How to hedge as a miner

Let's suppose you are a miner. Your farm outputs 185 Gh/s.

Your rigs (including all set-up costs, computers, raspberry pies, cooling, risers, everything and anything) cost you $245 per Gh/s, for a total of $45`325. This happened 9 months ago but you have chosen to amortise equally over 36 months, thus your monthly amortisation comes to $1`259.0.

Your power consumption is 13 Watts per Gh/s, and electricity costs 10 cents (per Kw/h) where you live so in total you're paying (13 * 185 * 3600 * 24 * 30) / (1000 * 3600) = $1`731.6 per month.

Thus your total costs are 1`259.0 + 1`731.6 = $2`990.6 monthly.

At 3 million difficulty you find a block on average every 70`000 seconds, which means you find about 37 blocks a month, which net you ~925.71 BTC.

On the face of it, this is a pretty sweet set-up, congratulations. As long as difficulty stays put and BTC stays over 2`990.6 / 925.71 = 3.23 USD you're in pretty good shape.

But what if difficulty doesn't stay put ? What if BTC/USD rate doesn't stay put ?

These are purely financial problems (so as to distinguish them from operational problems - rigs catching on fire and whatnot). Believe it or not, there are solutions to these financial problems. They are financial solutions.

I. Hedging difficulty.

You calculate the maximum difficulty at which you'd be breaking even, given a certain BTC/USD rate. In our example, if the BTC/USD rate is 18.5, you will be breaking even at

925.71 / (2`990.6 / 18.5) * 3mn ~= 17mn.
BTC mined / ( USD costs / BTCUSD rate) * diff = 17mn.

As long as BTC/USD stays at 18.5, difficulty can go as high as 17mn, and you'll still be making a profit.

In order to hedge, you proceed to buy X.IDIFF.MAR contracts. What is the benefit of this ? Let's compare graphs!

On the left you see your profit in BTC (qty mined minus expenses) as difficulty increases from 3 to 17mn, with no hedge. Predictably, it goes towards zero as difficulty increases. On the right you see your profit in BTC as difficulty increases from 3 to 17mn, hedged with 4`557 X.IDIFF.MAR contracts you bought at 0.1 BTC each (corresponding to a difficulty of 10mn). As you can see, the hedge allows you to keep a good chunk of the revenue on the lower difficulties, while also ensuring that no matter what happens your profit always stays positive, and in fact above about 100 or so BTC.

This is the point of a hedge : you transform a risky situation (you may gain BTC or lose BTC) into a riskless situation : no matter what happens you always gain at least X BTC. Obviously by altering the parameters of the hedge (qty of contracts bought and price at which you buy them) you obtain different yield curves. You can play with the graphs yourself here, just alter the respective variables correspondingly.

II. Hedging price.

Obviously there's no rule that BTC/USD rates have to stay glued at 18.5. This is where options come into play. Take for instance O.BTCUSD.C180T. It trades for about 0.16 / 0.24 at the moment. Here's a graph of its relation to BTC/USD rates :

On the left you have the BTC cost of running your farm for BTC/USD rates going from 5 to 50, without options hedging. On the right you have the BTC cost of running your farm for BTC/USD rates also going from 5 to 50, but hedged by having sold 150 O.BTCUSD.C180T at .16 each. As you can see, in exchange for fixing the cost at ~135 BTC for BTC/USD at or above 19, you obtain some reduction in the BTC cost at lower exchange rates. Obviously the exact parameters are yours to tinker with. If you use different strike prices (such as 15 or 20 instead of the 19 in our example) the flatout point will occur further left or right on the graph.

Alternatively to hedging by selling CALLs you could be hedging by buying PUTs :

The O.BTCUSD.P190T trades for 0.14/0.24. By buying 157 contracts at 0.24 you ensure that your costs stay within 100 and 200 BTC no matter where the exchange rate goes, even as low as 1 USD per BTC. Tinkerlink.

In conclusion : Hedging brings safety. Success is all about operating in safety. A well chosen combination of difficulty and exchange rate hedging is just as much part of being a successful miner today as a well built, well cooled rig used to be yesterday.