[Havelock] Bitcoin Difficulty Derivative (BDD)

Hey everyone,
The new contract is in the OP and will be published on Havelock after the end of Round 1.

I've broken out the major changes for you here:

This Round, Round 2 of BDD, differs from Round 1 in the following ways:

MINE units pay out dividends at a theoretical hash rate of 100 GH/s, compared to 5GH/s previously
Purchases of EXCH are subject to a 3.4% premium, of which 3% will go to the Manager and .4% will go to paying the exchange fee. Previously, 2% went to the Manager, .4% to the exchange, and .6% back to the capital on hand.
Redemptions of MINE/SELL pairs will still be bought back for 98% of NAV/U, but the 2% difference will go to the Manager instead of the capital on hand.
There will be a target of 180 days of dividends, as opposed to the 200 days previously.
The End-Game Via Decrease will be triggered by a NAV/U of 0.02BTC instead of 0.0002 BTC

Please see the OP for a detailed explanation of the set of contracts. This overview is subject to change indefinitely.

Happy Speculating!

-2070

Edited to Add Full Contract for Round2:

Bitcoin Difficulty Derivative is 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 contract (B.MINE) and a contract that is 'short' of the value of B.MINE (B.SELL).

This Round, Round 2 of BDD, differs from Round 1 in the following ways:

MINE units pay out dividends at a theoretical hash rate of 100 GH/s, compared to 5GH/s previously
Purchases of EXCH are subject to a 3.4% premium, of which 3% will go to the Manager and .4% will go to paying the exchange fee. Previously, 2% went to the Manager, .4% to the exchange, and .6% back to the capital on hand.
Redemptions of MINE/SELL pairs will still be bought back for 98% of NAV/U, but the 2% difference will go to the Manager instead of the capital on hand.
There will be a target of 180 days of dividends, as opposed to the 200 days previously.
The End-Game Via Decrease will be triggered by a NAV/U of 0.02BTC instead of 0.0002 BTC

Please see the overview below for a detailed explanation of the set of contracts. This overview is subject to change indefinitely.

Bitcoin Difficulty Derivative (BDD) is a set of three distinct linked contracts, B.MINE, B.SELL, and B.EXCH, that allows users to speculate on the future of the Bitcoin Network Difficulty.

B.MINE acts as a 100 GH/s (100 Gigahash per second) Mining Payout Contract (formerly colloquially known as a ‘Mining Bond’)
B.SELL is a bet that buyers overvalue B.MINE
B.EXCH is the contract that can be purchased to receive a BDD Pair (1 B.MINE and 1 B.SELL)

Overview

BDD 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 is expected to 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 any significant time horizon.

BDD, therefore, allows users to either purchase a contract that pays dividends as if they own Bitcoin mining equipment (B.MINE) or to, essentially, short the value of a B.MINE contract, believing that the market value of that contract is overvalued (B.SELL). The number of units of B.MINE and B.SELL on the market will always be equal, as the only method of procuring ‘new’ contracts of either B.MINE or B.SELL is to purchase them as a pair from the Manager through B.EXCH.

The Manager will only determine the value of B.EXCH, which is set at the daily NAV/U (Net Asset Value per Unit) plus 3.4%. The Manager will only issue equal pairs of B.MINE and B.SELL in exchange for B.EXCH. Only the holders of B.MINE and B.SELL will determine the price of those contracts on the open Market.

B.MINE

B.MINE allows its holder to receive daily dividends of the theoretical mining output of a 100GH/s Bitcoin miner. Dividends will be paid to holders of B.MINE at or around 12:00PM Eastern Time each day.

For an individual who wants to enter the Bitcoin mining space, purchasing B.MINE has the following advantages over purchasing a physical Bitcoin miner, or a miner-backed security:

•   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 acquire a B.MINE contract in one of two ways:
1.   Purchasing B.MINE on the open Market from another user, or
2.   Purchasing B.EXCH, which is automatically exchanged for a BDD Pair (1 B.MINE and 1 B.SELL); and selling the B.SELL contract 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 100GH/s (100,000,000,000 H/s)

Block Reward is the Bitcoin Network Block Reward for the current Difficulty. This is currently at 25 BTC per Block and will remain so until about sometime during 2016. However, When the actual Bitcoin Network Block Reward halves, this value will halve as well.

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 keep a maximum of 180 days (six months) worth of daily dividends at the current Difficulty in reserve for B.MINE. 180 Days of Dividends is referred to as the ‘Reserve’. 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 as well.

If the Difficulty increases then, at the Difficulty change, the total capital required to hold 180 days of B.MINE’s dividends will fall. If Difficulty falls, the total capital required to hold 180 days of B.MINE’s dividends will rise. If difficulty increases, a 100GH/s miner would pay out less in daily dividends; If difficulty falls, a 100GH/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 100GH/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 100GH/s miner

A rational decision would be: I believe that this miner will mine X amount of BTC over its 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 user would choose. If user has determined that the amount that people are paying for the miner (Y) is overvalued, he will sell that miner (buying/holding B.MINE).

Of course, no one can know how much a 100GH/s miner will mine over its lifetime; the user needs to do his own math and decide what he believes will happen with the Difficulty in the future.

