Sep 5, 2023 - Economy

Bitcoin miners take fresh look at hedging products

Photo illustration of Brian Rudick with geometric shapes and a photo of a bitcoin mining operation.

Brian Rudick, from GSR's Bitcoin team. Photo illustration: Shoshana Gordon/Axios. Photo: GSR

Bitcoin may be volatile, but the returns for miners don't have to be. That's the message from GSR, a firm pitching hedging products that would make miners' revenue more predictable.

Why it matters: The $500 billion Bitcoin network would be considerably more resilient if its largest operators weren't in danger of going under every time there's a massive drawdown.

Zoom out: GSR's effort isn't new, Brian Rudick, a senior strategist at the trading and market-making firm, tells Axios. He said they've been pitching miners on these instruments for years with very little uptake.

  • In the boom, miners had zero interest. Many believed bitcoin price was going to go much, much higher than it did.
  • GSR just put out a report on hedging. Looking at the financial reports of publicly traded miners, the only statements they found on hedges noted that companies weren't buying them.

Today, its pitch is better timed.

  • In the contraction, many miners had much larger problems of staying viable. Now they seem to be more interested, Rudick says.

How it works: GSR is pitching swap and options products that would allow bitcoin miners to lock in prices for future production.

  • That would make their business considerably more predictable. With swaps, miners sell future production now at a set price.
  • The advantage of swaps is that their counterparty is likely to agree to some kind of steadily increasing price.
  • The risk of the swaps is that the price rises considerably faster and they miss out on gains.

Options, on the other hand, allow a miner to buy an option to sell bitcoin at a certain price. If the price is higher, they don't have to exercise the option, but it also means they can still cover costs if price falls below the option.

  • The price of options is they cost a fee. That's a guaranteed new expense for miners, cutting into margins.

What others are saying: "We are seeing substantial growth and maturity in the hedging and derivatives markets as more products from traditional finance crossover into our industry," Gary Vecchiarelli, the chief financial officer of bitcoin mining company CleanSpark, tells Axios, via a spokesperson.

  • Its main concern as it explores using these products, he said, is counterparty risk.

Zoom way out: GSR's report contends that this model is well established in oil and gas exploration, and there's no reason it shouldn't be copied to bitcoin mining.

  • "These miners have a really hard time knowing what they are going to make in six months," Rudick tells Axios.

The impact: Rudick tells Axios that miners tend to get charged rates somewhere in the teens to finance expansion, because their business is so volatile.

  • Rudick is trying to convince miners that hedging will help lending partners justify lower rates.

Of note: Bitcoin miners win fresh bitcoin proportional to their contribution to the network. If they don't grow roughly as fast as the overall network, they start to fall behind.

  • In other words, expansion is existential.

Be smart: Bitcoin miners often boast about all the bitcoin that they are not selling. Holding mined bitcoin rather than selling is a kind of hedge. It's a bet that the price will be much higher later.

  • One bitcoin is thought to generally cost about $15,000 to mine these days, Rudick said. At $25,000+ today, that means miners are putting a lot of guaranteed profit at risk.

Show me the money: Readers might be wondering how GSR makes running a business where they are basically offering to overpay miners at times.

  • Basically, GSR will try to find buyers on both sides of every bet, so that when it overpays on miner, it underpays another. It all washes out.
  • Then it simply makes a profit on the fees for offering these instruments.
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