoin at a lower rate that they can buy it on the market and they don’t have to deal with some of those like weird complexities of you know, how you structure all of this in a warehouse, you know, then it becomes more real and when there’s products that are structured in ways that they already know I think that it will be more appealing to them.

Christopher Bendiksen:

It could.

Laura Shin:

Okay, so this is a little bit different from the you know, kind of like have your own keys ethos, like this is seeing build up infrastructure essentially in such a way where that’s abstracted away for people and they don’t have to deal with that kind of thing.

Amanda Fabiano:

Yeah. It could happen, right? 

Christopher Bendiksen:

It’s also about choice. I mean, not everyone wants to custody their own gold or custody their own bitcoin. You know, bitcoin gives you the optionality to be self sovereign but you don’t have to. You know, sometimes it can be more efficient for you to not be, it depends on how you want to interact with it. So what makes bitcoin fantastic as a monetary system is that it at least gives everyone the optionality to be self sovereign and interact with it the way that you want. I’m just pointing out that it would be fantastic if we on top of that additionally got the types of financial products that we have that are already quite excellent in their ways.

Laura Shin:

Yeah. Yeah. More choice obviously is better. So at some point one of you mentioned something about yeah, I think it was Christopher, you said something about the Western financial markets being unleashed on bitcoin, but one other thing that we had heard about in recent years was that there was going to be this wall of institutional money that was going to enter bitcoin and I think people were saying that like you know, three years ago, and it hasn’t exactly materialized. So I kind of wondered, especially Amanda since you are more on the institutional side, how you would say institutions have been thinking about bitcoin over this period and whether you think that that has changed over the last few years. 

Amanda Fabiano:

Yes, I was recently listening to a podcast with our head of sales in marketing in FDAS, and Christine Sandler is the head of sales and marketing for FDAS and she said that she has had a ridiculous amount of inflow over the past like three to four months. So I think that you know, there is inflow coming in which is really interesting. I don’t work on the FDAS side so I can’t speak to you know, the inflow of that specifically but you know, I think the things like that survey that we had is really interesting that 20 percent of people are just interested in mining and FDAS will be publishing some more of those stats an data points coming out soon so I think you know, that’s something to look out for to see what our research is showing from institutions, like what they’re looking for.

Christopher Bendiksen:

I think it’s also important to note that institutions need products that have certain structures. They can’t necessarily go ahead and buy whatever they want, a lot of them have very tight mandates so I think it’s very important, too, that we get more financial products around bitcoin that are fit for purpose and that actually suit the demands of institutional investors, and that is something that we are working on actively at CoinShares, too. 

So sort of a broadening of the availability of financial products I think is going to help this as well so that institutions can go and buy products that look and feel exactly the same as the ones that they’re used to handling and that doesn’t require them to for example self custody or do anything like that. 

Laura Shin:

And Christopher, I’m sure CoinShares also deals with institutions. When you know, you deal with them what do you see in terms of their interest with bitcoin, like why are they interested in it or what do they plan to do with it?

Christopher Bendiksen:

I mean, it’s a lot of different reasons but worrying about the health of the current fiat monetary system is a common thread. Thinking about it as an inflation hedge. Over the past years bitcoin has been very uncorrelated to the remaining financial markets which is also an attractive trait. Now we’ve seen that fall off a little bit lately, but having uncorrelated assets is a rarity these days and it’s something that many of them are looking for. But again, it just really depends on the institution and it depends on their individual funds and what they want to achieve with their portfolio.

Laura Shin:

And do you guys see other institutions also taking an interest in mining bitcoin the way Fidelity is? 

Christopher Bendiksen:

I would say that that’s not something that I’ve seen a ton of. At the very least I think Fidelity are very much the pioneers there, so kudos to them for that. But I think other institutions should take note but you know, not everyone can be as awesome as Fidelity.

Amanda Fabiano: 

Thanks, Chris. We’ve seen some other institutions looking for mining. 

