Bitcoin Difficulty Derivative (BDD)I'm very pleased to announce Bitcoin Difficulty Derivative, which will be listed on Havelock Investments under B.MINE, B.SELL, and B.EXCH.
BDD allows users to speculate on the future difficulty of Bitcoin mining via a Mining-bond-like security (B.MINE) and a security that is 'short' of the value of that security (B.SELL).
Those of you that were active on BTC-TC may remember
Deprived's DMS set of securities, to which this is similar, but not identical. DMS was one of my favorite securities to trade and speculate on, so I felt compelled to bring a version of it back to the market. I greatly respect Deprived; however, he has nearly completely disappeared in the past few months. I wish him the best and hope that he is well but I do want to keep the idea of a difficulty speculation security alive. To be clear,
this asset is in no way related or connected with Deprived or DMS, this is a totally separate security with its own contract and shareholders.
Bitcoin Difficulty Derivative is different from, and I believe improved over, DMS in the following ways:
- The funds held in reserve for dividends will not be invested whatsoever. I understand the reason why Deprived instituted this for the benefit of SELLING holders, but it clearly led to quite a few problems with liquidity and a near-miss with Coinlenders' default
- All of the securities' funds will be held in escrow by Havelock - I will not have access to the funds whatsoever. This grealy reduces counterparty risk, as I cannot simply run with the funds. There is still always the risk of Havelock's future insolvency, but I do not regard this as a significant risk
- There is no Management Fee. DMS included a 3% management fee to compensate Deprived for his time to run the fund. I have worked out an alternate method of compensation with Havelock
- There will be a target of 200 days of dividends, not 400 days of dividends as with DMS. I believe that this will allow for a bit shorter time horizion before reset, which brings up the next point:
- There is a definitive end-point. DMS never had an actual end-point in the case of continued Difficulty increases. BDD does have an 'End-Game' for both Difficulty increases and stagnation/decreases.
Please see the contract below for a detailed overview of the set of securities. This contract is subject to change up until the securities go live on Havelock, which will be within the next week or two.
Bitcoin Difficulty Derivative (BDD) is a set of three distinct linked securities, B.MINE, B.SELL, and B.EXCH, that allows users to speculate on the future of the Bitcoin Network Difficulty.
They are listed on Havelock Investments as B.MINE, B.SELL, and B.EXCH respectively.
B.MINE acts as a 5 GH/s (5 GigaHash per second) Mining Bond
B.SELL is a bet that buyers will overvalue B.MINE
B.EXCH is the security that can be purchased to receive a BDD Pair (1 B.MINE and 1 B.SELL)
OverviewBDD exists to allow users to speculate on the future of the Bitcoin Network Difficulty (Difficulty) via the trading of the value of theoretical Bitcoin mining equipment.
In reality, Bitcoin mining equipment’s value is derived from the amount of Bitcoin that the mining equipment will produce over its useful lifetime. The amount that the equipment’s useful lifetime is normally considered to cease once it no longer mines enough Bitcoin to pay for its power costs.
However, in order to determine the value of Bitcoin mining equipment in advance, foresight of future Bitcoin Network Difficulty changes would be required. Since the Difficulty changes based on the computation power of Bitcoin miners in aggregate (the Network Hashrate), and since the aggregate computation power of Bitcoin miners is constantly in flux, it is practically impossible to estimate Difficulty changes with precision over a significant time period.
BDD, therefore, allows users to either purchase a security that pays dividends as if they own Bitcoin mining equipment (B.MINE) or to, essentially, short the value of a B.MINE share, believing that the market value of that security overvalued (B.SELL). The amount of B.MINE and B.SELL on the market will always be equal, as the only method of procuring ‘new’ shares of either security is to purchase them as a pair from the Issuer (B.EXCH).
The Issuer will only determine the value of B.EXCH, which is set at the NAV/U (Net Asset Value per Unit) plus 1%. The Issuer will only issue shares of B.MINE and B.SELL in exchange for B.EXCH; the Issuer will not sell or buy B.MINE or B.SELL on the market. Only the holders of B.MINE and B.SELL will determine the price of those securities on the open Market.
B.MINE
B.MINE allows its holder to receive daily dividends of the theoretical mining output of a 5GH/s Bitcoin miner. Dividends will be paid to holders of B.MINE at 12:00PM Eastern Time each day. The same dividend will be issued to B.EXCH, as B.EXCH simply represents a BDD Pair (1 B.SELL and 1 B.MINE).
