Monthly Archives: July 2013

Understanding DMS

Disclaimer: This article contains information about investments in cryptocurrency assets. Investments such as these are extremely risky and you should carefully read and understand all aspects of investment and what makes cryptocurrency investments even more risky. Also, the author is an issuer of a cryptocurrency asset and may (or probably does) have vested interests.

So, you’ve become interested in the Deprived Mining Speculation, or DMS, securities have you? DMS.Purchase, DMS.Selling, and DMS.Mining seem to get a lot of attention these days, but can you quickly tell me which asset does what?

Well, you’ll be forgiven for not fully understanding how it all works because this is a very complex set of assets that confuse seasoned investors to no end. Add to the situation that a lot of community participants have very wrong ideas about what these assets do, and you’re pretty close to a guarantee of misunderstanding what you’re actually buying.

Note: Please read the update at the end of the article as it reveals how deceptive these assets can be.

Don’t worry, though, because in this article, I’ll explain it as easy as I can. I’ll take some shortcuts around the math as usual by using some silly numbers, while maintaining the integrity of the idea behind this security. Also, I’m assuming you have a fairly good understanding of what Bitcoin mining is, so I’ll skip the basics of explaining that.

An Executive Overview

DMS is a set of three correlating assets that works most of all like a bet. The three assets are DMS.Purchase, DMS, Selling, and DMS.Mining, and each work as a separate investment opportunity.

The bet is on whether mining investments will ever make money at all. The buyers or holders of DMS.Selling believes mining investments will never make back what their buyers have paid. The buyers or holders of DMS.Mining believes that mining investments will be profitable.

DMS.Purchase is a bit different because it is the entry point of each of these bets. Buyers of DMS.Purchase gets one share of each of DMS.Selling and DMS.Mining and would be smart so sell the share against which they bet.

However, unlike what many people seem to think, though, there’s no Bitcoin mining involved. The confusion stems from the fact that under certain conditions, DMS.Mining may appear to act like a mining bond and people seem to want to compare it to other mining bonds and contracts based on this fact. Doing so, however, is at best a bit naïve and at worst deceptive; there’s no mining involved, simply a dividend payment that mimics that of a bond under certain conditions. In fact, as I’ll show you later, there’s no way you can reap the benefits of being right in your bet on DMS.Mining.

What’s more confusing is that DMS.Selling, which is the bet against DMS.Mining ever making more than 100% return-on-investment, only pays out if the situation is such that DMS.Mining keeps acting like a mining bond. If that situation stops, DMS.Selling won’t get any more money and shortly thereafter DMS.Mining will shut down.

Confused yet? Let me see if I can clarify, one asset at a time.

DMS.Purchase

The DMS.Purchase asset is by far the easiest to explain because it is simply the way new shares are issued onto the market.

The purpose of a DMS.Purchase share is to give you one share of DMS.Selling and one share of DMS.Mining. In other words, the price of DMS.Purchase should always be the sum of one DMS.Mining and one DMS.Selling.

For the sake of the example, and silly numbers, let’s say that DMS.Selling and DMS.Mining both sell for 1BTC each. The price of DMS.Purchase will thus be 2BTC.

You can exchange one DMS.Purchase into one DMS.Mining and one DMS.Selling at any time, and really, this is usually the only thing that makes sense. The funds received will be invested in a very conservative way with just a few investment options being on the approved list. Considering the low-risk returns from investment and the management fee of 3%, the return from holding DMS.Purchase would be lower than simply investing in the underlying investment options directly.

DMS.Purchase receives dividends equivalent to what both DMS.Mining and DMS.Selling gets. However, because the price and thus resale value of DMS.Purchase options are defined by the price of DMS.Mining and DMS.Selling, which in turn is designed to go down as dividends are paid out, the price of DMS.Purchase will not rise.

DMS.Mining

Contrary to what many seem to believe, DMS.Mining is not a mining asset. However, it does represent a bet that Bitcoin mining assets will make money.

