Crypto Long & Short: Bitcoin Markets Are Growing Up. Bitcoin Mining Is, Too

When Paul Tudor Jones II says he’s long bitcoin, investors pay attention. Even if they don’t agree with his stance, he’s a well-known hedge fund investor, one of the great commodity inventors of all time, an iconic name in the “smart money” set. Most investors tend to follow the “smart money” – perhaps not right away, but the external validation from someone paid to be skeptical of hype will most likely act as a trigger for many. On the whole, investors tend to move as a herd.

Even more interesting are the reasons given: According to reports, he is buying bitcoin “as a hedge.” This is very different from funds speculating on bitcoin’s price going up. This is a hedge position, which is more fundamental and long-term. 

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It also indicates an understanding of bitcoin’s value proposition. Crypto investors got excited when it was revealed a few weeks ago that Renaissance Technologies was contemplating trading bitcoin futures. Reniassance’s Medallion fund is a quant fund, interested in discrepancies in volatilities and other relatively obscure metrics. It doesn’t really care about the underlying asset. Tudor Investment Corp., however, has studied bitcoin enough to understand its monetary properties and technological resilience.  

This isn’t an institutional investor pontificating about the need for real assets in the face of unlimited money issuance and economic strain. This is hedge fund royalty publicly acknowledging that he is betting on bitcoin as a hedge. This is different.

Coming of age

Back in 2015, in what feels like a lifetime ago but is only slightly more than the average age of your standard laptop, I read an article in CoinDesk about a conference held in Hong Kong. It featured a photo of a panel session that had generated a lot of excitement. For the first time, approximately 90% of Bitcoin mining hashpower (the computational capacity of network processing) was on the same stage. To many of us back then, Bitcoin mining had the allure of secrecy and power – it was the motor of the industry, and yet we knew so little about it: the who, the where, the with what.

Fast forward to today, and bitcoin mining is still dominated by large mining pools based in China. But the sector has changed so much. 

First, the balance is shifting, with the growth of mining business in Europe, North America and elsewhere. Earlier this week, the Cambridge Center for Alternative Finance launched an interactive chart of hashpower distribution, which shows a notable drop in China’s concentration. (Tune in to our show on Consensus: Distributed TV tomorrow at 2:30 p.m. ET to hear Christine Kim talk to some of the principals leading this shift).  

Second, the sector is much less secretive. A few days ago, mining pool Poolin released a report with detailed information on hashrate distribution and the energy costs of different machines, an unusual trove of information from a key industry operator. 

Miners appear to be more willing to talk: my CoinDesk Research colleague Christine Kim hosted a series of podcasts talking to miners about their businesses, and many contributed comments to our Bitcoin Halving Report. There are even miner-centric newsletters and podcasts. 

What’s more, some key miners are now listed companies, complying with the requisite disclosures which lend insight into how mining businesses are run. 

There is also a notable shift in the style and profile of bitcoin miners, towards more sophisticated structures and financial engineering. I’ve written before about how bitcoin markets are growing up. Bitcoin mining is, too. 

Some leading derivatives exchanges are offering increasingly flexible products. Rather than the quarterly maturities most common in traditional options, bitcoin options are now available for a range of settlement dates, which gives producers more flexibility.  

Going even further, some infrastructure participants are designing tools specifically for miners. Late last year, crypto liquidity provider GSR announced a partnership to develop a “tailored risk management solution.” Some lenders have talked about structuring collateralized loans specifically for miners.

And earlier this week, crypto data provider Coin Metrics unveiled a new type of hashrate index, which could remove some of the subjectivity of the traditional hashrate measure and serve as a basis for hashrate derivatives, allowing miners to hedge one of their main sources of uncertainty. 

Outside of financial products, the business itself becoming more investable. Cloud mining removes the need to deal with hardware issues, and some unrelated businesses are entering the mining game.

With all this going on, it’s not hard to see why the third Bitcoin halving (in which the number of bitcoins issued to miners for their processing work gets halved), expected tomorrow, is so different from the previous two. 

The sector’s resilience no longer lies at the mercy of bitcoin issuance and market price. These are significant, yes, but there is a growing array of tools to mitigate their impact, and the profile of the participants in the mining industry is becoming more diverse. This adds resilience.

