DADA Crypto Mining Hedging Strategy Demystified
The legacy derivatives have futures markets, where the investors long and short the stock to lock in the profits before a rally or a crash. Because Bitcoin behaves like a stock, and its price remains the biggest variable in a miner’s profit, for successful miners, part of their job is to manage risk hedging against the Bitcoin price.
According to a review from cryptonews.com, only a handful of miners are using sophisticated financial instruments to do risk hedging.
This story explores some simplified versions of models that are used by DADA’s mining project managers.
A simple hedging strategy using Bitcoin as collateral:
- Suppose, a mining farm produces 100 Bitcoin in 12 months. If Bob bets on the bitcoin price to drop, he would loan out BItcoin and sell them, to receive the cash at the current BTC price.
- If Bob bets on the Bitcoin price to increase, he would directly buy mining machines. The machines are comparable to low-cost futures. To gain more, Bob can collateralize his machines or the Bitcoin mined to buy more machines to increase production capacity.
For example, our latest mini DAO project:
WhatsMiner M20S Mining Hedging
We budget 61100 USDT to purchase 47 WhatsMiner M20S from Xinjiang BitExpress mining farm at its current price of 1300 USDT / miner; Hedging with futures of the 12-month full Bitcoin production capacity at the current price; 10-month payback period; adjusting the numbers of the futures contract every month to pay for the electricity, among other costs, with fiat currency.
If Bob used up all his cash in mining machine purchase, he could borrow 10 Bitcoin and apply leverage on it.
- If the Bitcoin price is entering a volatile period, or the electricity regulation change hits the market, to protect his asset from uncertain market moves, Bob could use parts of his fund to purchase mining machines and use the rest of the fund to short Bitcoin with leverage.
For example, DADA had a project like this:
WhatsMiner costs 15000–17000 RMB per unit. We budget $200,000 as the soft cap: $100,000 for the mining machine inventory and $100,000 for Bitcoin price hedging.
A more complicated model with Hashrate and Mining Difficulty as variables:
- When Bitcoin price increases, the network hashrate and mining difficulty increase with it. As a result, the profit for unit hashes per second reduces. A farm that budgeted to produce 100 Bitcoin in reality produces 80 Bitcoin.
Leverage
- Long Position (In Bitcoin terms): collateralize the existing machines or hashrates to purchase more machines, increasing the hashrate and maintaining a steady production capacity. If Bob’s hashrates catch up with the network hashrates, then he still can mine 100 Bitcoins or more.
- Short Position (In Bitcoin terms): loan out Bitcoins and sell them in advance to lock in the profit. When in reality Bob mined 80 instead of 100 Bitcoins, his actual loss is over 20 Bitcoins, taking the interests of the loan into account.
Hedging
If Bob isn’t sure whether Bitcoin price would increase or decrease, he could hedge with fiat currency. If Bob hedges with Bitcoin loaning, when Bitcoin price increases and Bob’s production decreases, Bob might experience a margin close-out and receives less than 80 Bitcoin. In comparison, fiat hedging is less volatile.
2. Suppose Bitcoin price decreases, then the network hashrate and difficulty drops. Profit for unit hashes per second increases.
When the difficulty decreases, he could produce more than expected. Suppose the mining difficulty decreases, Bob’s production capacity will increase. He may have budgeted to produce 100 Bitcoins and eventually mined 120.
Leverage
- Long Position: Bob spends part of the Bitcoin mined to cover the collateral service fees. Even though he produced more than 100 Bitcoins, as originally planned, in fiat terms, counting in the fees, his profit drops.
- Short Position: loan out and sell Bitcoin in advance. Thanks to the Bitcoin rally, Bob may early a surplus after covering the loan interests and principal repayment.
Hedging
Suppose one Bitcoin equals one US dollar, when BTC price drops 25%, it takes 1.3333 Bitcoin to exchange with one dollar — meaning Bob’s futures contract in shorting Bitcoin has to return 33.3% in profit.
If Bitcoin price drops 50%, then it takes two Bitcoins to exchange for one dollar — Bob’s futures have to profit 100%. The real model needs more calculation.