The way this bet works is that DMs.Mining pays dividend as if it were a mining bond with 5mhs hashing power, at least based on a formula for what an average of mining output would be, sans transaction fees, miners luck, and pool fees.

Note: This isn’t the same as a 5mhs mining contract or operation. Read more in my comparison of PMB and mining contracts.

The first question you should ask yourself is this; if there is no mining going on, from where do the funds come to pay the dividends?

The answer to this, as I eluded previously, is that the money comes from people buying DMS.Purchase, which may mean you if you got your DMS.Mining shares from swapping in a DMS.Purchase.

This may sound a bit sneaky, but it works as a way to speculate. After all, you pay 2BTC, get one share of DMS.Mining and one share of DMS.Selling. If you want the mining equivalent income, you can just sell your DMS.Selling for 1BTC.

You can, of course, also buy 1 DMS.Mining directly from the market and skip the DMS.Purchase route; the effective price you pay is the same. Regardless of which path you choose, DMS.Purchase has received the funds from someone and those funds will later be used to pay out dividends.

DMS.Selling

So now that we’ve explored DMS.Purchase and DMS.Mining, the rest should be easy, right?

Sorry to disappoint, but there is a major twist on the last leg of our exploration, and that is DMS.Selling.

You see, the entire DMS portfolio is a bet on whether Bitcoin mining assets will ever make money. Those that buy DMS.Selling believe that this will not be the case, so they should get some for of reward if they are correct, right?

Well, they do, and here is how it works.

The dividends paid to DMS.Mining goes down as Bitcoin mining difficulty goes up. That means that the price paid for DMS.Purchase may never be exhausted if the mining difficulty goes far enough up. In other words, if difficulty rises so much that a DMS.Mining share will never get back more than you paid for it plus what someone paid for DMS.Selling, then those excess funds will be paid out as dividends to DMS.Selling share holders.

In theory, this makes payments very difficult because who can say whether DMS.Mining will ever get paid enough to get all the funds paid in? After all, eternity is a very long time.

In practice, DMS solves this by introducing several steps of coverage. This coverage is determined by how many days of DMS.Mining dividends are available.

For DMS.Selling dividends, as long as the funds from sales of DMS.Purchase exceeds 400 days of dividends to DMS.Mining, any excess funds are paid out as dividends to DMS.Selling.

To understand how this calculation works, let’s imagine that 500 people buys DMS.Purchase for 0.4BTC each for a total of 200BTC and the immediately converts those DMS.Purchase shares to DMS.Mining and DMS.Selling shares.

If each DMS.Mining should get 0.001BTC per day, for 400 days, this amounts to a funding requirement of exactly 200BTC (500 shares x 0.001/share x 400 days). Because this is the same amount paid for buying the DMS.Purchase shares, no dividends are paid.

However, if difficulty then rises so that the payments drop by 10% to 0.0009 per day, the funding requirement for DMS.Mining is now just 180BTC. The excess 20BTC are thus paid out to DMS.Selling share holders, for a total dividend of 0.05/share.

The numbers aren’t quite so easy to understand, though, because the funds available obviously goes down as DMS.Mining dividends are paid out. Also, dividends to DMS.Selling won’t be paid out until there is more than 410 days of DMS.Mining dividends available.

In short, however, as long as difficulty goes up and does so by a certain amount, DMS.Selling will get dividends.

Now that we’ve explored the assets, let me explain why this becomes a very tricky investment.

Where’s The Catch?

You may have several questions at this point, and if you don’t, you have either cheated and read the contract already or you’re far smarter than me.

For the rest of us mortals, however, let’s consider some of the consequences of this bet. I’ll also show you why DMS.Mining isn’t a mining asset and is doomed to lose, regardless of whether you are right in betting that the difficulty rise will slow down.

First, what happens if difficulty doesn’t go up or even goes down? After a relatively short time, the 400 days will expire, especially if difficult goes down because this will increase the dividends to DMS.Mining.