The financialization of mining may dilute some of the original ethos of bitcoin as a decentralized, hard form of money; but the flexibility and relative stability it could add should make the market more resistant to protocol adjustments and price swings. 

Anyone know what’s going on yet?

U.S. job losses announced this week broke all records (20.5 million for April, 10 times the previous record decline in 1945), but that didn’t stop the S&P’s perplexing rise, which makes me wonder where investors think the earnings boost will come from. It’s not like companies will be buying back their own shares in bulk in this environment. Maybe the market thinks the Fed will start buying shares? 

Also disconcerting are indications that the futures market is pricing in negative rates. But is that enough to spook the market? Not yet. Momentum investing seems to be the ruling strategy. 

Speaking of momentum, bitcoin breaking $10,000 did not attract the fanfare it would have a few weeks ago. Just as well, since it was fleeting. (The chart below was compiled before an almost 20% drop, to just over $8,200 at time of writing on Sunday evening.) 

Chain links

Crypto asset manager Bitwise has published a report that shows even a small allocation of bitcoin to multi-asset portfolios would have boosted cumulative returns, even if it was bought at the December 2017 high and rebalanced. TAKEAWAY: The advantages of a low correlation. 

Given the hype around the potential price impact of the upcoming bitcoin block subsidy halving, many believe the price will continue to go up afterwards. History shows that is not necessarily the case. TAKEAWAY: One of the reasons could be profit taking (“buy the rumor, sell the news”). Another could be an uptick in selling pressure as miners liquidate inventory to compensate the cut in income. Some investors probably fear weakened network resilience as a sell-off could push even more miners out of the market. Tomorrow’s halving has the added overlay of heightened general market risk. So, the bitcoin price might continue its upward trend post-halving … or, it might see a correction.

Crypto data site Coin Metrics has created a hashrate index, intended to serve as the base for derivative products that could help miners and investors hedge their positions. TAKEAWAY: Miners can control their own hashrate, but they have no way of knowing how much of the total processing power of the sector their share accounts for – the hashrate index is based on an estimate derived from the time it takes to mine recent blocks. The new “observed work” metric aims to remove some of the subjectivity around hashrate observations, and could form the basis of hashrate derivatives. As I stressed in THE BRIEFING above, the crypto mining sector is maturing at a breathtaking pace. 
Transactions on the Ethereum blockchain have reached their highest level since the summer of 2019. TAKEAWAY: This is likely due to the strong growth in stablecoin transactions and supply – most stablecoins run on Ethereum. It could also be partially due to the impending network shift to proof-of-stake, as the number of addresses holding 32 or more ETH – the minimum required to become a network validator – has increased sharply.

Tether is easily the leader in the stablecoin pack in terms of market cap and growth – yet that growth is not evenly distributed amongst its various forms. Supply on Omni, the first tether blockchain, is declining, while that on Ethereum and Tron is growing fast. TAKEAWAY: This discrepancy shows why it’s important to look into the nuts and bolts of the blockchain on which your stablecoin of choice runs. Omni, based on the Bitcoin blockchain, is more robust than other blockchains, and has multisig capabilities (which allow for more complex transaction configurations). However, it also suffers sudden transaction fee spikes and longer confirmation times. The decline in its use shows what stablecoin characteristics users value more. 

Every day, around mid-morning New York time, the average bitcoin transaction fee spikes for up to an hour, then returns to normal. A recent paper claims that this is due to crypto derivative exchange BitMEX’s policy of transmitting thousands of transactions at once, at the same time every day. TAKEAWAY: Bitcoin transaction fees are not obligatory, but are usually estimated by wallet software according to the network congestion at the time. Users tend to accept whatever is proposed, since insisting on paying lower fees implies a potentially longer processing wait. What’s interesting here is that exchanges can influence the fees that users pay miners, even without being at all involved in the transaction.
Nearly 85% of bitcoin addresses are “in the money,” having accumulated their bitcoin at a lower average price than the current market price. TAKEAWAY: Some investors believe this implies potential selling pressure, as investors start to take profits. 