For an individual who wants to enter the Bitcoin mining space, purchasing B.MINE has advantages over purchasing a physical Bitcoin miner, or a miner-backed security, for the following reasons:
• Mining payouts start immediately – there is no pre-order or shipping delay
• Since the payout is calculated via formula instead of on actual mining hardware performance, there are no mining pool fees, no risk of hardware failure, no risk of power outage, no risk of mining hardware underperforming its specifications, and no electricity bills
• Dividends are paid daily and not subject to minimum dividend payment limits
• B.MINE may be sold at any time into the Market for the Market Price, provided that there are buyers for it
Buyers can purchase B.MINE in one of two ways:
1. Purchasing B.MINE on the open Market from another user, or
2. Purchasing B.EXCH; exchanging it for a BDD Pair (1 B.MINE and 1 B.SELL); and selling the B.SELL on the open Market
B.MINE’s daily dividend payout is calculated using the following formula:
B.MINE Hash Rate * Block Reward * 86400 * ((65535 / 2^48 )/Difficulty)
B.MINE Hash Rate is the set hash rate, in H/s (hashes per second) of B.MINE. This is set at 5GH/s (5,000,000,000 H/s)
Block Reward is the Bitcoin Network Block Reward for the current Difficulty. This is currently at 25 BTC per Block
86400 is the number of seconds in a day, which is relevant because Bitcoin mining computation power is measured in hashes per second (H/s)
65535 / 2^48 is the constant which is divided by Difficulty to produce the likelihood of producing a Block in a single hash
Difficulty is the Bitcoin Network Difficulty at 12:00 PM Eastern Time on the day that dividends are paid out
B.MINE and Difficulty
Bitcoin Difficulty Derivative’s goal is to always keep 180 days (six months) worth of daily dividends at the current Difficulty in reserve for B.MINE. To provide a bit of a buffer, BDD aims to keep 200 days of daily dividends in Reserve (20 days in excess of the 180 day goal). The formula for calculating B.MINE’s dividend payout is based partly upon the Bitcoin Network Difficulty (the Difficulty). As the Difficulty changes, the fund’s target Reserve will change proportionally.
If the Difficulty increases, then at the Difficulty change, the total capital required to hold 200 days of B.MINE’s dividends will fall. If Difficulty falls, the total capital required to hold 200 days of B.MINE’s dividends will rise. If difficulty increases, a 5GH/s miner would pay out less in daily dividends; If difficulty falls, a 5GH/s miner would pay out more in daily dividends
B.SELL
Holding B.SELL allows the holder to, in essence, short the value of B.MINE. For a comparison, imagine that a Bitcoin user holds 5GH/s miner in their hand. They have a calculation to make here – would it be more profitable to mine with the equipment or to sell it to someone else?
This calculation would depend on two factors:
1. How much Bitcoin the user thinks that the miner will mine over its useful lifetime, and
2. What people are paying to purchase a comparable 5GH/s miner
A rational decision would be: I believe that this miner will mine X amount of BTC over it’s lifetime, but people are buying this miner for Y amount of BTC on the market. Whichever amount is greater (X or Y; the mining value versus the sale value), the company would choose. In this example, the user has determined that the amount that people are paying for the miner (Y) is overvalued, so he will sell that miner.
Of course, no one can know how much a 5GH/s miner will mine over it lifetime; the user needs to do his own math and decide what he believes will happen with the Difficulty in the future.
Buyers can purchase B.SELL in one of two ways:
1. Purchasing B.SELL on the open Market from another user
2. Purchasing B.EXCH; exchanging it for a BDD Pair (1 B.MINE and 1 B.SELL); and selling the B.MINE on the open Market
B.SELL and Difficulty
Holders of B.SELL believe that B.MINE is overvalued by the Market. As mentioned in ‘B.MINE and Difficulty’ above, the amount of capital required in reserve for B.MINE changes proportionally with the Difficulty.
At each Difficulty change, the Reserve of 200 days of B.MINE daily dividends will be recalculated. If the funds on hand per unit (at Net Asset Value per Unit, or NAV/U) exceed 200 days of B.MINE daily dividends (the Reserve), then a dividend for this surplus amount will be issued proportionally to B.SELL and B.EXCH (since B.EXCH consists of 1 B.MINE and 1 B.SELL).
The total amount of units for calculating NAV/U is the total outstanding number of B.SELL or B.MINE units (there will be an equal number of units outstanding) plus the number of B.EXCH units (since B.EXCH represents one of each unit).
For example:
In Period 1, Difficulty is 2,514,532 and B.MINE is paying out 1 BTC per day. 200 Days of B.MINE daily dividends is 200 Days * 1 BTC = 200 BTC, so the fund needs to hold in Reserve 200 BTC.
At the next Difficulty change, for Period 2, the Difficulty increases 20% to 3,017,438.