Buyers can acquire a B.SELL contract in one of two ways:
1.   Purchasing B.SELL on the open Market from another user, or
2.   Purchasing B.EXCH, which is automatically exchange for a BDD Pair (1 B.MINE and 1 B.SELL); and selling the B.MINE contract 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 180 days of B.MINE daily dividends will be recalculated. The funds on hand divided by the total number of contract pairs (B.MINE and B.SELL pairs) equals the Net Asset Value per Unit (NAV/U). If NAV/U exceeds 180 days of B.MINE daily dividends (the Reserve), then a dividend for this surplus amount will be issued proportionally to 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).

For example, using a very simple model:

In Period 1, Difficulty is 2,514,532 and B.MINE is paying out 1 BTC per day. 180 Days of B.MINE daily dividends is 180 Days * 1 BTC = 180 BTC, so the fund needs to hold in Reserve 180 BTC to pay out 180 days of dividends for one unit of B.MINE.

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.

180 Days of B.MINE daily dividends, at the new Difficulty, is 0.8333BTC * 180 = 149.994 BTC.

For Period 1, the fund held 180 BTC in reserve. Now, for Period 2, the fund is only required to hold 149.994 BTC on hand, leaving a surplus of 30.006 BTC (180 BTC – 149.994 BTC = 30.006 BTC). This example does not take into account the MINE dividends that have already been paid out before the difficulty increase.

The outstanding B.SELL contract would then be issued a dividend of the 30.006 BTC surplus, as those funds are no longer required to be held for B.MINE’s 180 days of daily dividends.

If the funds required for B.MINE’s new 180 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

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 individually by the Manager. B.MINE and B.SELL must always be issued in equal amounts, and remain in equal amounts outstanding, to ensure that each B.MINE contract is backed by the funds of a B.SELL contract.

A user can purchase B.EXCH for the NAV/U (Net Asset Value / Unit) plus 3.4% on the open market. The 3.4% surcharge breaks down into 3% as a Management Fee paid to the Manager, and .4% to cover the Exchange Fee assessed by Havelock Investments on all sales on the site. The fund 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 + 3.4%. Once B.EXCH is purchased by a user, the exchange will automatically buy back the EXCH contract(s) at zero value and issue one B.MINE contract and one B.SELL contract (a BDD Pair) for each B.EXCH contract purchased. The user can then sell or hold one or both of the contracts.

The Period NAV/U is calculated at the beginning of each Period, which begins after a Difficulty change. The Manager will also provide a Daily Published NAV/U on the Bitcointalk thread.

B.EXCH Buy-Back

The fund will buy back equal pairs of B.MINE and B.SELL at the last Daily Published NAV/U less 2%.

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 contracts on the Market and then send them to the Manager for redemption at the NAV/U less 2%

To sell back a BDD Pair, simply send an equal number of B.SELL and B.MINE to the Manager – bitcoinderiv@gmail.com . After the pair is received, the fund 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 increases substantially and continuously and the daily B.MINE dividend payments become smaller and smaller as time passes. In the event that the fund Reserve (180 days of dividends) is calculated after a Difficulty increase to less than 0.02 BTC per unit, then each B.MINE contract will be bought back (forced) by the Manager for 180 Days of Dividends at the new daily dividend rate.

B.SELL contracts will be bought back (forced) by the Manager for the proportional value of the excess capital (total excess capital after B.MINE buyback divided by total B.SELL contracts outstanding).

Example: It is determined that, after the Difficulty change, the NAV/U is 0.023 BTC and that 180 days of daily dividends (the Reserve) is 0.017 BTC.

Since the Reserve (180 Days of B.MINE dividends) is less than 0.02 BTC, all B.MINE will be bought back for 0.017 BTC each (180 days of dividends at the current rate). The excess per unit, 0.006 BTC, will be paid out to B.SELL contracts 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 180 days of dividends at current Difficulty). In this scenario, B.MINE 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 B.SELL contracts 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).

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 in excess of 180 days worth of current B.MINE dividends for B.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 Manager cannot withdraw funds from the Manager account to an external BTC address.

Fund Initialization
To begin the fund, the Manager will issue B.EXCH contracts at a value of 190 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 contracts offer any guarantees of return of value.

B.MINE will pay out the equivalent of a 100 GH/s miner each day up until the BDD End-Game. At the End-Game, either B.MINE’s dividend Reserve will have decreased to below the minimum threshold (0.02 BTC) due to Difficulty increase, or the fund’s reserves will be exhausted due to Difficulty stagnation / decrease. A true physical 100 TH/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 these contracts are bought back at no value. B.SELL holders must remember as well that, in the End-game via Increase, B.MINE holders will still receive the fund Reserve (180 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 Manager 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 contracts are entitled to receive dividends at the time that the Manager 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 or discrepancy with the Bitcoin Blockchain (Blockchain), a Blockchain fork, Blockchain roll-back, or other issue that affects the Bitcoin Network Difficulty, the Manager 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 Manager will perform his duties and calculations as best possible in the spirit of the contract.

Managerial Discretion
At all times, the Manager will have the discretion to make changes to this contract as necessary or desired. Buyers and holders of B.MINE, B.SELL, and B.EXCH contracts, through their purchase or possession of these contracts, agree to accept the decisions of the Manager without appeal.

Immediate Closure / Exchange Shutdown / Theft of Funds
In the 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 Manager, at his sole discretion, may either re-list on another Exchange or take the contract off-exchange to a direct format. In the event of exchange insolvency, theft of BDD funds, or mysterious disappearance of BDD funds, buyers and holders of BDD contracts waive all rights of recovery against the Manager and release and hold harmless the Manager from any liability.