Use case: CTA for mining operations
As business owners ourselves we know how tedious it can be when people approach you with a pitch on “having the perfect solution for you”. In this case, however, we make a provable mathematical point.
The business we are talking about is Bitcoin mining. For the last several market cycles mining certainly became a respected Blue-Chip element of the crypto industry. Despite being rattled by bankruptcies and having to deal with at times challenging jurisdictions, it made its way up the attention ladder for many serious investors and for good reason. Margins can be phenomenal; investments are becoming more reliable and many serious players in the energy sector utilize crypto mining operations as part of their peak energy production off-loading and grid stabilization.
The risk, however, is still closely related to the Bitcoin price. In this piece we make the case for reducing this risk by using CTA Models or trend following as a hedging tool. In fact, the name CTA (Commodity Trading Advisors) originated from hedging out commodity risks for producers. Bitcoin mining should be no different than hedging a potential crop harvest.
There are many ways to reduce risks via derivatives and it is highly dependent on the capital structure and operational cashflow of the mining operation which derivative based strategy to deploy. CTA like strategies, however, offer an agnostic way to reduce risks at times with high uncertainty and retain mining rewards at times when hedging is not necessary (e.g. in an ongoing bull market).
In the below example we assume a constant hash rate of 50k TerraHash and take historical global BTC hash rates and mining rewards into account to simulate the performance of a hedging overlay using CTAs. We assume that every mined BTC is immediately invested in the hedging program. The program is taking long, and short positions and no operational outflows are incorporated. Cash for operations can be deducted without a meaningful change in results. We compare our results to a scenario where the mining operation would have retained all their BTC without selling.
January 2021 was chosen as a start date to incorporate a full cycle of bull and bear market. A longer test is possible but with increasing global BTC hash rate and no further investments in new hardware to adjust for that, the chart becomes less meaningful as existing BTC outnumber newly mined BTC.
It is visible that for certain periods of time during bull markets, a hedging program can slightly underperform compared to holding BTC on the balance sheet. However, we argue that having less BTC exposure during the market turning into a bear market significantly reduces balance sheet risk and therefore stabilizes operations.
As a sidenote, our algos work across all asset classes making it possible to help hedge commodity producers/miners of any kind.
We can go into significantly more detail on each element of the hedging strategy and would love to continue a more long-form conversation. If you believe we could help you make better decisions in your mining operation, feel free to reach out to us.
This blog post is shared with the intention to provide educational content, general market commentary or company specific announcements. It does not constitute an offer to sell or a solicitation of an offer to buy securities managed by The Well GP.
Any offer or solicitation may only be made pursuant to a confidential Private Placement Memorandum, which will only be provided to qualified offerees and should be carefully reviewed by any such offerees for a comprehensive set of terms and provisions, including important disclosures of conflicts and risk factors associated with an investment in the fund.
Past performance is not necessarily indicative of or a guarantee of future results. The Well GP makes no representation or warranty, express or implied, with respect to the accuracy, reasonableness or completeness of any of the information contained herein, including, but not limited to, information obtained from third parties. The information contained herein is not intended to provide, and should not be relied upon for accounting, legal, tax advice or investment recommendations.