At each Difficulty change, B.MINE’s daily dividend is recalculated. Since the formula to determine B.MINE’s daily dividend moves proportionally with the Difficulty, a 20% increase in Difficulty would cause B.MINE’s daily payout to decrease by 16.666% (as difficulty increases, miners generate less BTC) to 0.8333BTC per Day.
200 Days of B.MINE daily dividends, at the new Difficulty, is 0.8333BTC * 200 = 166.666BTC.
For Period 1, the fund held 200BTC in reserve. Now, for Period 2, the fund is only required to hold 166.666BTC on hand, leaving a surplus of 33.333… BTC (200BTC – 166.666BTC = 33.333BTC).
Shares B.SELL and B.EXCH (which itself contains 1 B.SELL) would then be issued a proportional dividend of the 33.333BTC surplus, as those funds are no longer required to be held for B.MINE’s 200 days of daily dividends.
If the funds required for B.MINE’s new 200 days of daily dividends do not leave a surplus (due to Difficulty stagnation or decrease), then B.SELL will not receive a dividend for that Period (nor will B.EXCH).
Example of the Effect of Difficulty Change on Fund Reserves:
20% Difficulty Increase
No Difficulty Increase OR Difficulty Decrease
B.EXCH exists to provide a means through which B.MINE and B.SELL can be distributed into the market in equal amounts without being sold directly by the Issuer. B.MINE and B.SELL must always be issued in equal amounts, and remain in equal amounts outstanding, to ensure that each B.MINE share is backed by the funds of a B.SELL share.
A user can purchase B.EXCH from the Issuer for the NAV/U (Net Asset Value / Unit) plus 1% on the Market. The 1% fee covers the Exchange Fee assessed by the Exchange on all sales of securities and adds a small buffer for any future fees needed by the fund. The Issuer may issue an unlimited number of B.EXCH into the Market via direct sales to users on the Market, but only at the NAV/U + 1%. Once B.EXCH is purchased by a user, the Issuer will buy back the EXCH share(s) at zero value and issue one share of MINE and one share of SELL (a BDD Pair) for each share of B.EXCH purchased. The Issuer will perform the exchange within 24 hours. The exchange will normally be processed much quicker than 24 hours. The user can then sell or hold one or both of the shares.
The NAV/U is calculated at the beginning of each Period, which begins after a Difficulty change. The NAV/U is calculated by dividing the total assets of the fund by the total number of issued shares (number of B.SELL or B.MINE outstanding plus the number of B.EXCH outstanding).
B.EXCH Buy-Back
The issuer will buy back equal pairs of B.MINE and B.SELL at the NAV/U less 0.5% times the number of B.MINE dividend payouts that have been paid out during that Period. For instance, if three days have passed since the beginning of the Period (three B.MINE dividends have been paid), then the issuer will buy back the BDD pair at NAV/U less 1.5% (0.5% * 3). This calculation will be made effective at the time that the share(s) is/are received in the Issuer’s account.
This deduction is made to ensure that shareholders do not simply hold the BDD Pair, receive the daily B.MINE dividends, and then sell back the share for same price at which they purchased the share (or more).
This buy-back provides an opportunity for arbitrageurs to profit if the Market Price for both B.MINE and B.SELL are too low, as they can buy both shares on the Market and then send them to the Issuer for redemption at the Current NAV/U.
To sell back a BDD Pair, simply send an equal number of B.SELL and B.MINE to the Issuer –
bitcoinderiv@gmail.com . After the pair is received, the Issuer will buy them back for the amount described above.
Bitcoin Difficulty Derivative End-Game
There are two possible end-game outcomes for BDD:
BDD End-Game via Increase
The first possibility is that Difficulty continues to increase and the daily dividend payments become smaller and smaller as time passes. However, at some point, the dividends will become too small to pay out in any meaningful amount. In the event that the fund Reserve (200 days of dividends) is calculated after a Difficulty increase to less than 0.0002 BTC (0.2 mBTC) per share, then each B.MINE share will be bought back (forced) by the issuer for 200 Days of Dividends at the current daily dividend rate.
B.SELL shares will be bought back (forced) by the issuer for the proportional value of the excess capital (total excess capital after B.MINE buyback divided by total shares outstanding). Remember to note that the total number of shares outstanding is the sum of B.SELL and B.EXCH, as B.EXCH contains one B.SELL.
B.EXCH will be bought back (forced) for the sum of B.MINE and B.SELL’s buyback amounts (which will be the NAV/U).
Example: It is determined that, after the Difficulty change, the NAV/U is 0.00023 BTC and that 200 days of daily dividends (the Reserve) is 0.00017 BTC.