Crypto data provider CryptoCompare has released its April 2020 Exchange Review, which shows that derivatives volumes fell by 25% over the month, while spot volumes were down only 13%. TAKEAWAY: Part of the derivatives decline may be the fallout from the March crash, as high-risk traders retreated to lick their wounds. BitMEX, traditionally the largest crypto derivatives exchange by volume and one of the protagonists behind the Black Thursday slump, has lost its throne, slipping to fourth place, behind Huobi, OKEx and Binance. It seems that network effects aren’t everything when it comes to market infrastructure totem poles. 
Volumes on most derivative exchanges may be down (see above), but open interest on the CME is at an all-time high. TAKEAWAY: The CME’s volume is negligible in comparison to offshore exchanges such as OKEx and Binance, but it is the derivatives platform that regulated U.S.-based financial institutions must use. Renaissance Technologies recently disclosed that it was contemplating trading crypto derivatives on the CME; and Paul Tudor Jones’ revelation earlier this week has led many to speculate he’s behind a large part of the open interest growth. Whoever is accumulating positions, the OI growth on the CME is a sign that institutions are coming back into the market after the risk-averse retreat following Black Thursday in March. And the fact that the OI growth is outstripping volume growth shows that these accumulators are not short-term traders.

The Cambridge Centre for Alternative Finance has launched a new interactive Bitcoin mining map, which visualizes the average monthly share of Bitcoin’s hashrate by country for the first time, and provides an exclusive visualisation of China’s hashrate distribution at the provincial level. TAKEAWAY: China has 65% of bitcoin hashrate. This is lower than in the past, and is likely to continue to shift as hardware technology advances and business models become more financialized. My colleague Christine Kim is hosting a talk on Monday, May 11 as part of our Crypto Long & Short show at Consensus: Distributed, in which she’ll be speaking to representatives from some of the large North American crypto mining groups that are emerging. 

Digital Assets Research has produced a review of notable institutional interest in blockchain projects and crypto assets. TAKEAWAY: This was a fun read, I confess I’d lost sight of many of these projects. The report shows that, while the initial hype has been subdued under a barrage of delays and corporate shifts, there is still a significant amount of work going on in so many different areas of capital markets. Even if most of the projects do not end up in production, this will further our collective knowledge of the limitations and the potential. 

Iran’s Ministry of Industry, Mine and Trade has granted a cryptocurrency mining license to Turkey-based iMiner, which plans to operate up to 6,000 mining rigs in the city of Semnan.  TAKEAWAY: Without going into the utility of the potential use case in nations hit by sanctions and the punitive effect on individuals and businesses of a lack of dollars, one aspect investors should keep an eye on is broadening adoption. This is an example, and given Iran’s famously low average energy cost, could end up becoming a robust industry in the country. (Also, keep an eye out for Leigh Cuen’s series looking at cryptocurrency adoption in emerging markets.)

Crypto exchange Bitfinex has launched a derivative (BTCDOM) that allows investors to take a position on bitcoin’s overall share of the cryptocurrency market. TAKEAWAY: The relatively light oversight on some offshore exchanges allows for rapid creativity when it comes to crypto derivative products. Greater choice for investors and traders is not a bad thing, if the risks are identified and monitored. 

Swiss fintech firm Amun has launched a daily inverse token, BTCSHORT (BTCS), which returns gains based on inverse price movements of bitcoin in a given 24-hour period. The product complements a recent bitcoin inverse exchange-traded product (ETP) released by Amun in January. TAKEAWAY: Hedging has long been a part of advanced crypto portfolios, the emergence of tokens such as these should make more sophisticated portfolio structures available to a wider audience, as they don’t require complicated margin provisioning, and they can be used for hedging but also as a speculation tool. 

Eris Clearing, the clearing and settlement arm of crypto platform ErisX, has been granted a BitLicense from New York’s Department of Financial Services. TAKEAWAY: Not an easy thing to get, given the procedural hurdles and the cost – since the requirement went into effect in 2015, fewer than 30 firms have been awarded the license. This places another institutional-grade exchange within reach of Wall Street firms (that aren’t based in New Jersey).