Laura Shin:

And they’re essentially just coming to you kind of for advice, asking you how you did it, or like is this something where they would you know, partner up with you in some way or hire you for their mining business?

Amanda Fabiano:

So we haven’t provided like advisory services to anyone. I think you know, through our exploration of just being super nerds about bitcoin mining we have come across some groups that have been doing it for a while, some being you know, these traditional what we would expect from a miner, and some more of an institutional grade. So you know, miners come in all shapes and sizes, right? And anyone can mine bitcoin which is the beauty of it, so you know, I think that we will see more influx of institutional activity within mining you know, over the next however long but you know, there are some people out there doing it, maybe just not as public as we are. 

Laura Shin:

And earlier when you talked about how Christine had said that there was an uptick in institutional interest in the last few months, did she say whether that was you know, due to the coronavirus and the economic fallout from that, or was that just kind of already happening?

Amanda Fabiano:

So on the podcast with Zack she didn’t say that but you know, one could imagine that that was the case, right? With the current climate as it is today it makes sense to think about different strategies for your portfolio.

Laura Shin:

And Christopher, is CoinShares noticing that that’s having an impact on interest in what you guys are doing?

Christopher Bendiksen:

I think interest in bitcoin is just accumulating in general. It’s always hard to pinpoint single things in particular that are raising interest. I think pretty much the totality of everything that’s happening in the world right now is increasing interest and what I mentioned earlier, too, you know, the way people interact with bitcoin I think has a lot to do with when they first heard about it and how long it’s been since then, and the fact that a lot of them when they first interacted with it thought that it would be gone within a few months because that’s everything they were ever told, and the longer they observe that no, that’s actually not happening, the more motivated they are to actually look at things deeper and deeper, and that’s what I think is happening right now, like a lot of these companies are dedicating more and more mental capacity towards trying to understand bitcoin and trying to get a better grip on how it works and the things that it can do. So yeah, it’s hard to pick out specific reasons.

Laura Shin:

But so obviously there is this like increased interest and we even have these kind of macro economic effects that probably are fueling that, but I wondered you know, when you sort of look at where the industry is broadly, what do you feel like are the current obstacles in getting more institutions on board, or they don’t even have to be obstacles but just like you know, what are the challenges that institutions have in trying to get into the space?

Christopher Bendiksen:

Product fit is a big one. They can’t necessarily go…and yeah, Amanda, if you want to follow up on this…

Amanda Fabiano:

I was just going to say I think you know, product that makes total sense and just like generally if we think back to like when we started thinking about bitcoin it’s kind of difficult to figure it all out, right? A lot of I think what Chris and I both do is focus on research and like sharing back that research with people to help them make decisions and just help be better suited for if they wanted to jump in. So I think that that’s really helpful.

Christopher Bendiksen:

Yeah, we see that a lot, too. We get a lot of questions about research and you know, questions of where people can find more. Another obstacle is still the volatility. The volatility makes people uncomfortable, there’s just no way around it. 

Laura Shin:

Well, nowadays maybe it seems tame compared to what’s happening in you know, for instance oil.

Christopher Bendiksen:

Absolutely. I mean, I don’t know about you guys but I found it hilarious that oil went to zero before bitcoin.

Laura Shin:

Well, so just kind of gathering together all the different thoughts or threads that we’ve been covering here, it sort of feels like in this sense this sort of next epoch of bitcoin is maybe greater institutionalization or financialization if you know, where we are is like there sort of needs to be more products and we do have this demand that’s knocking at the door, but there aren’t really you know, products suitable for those institutions. Would you say that that’s kind of like a fair assessment of what might happen between now and the next bitcoin halving? 

Christopher Bendiksen:

I certainly think so. I think that we’re going to get better financial products around bitcoin between now and the next halving, and in terms of volatility I mean you know, this is a bit of a self fulfilling prophecy, right? Like the smaller the market the more volatility you have when you have large movements. A lot of the large institutions are not going to get out of bed in the morning unless we’re talking about you know, dozens of millions of dollars in clip size. 