Since the Reserve is less than 0.0002 BTC, all B.MINE shares will be bought back for 0.00017 BTC each (200 days of dividends at the current rate). The excess per share, 0.00006 BTC, will be paid out to B.SELL units when they are bought back. Any outstanding B.EXCH shares would receive the full 0.00023 BTC NAV/U when they are bought back.
BDD End-Game via Decrease
The second possibility is that Difficulty stagnates or decreases and the fund Reserve is deficient (no longer holds 200 days of dividends at current Difficulty). In this scenario, B.MINE (and B.EXCH) will continue to receive daily dividends until the fund’s capital is exhausted. If the difficulty continued to decrease or stagnate, B.SELL would receive no further dividends and all shares would be bought back (forced) for no value after the fund’s capital is exhausted (as all funds would have been paid out to B.MINE and B.EXCH).
In cases of changes between increase and decrease/stagnation in Difficulty, the fund’s Reserve will be the determining factor as to whether B.SELL receives any dividends. There must be an excess of 200 days worth of current dividends for SELL to receive a dividend.
Important Notes and Addendums
All Fund Held In Escrow by Havelock
Havelock Investments will hold all funds in escrow. The issuer CANNOT withdraw funds from the Issuer account to an external BTC address, nor should he need to in any case, except for closure of the Exchange.
Fund Initialization
To begin the fund, the Issuer will issue B.EXCH shares at a value of 210 days of dividends at the current Difficulty. This addition of 10 days of dividends will provide a small capital buffer in case of slight Difficulty stagnation / decrease before the first fund Difficulty change calculation.
BDD Risk Factors
It is important to note that none of the three securities offer any guarantees of return or value.
B.MINE will pay out the equivalent of a 5GH/s miner up until the BDD End-Game. At the End-Game, either B.MINE’s dividends will have decreased to below the minimum threshold (0.0002 BTC) due to Difficulty increase, or the fund’s reserves will be exhausted due to Difficulty stagnation / decrease. A true physical 5GH/s Miner would instead mine until the user sells it or until it is otherwise disposed of.
B.SELL is similarly susceptible to Difficulty stagnation or decrease. If the Difficulty does not increase, or decreases over a long enough time period there will be no further dividend payouts to B.SELL until the shares are bought back at no value. B.SELL holders must remember as well that, in the End-game via Increase, B.MINE holders will receive the fund Reserve (200 days of dividends) as a final payout.
Difficulty Increases and Time
Dividends will be paid at 12:00PM Eastern Time daily, based upon the Difficulty at that time. In cases of Daylight Savings Time or any other time changes / discrepancies, 12:00PM in New York City, New York, USA will be the prevailing time.
Dividend Payout Times
All reasonable care will be taken to pay out dividends on time. In the event that the Issuer is available to pay out dividends on time, for any reason, then dividends will be paid out as soon as possible afterwards. The holders of the shares are entitled to receive dividends at the time that the Issuer pays the dividends, not at the scheduled time at which dividends are normally paid.
Blockchain Forks / Errors / Roll-Backs
In the event that there is an error with the Bitcoin Network Blockchain (Blockchain), a Blockchain fork, Blockchain roll-back, or other issue that affects the Bitcoin Network Difficulty, the Issuer will have discretion over what Difficulty is used to calculate dividends and NAV/U.
Contract / Calculation Discrepancy
In the event of any discrepancies in this contract or the calculations within, the Issuer will perform his duties and calculations as best possible in the spirit of the contract. In cases of B.MINE versus B.SELL, the calculations will most likely be to the benefit of B.MINE, as those share dividends are the crux of this contract.
Immediate Closure / Exchange Shutdown
In the very unlikely case that the Exchange upon which BDD is listed must cease operations, shut down, or otherwise does not provide sufficient functionality to operate the fund, the Issuer, at his sole discretion, may either re-list on another Exchange or take the shares off-exchange to a direct share format. In the case a new Exchange is selected or a direct share format is instituted, the Issuer may institute a Management Fee on sales of B.EXCH or otherwise assess a fee for management of the fund.
I'm happy to answer any questions that prospective speculators may have about the securities and their workings. Again, the fund should be open within the next week or two and I will update this thread with more details as they are available.
EDIT:
1/24/2014 1040AM ET: Updated example SELL/EXCH Dividend Payout calculation error - Thanks Rannasha!
1/29/2014 1000PM ET: Updated Buy-back method and added issuer's email address
1/30/2014 1244PM ET: Updated EXCH exchange mechanism - users no longer need to send shares to the issuer
2/1/2014 0603PM ET: Removed old EXCH exchange mechanism vestiges
2/4/2014 1000AM ET: Removed additional old EXCH exchange mechanism verbiage, updated for clarity of BDD-End Game via Decrease
