Bitcoin and other cryptocurrency miners are exposed to risks from their operations. Because these miners often hold onto the asset that they mine, they take on risk from price fluctuations in that asset. Miners also take on risk by making heavy capital investments (ASICs and related equipment) and holding the coins they mine, accepting bitcoin’s volatility. Some miners sell the coins that they mine to cover expenses or reduce their exposure to the crypto market. But for those miners that accept the risks of holding hardware and cryptocurrency, some basic hedging strategies can be helpful to reduce risk.
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This article breaks down hedging strategies that miners can use to mitigate the downside risks of holding inventory and even provide excess rewards.
Crypto mining risk overview
A crypto miner’s revenue risk comes from changes in cryptocurrency prices and network hash rate. When the network’s hash rate increases, miner’s bitcoin denominated revenue decreases. Therefore, a miner’s default position is ‘short hash rate’. A bitcoin, or crypto miner can hedge against increases in hash rate and declines in bitcoin price.
The price of a miner’s ASICs and other equipment is also impacted by the bitcoin price. However, ASICs “print” the underlying asset, making the correlation between bitcoin price and ASIC price 100% correlated. To hedge declines in ASIC prices, a miner can simply hedge against declines in bitcoin’s price.
Using crypto mining stock options
Cryptocurrency mining stocks are high beta plays on bitcoin. This means that their price swings with more intensity than the underlying asset (bitcoin). When the price of bitcoin increases, the price of these mining company stocks increases sharper. To hedge against bitcoin price declines, miners can buy put options on these stocks. If bitcoin price declines, they will profit from the move regardless of whether or not the option is in the money. The miner will profit as the price swings closer to the strike price of the option contract, the contract does not have to be in the money. Miners do not have to hold these options to expiry, they can close the position without exercising the contract. Miners can then use these profits to cover expenses.
Using bitcoin options contracts
Another strategy a miner can use to collect income on their inventory (coins mined) is by writing, or selling, call and put options. If a miner plans to sell some of the coins that they mined, instead of selling those coins at the current market price, they can sell (write) an options contract. In this case, the miner will collect a premium (payment) for selling the contract. The miner will also be required to deliver the coin at a set future date if the contract expires in the money (ITM).
If a miner is bullish on price increasing, they can sell puts. That means they can collect the premium of the contract sold, wait until expiration, and then deliver the BTC at the strike price they sold at if it expires in the money. However, like options on mining company stocks, miners do not have to hold these options to expiry, they can close the position without exercising the contract. If the put option expires out of the money (due to an increase in price), the holder would benefit from the premium collected and the additional upside from bitcoin’s price appreciation.
If the miner has a higher risk tolerance, they can use leverage: a miner can enter into a contract to sell more BTC than they intended and mine the difference during the duration of that contract. This strategy is ideal during periods of lower price volatility.
CME bitcoin and micro bitcoin futures
Futures contracts are an agreement to buy or sell an asset on a specific date in the future at a specific price. As is the case in other futures markets, bitcoin futures can be used to hedge asset holdings. In this case, bitcoin inventory. If the price of bitcoin falls between the date you entered into the contract and its expiration date, the price of the contract will typically drop, and the owner can then buy the same contract at a lower price to close the position before the settlement date. This can help offset the price decline in their actual bitcoin holdings.
On the other hand, if bitcoin’s price rises, the price of the bitcoin futures contract will also rise, and the holder can buy the contract (close position), or wait until settlement, and take a loss at the higher price.
Keep in mind that the sizes of the CME bitcoin futures and CME micro bitcoin futures contracts are 5 bitcoin and 0.1 bitcoin, respectively.
Hash rate derivatives
As mentioned earlier, bitcoin miners are inherently ‘short hash rate’ simply by operating since they profit more when the network hash rate declines. In order to hedge against increases in hash rate, miners can go long hash rate (buy hash rate derivatives). When bitcoin’s hash rate increases, the price of the hash rate derivative also increases. The miner can then close the position and capture profits. Unfortunately, there aren’t reliable, mature, and liquid derivatives products like this on the market right now.
However, after the Chinese crackdown on mining this summer, the demand for hedging against hash rate increases has gone down.
Hedging as a home miner
Hedging strategies are not reserved for large or midsized and institutional crypto miners. At-home or smaller scale miners can also easily implement these hedging strategies. Any miner can open an account with an institution that offers the above products.
Although miners can sell their inventory to cover expenses or just hold that inventory and pay their expenses with fiat currency, this is not ideal for all miners. The above strategies can help mitigate the downside risks that come with holding inventory and offer additional profits.