Well, if the funds available in DMS.Purchase at any point gets below 100 days worth of dividends to DMS.Mining, all the funds will close immediately and DMS.Mining gets whatever remains in a lump sum payment. In other words, you won’t get any more dividends but you get just over three months of dividends paid out right away.

This may sound generous but there’s a catch. You see, if you buy or keep DMS.Mining, it is likely because you believe mining will be profitable. If DMS.Mining closes, and it would do so because mining has become too profitable, you’ll probably want to move your funds into a different asset.

However, the situation that may make mining profitable is a stop in the rise of mining difficulty. If that happens, all mining assets suddenly becomes vastly more profitable and thus prices will rise rapidly.

At the same time, everyone will know that DMS.Mining will stop operating and pay out a lump sum but will have no chance of reaping the potential huge rewards that a stop in rise or even a drop in mining difficulty will cause.

There’s no reason for anyone to pay more than dividends for whatever time remains until DMS.Mining closes plus 100 days, so prices for DMS.Mining will not rise. Thus, the funds you get from selling or liquidating DMS.Mining will certainly not be enough to buy an equal share of hashing power in a different asset, which by then will have risen dramatically because they can reap rewards from lower difficulty forever.

Let’s run a thought experiment again, where the funds in DMS.Purchase is now 1BTC and only one DMS.Selling and DMS.Mining exists. Dividend payment for DMS.Mining is 0.0025 so the DMS.Purchase funds are enough to secure 400 days of dividends. The price of a DMS.Mining share is 1BTC and a competing asset ACME Mines also cost 1BTC and pays exactly the same dividends.

Then, disaster strikes. Godzilla lays waste to Tokyo and several Chinese cities and takes out 50% of the Bitcoin mining network. This means that the profitability of mining for the remaining network doubles immediately and in a rational market, that would also double the prices. Of course, if ACME Mines is backed by hardware located in Tokyo, the hardware will also be lost, but that is a risk of any hardware based mining.

However, because the funds in DMS.Purchase are limited to 400 days (and now 200 days due to the drop in difficulty) a buyer knows that there is no possible way to get more than 200 days worth of dividends out of a DMS.Mining share. Even if dividends are paid out immediately, the maximum that can be paid is 1BTC.

For ACME Mines, however, the drop in difficulty means that long-term profitability will skyrocket. In fact, the return on investment (ROI) of ACME Mines bought for 1BTC is now 91.25%, which is an insane return for any investment (NASDAQ Composite usually does 4-7% per year).

In two years, someone buying an ACME Mines share will not just have gotten back everything they invest but a healthy 82.5% interest on their investments on top of that, and they can keep reaping that reward until they retire. Prices on shares like that go through the roof and probably double overnight.

Why DMS.Mining Will Always Lose

For DMS.Mining, however, well, there’s no such future. In just three months, the fund will forcibly close and you’d get another three months and a bit worth  of dividends plus probably a pat on the back and a ‘thanks for playing’ from Deprived. You’ll at most get 200 days or just over six months of dividends, representing just 1 BTC.

ACME Mines shares on the other hand, and assuming its hardware is not residing in the bowels of Godzilla, now cost 2BTC. Effectively, you’ve lost 50% of your mining investment even if you were right in your bet.

Note: Keep in mind, I’m using silly numbers to exaggerate the example to show how DMS.Mining is not a mining asset and only behaves that way if you are wrong in your bet on mining profitability.

The idea behind the DMS assets is that DMS.Selling should represent a bet that difficulty will go up and that DMS.Mining should represent a bet that difficulty will not rise by too much. Both assets reward investors who are right. In other words, if you believe mining to be a profitable undertaking, you’ll want to buy DMS.Mining shares.

This is correct, as long as you only consider DMS and not what happens in the rest of the Bitcoin investment world. If you believe in mining profitability and you’re right, you’ll want to reap the rewards.

However, as I’ve just explained, this won’t happen. If you are right, you’ll get a fairly small amount in payment from DMS.Mining and may even be stuck the shares because nobody will want to pay a dollar now for a dollar in the future so you’ll probably need to sell for less than you’ll get in dividends and lump sum over the next months.

