Bitfinex announced today the start of mining contracts as a trading product on their platform. In total 100 THS (terahashes per second) with an expiration in 3 months have been made available for trading under the name TH1BTC. The 100 THS are part of a larger pool of 3500 THS so more mining contracts might become available in the future. Interestingly, this marks the first time that it is possible to short a mining contract.
Shorting a mining contract means to receive an amount of Bitcoin now (the price we sell it at) and subsequently paying dividends (in Bitcoin) over the following 3 month until the contract expires in the middle of December. A profit is made if the sum of all the dividends paid out (plus the interest we paid to short the contract) is less than what we received at the beginning when we sold the contract (to someone else obviously).
This means the price of TH1BTC should depend on 3 variables (in decreasing order of importance):
- The change of the mining difficulty until 15 December
- The time remaining until 15 December
- The interest rate (swap rate)
If difficulty increases dividend payments become smaller because 1 THS represents a smaller fraction of the whole network hashing power. Therefore the price of one contract should decrease if difficulty increases. The closer we get to expiration the fever Bitcoins can be mind with 1 THS in total. Therefore the price of one contract should decrease the closer we get to expiration and reach a price of 0 at expiration.
The higher the interest rate the more costly it is to enter and keep the contract over the full length of 3 month. Bitfinex does not offer 90 days swaps, therefore entering a contract with the goal to hold it until the end contains quite a bit of interest rate risk because at some point a new swap has to be taken out (at a potentially unfavorable interest rate). This is less of a problem when going long (Bitcoin rates are typically low) than when going short (there is only a maximum of 100 contracts available in total, no naked shorting). To compensate for the risk prices should increase when swap rates are increasing.
The big unknown is of course the change in the mining difficulty over the next 90 days. In the following figure we see how difficulty changed over the previous 6 month.
The data is from Tradeblock and it shows not only a graphical representation of past changes in the difficulty (difficulty changes every 14 days depending on past hash rate. More info can be found in the wiki) but also some basic summary statistics. On average difficulty has increased 27% over the last 30 days and 77% over the last 60 days.
To estimate the fair price of one TH1BTC we will assume that difficulty will increase on average 15% per month over the next 3 month. Currently the price of buying one contract worth 1 THS is 2 BTC. The pool fee is 3% and we will ignore interest rates. Filling in all the information we get the following results:
Hence if we go long one contract based on our assumptions we would make a loss of about 0.39 Bitcoin (a bit more in reality since we will start mining in the middle of September until the middle of December) because the expected dividends (monthly revenue) is not going to cover our initial costs of 2 BTC before the contract expires.
On the other hand, going short at a price of 2 Bitcoin would have generated a profit of about 0.39 Bitcoin per contract. Keep in mind that we didn’t include swap costs which are currently at around 1% per day (!).
There are two ways to look at the results. Either we could say prices for TH1BTC are currently overvalued and should be closer to around 1.5 BTC. If we assume difficulty will increase more than 15% per month then prices should be even lower than that. Or we could say that the market is efficient and prices are correct, which would imply that the market is expecting difficulty to decrease on average about 2% per month over the next 90 days. Either way, results will be known with certainty in 90 days.