So in order for them to be able to even get their toes wet they need certain liquidity sizes in these products so you know, we have to build it kind of step by step and you know, I don’t expect like a sudden flow you know, like a tsunami hitting this market, I think it’s going to take time, but I do think that this will happen over this time.

Laura Shin: 

Four years in bitcoin is like a lifetime, right? 

Christopher Bendiksen:

Bitcoin years are like dog years. 

Amanda Fabiano: 

Seriously. I think that it’s reasonable that one scenario could be that by you know, in four years from now the three of us have a conversation again that we’ll see more institutional investors. That’s definitely one possible scenario. 

Laura Shin:

All right. Well, it’s funny what you said about how four years in bitcoin it’s like 20 years because actually when I was researching this show I got to thinking, and I was like oh, I think actually right around the bitcoin halving is when it’s my five-year anniversary of covering bitcoin regularly and you know, you can’t put it on like an exact date but when I looked at my calendar it’s roughly around yeah, the middle of May and so for me it is a significant anniversary and you’re right, it does feel like ages ago.

Christopher Bendiksen:

Congratulations. 

Amanda Fabiano:

Congratulations.

Christopher Bendiksen:

You’ve been 40 years in this industry. 

Amanda Fabiano:

I actually had one question for you guys. Is it the halving or the halvening?

Laura Shin:

I think it’s the halving but what happened is that back in 2017 when everybody was talking about the flippening, I think people at that point thought it would be funny to call the halving the halvening so I think that’s why this time around…some people are also calling it the halvening because it’s like that combo of flippening and halving. But…

Amanda Fabiano:

I really like the halvening and I was having a conversation with someone in January who has been in bitcoin for a while and I kept using halvening and he said you know, I feel like as bitcoiners we make up these terms, so I kind of also like the halvening. 

Christopher Bendiksen:

That’s true.

Laura Shin:

So that’s what I’ve been going with. 

Christopher Bendiksen:

This is our universe, we make up the words.

Amanda Fabiano:

That’s right.

Laura Shin:

Seriously, we make up anything we want to make up. So that’s what’s so fun about working this space, like we can just be creative and we all have really different backgrounds. It’s not like anybody’s an expert in this stuff because we’re all new in it, so…

Christopher Bendiksen:

Agreed and I often say that you know, to a large extent like everyone in this space you know, we don’t drop this technology that no one that’s currently in this space made and you know, we’re making it up as we go, like we’re figuring this out and we have large senses of curiosity and there’s like a fearlessness about it, too. Everyone’s just diving in the deep end like head first and you know, see what comes out of it. It’s amazingly motivating and interesting.

Laura Shin: 

Yeah, and for me it’s fun to watch. I tell my friends that for the last few years I’ve had a front row seat to the most suspenseful movie that you could ever imagine and that it’s going to last decades and yeah, I feel so lucky to be sitting here and being a journalist covering it. 

Christopher Bendiksen:

Absolutely. The single funnest industry on the planet.

Laura Shin:

All right. Well, thank you both so much for coming on the show, it’s been great having you on Unchained.

Amanda Fabiano:

Thanks for having us, Laura.

Christopher Bendiksen:

Yeah, thank you so much.

Laura Shin:

Thanks for tuning in. To learn more about Amanda, Christopher, and the bitcoin halving, be sure to check out the links in the show notes of your podcast player. Whatever your favorite crypto meme is, Lambo’s Unicorns or the Guy Fox Mask, it’s probably on the Unchained Rabbit Hole T-shirt. Check it out at shop.unchainedpodcast.com, and also be sure to check out our hats, mugs, and stickers, too.

Unchained is produced by me, Laura Shin, with help from Fractal Recording, Anthony Yoon, Daniel Nuss, Josh Durham, and the team at CLK Transcription. Thanks for listening.