Other mining assets will rise, though, so your ability to cash out and earn from being right is limited at best and completely gone at worst.

So, the brutal result is this: If mining difficulty keeps going up, DMS.Mining will lose the bet. However, if mining difficulty goes down or even flattens out, DMS.Mining will also lose the bet. There’s actually no way that DMS.Mining can win this game.

It is very important to understand this catch. DMS.Selling is the only asset that in reality can actually make money in DMS. If DMS were the only assets available in the world, then yes, DMS.Mining could earn money, but in a world where other mining assets exist, the loss in rising prices of those other assets will quickly and brutally cancel out any earnings from DMS.Mining.

So, DMS.Mining is not a mining asset and doesn’t behave like one, except when you are slowly losing money by holding it due to difficulty increases. If difficult slows down, you’ll only lose money faster.

Sounds harsh? Indeed it may be, but now at least you know. You also know why I really don’t consider DMS.Mining a mining asset and thus don’t want to compare it to BFMines.

Update August 10, 2013:

Deprived, the issuer of DMS, was apparently being less than completely honest about the outlook of his assets and in several drunken posts on Bitcointalk admitted that there is no way that DMS.Mining would ever make money and anyone investing in DMS.Mining were idiots. Interestingly, his claim is that there was no way DMS.Mining would make money until now so if you believe him this time, you should definitely run over and buy.

If you believe this article, of course, you wouldn’t.

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Why BFMines is a Better Mining Investment than a PMB

Disclaimer: This post promotes an asset of which I am the issuer. I have a direct, personal benefit from you buying BFMines. Do you own research, always listen to multiple and contradicting opinions, and do not invest more than you can afford to lose.

During the design of BFMines, my mining contract asset traded on BTCT, I thought it would be easiest for potential investors to use the term perpetual mining bond (PMB) because the community seemed to understand how PMBs worked and would see the differences themselves.

It soon became apparent, however, perhaps due to me continuously comparing BFMines to PMB-style mining operations, that there was still a significant confusion among both investors and the community. I even wrote an article explaining the differences between mining contracts and PMBs, which was more of a general comparison and doesn’t speak specifically to BFMines.

In this article, I’ll explain specifically why BFMines offer significant advantages over traditional PMBs.

Virtual versus Real Mining

The first and possibly least obvious benefit is that BFMines does actual mining. I’m mentioning this right away because it is a significant difference but also a benefit to Bitcoin itself.

Bitcoin depends on miners to verify transactions, and miners are rewarded for their contributions based on their assistance in verifying these transactions. Bitcoin can only be healthy if there is a large number of miners that distribute that power globally.

Virtual mining operations like DMS.Mining and TAT.VirtualMine does not contribute to the diversification because they either don’t do mining at all or are simply backed by existing mining operations. As such, and although a minor benefit, a real mining operation like BFMines contributes to the overall health of Bitcoin.

Note: This difference isn’t true for all PMBs, though. PAJKA, for example, does at least partial real mining.

One particular case where this becomes apparent is with DMS.Mining. DMS.Mining, although an interesting speculator’s tool, is designed to fail if mining is profitable. The dividends you get from DMS.Mining is the same funds you pay when you buy the shares or when someone else (or you) buy shares in the sister asset DMS.Selling. If it turns out that mining difficulty does not grow indefinitely, DMS.Mining will close down because it won’t actually have more funds to pay out.

Update: Deprived, the operator of DMS.Mining (and its sister) commented on my explanation in the BFMines forum. I would like to stress that my explanation is by far a complete description of the DMS assets (and they are very complex), so I’ll include two paragraphs of Deprived’s clarification here:

“That’s not accurate.  The funds available are MORE than what you pay when you buy a DMS.Mining – depending on how you look at it, they’re either ~400 days of current dividend OR the funds from the sale of one DMS.Purchase OR the funds you pay PLUS the funds someone buying (or holding) a DMS.Selling paid.  All three descriptions amount to the same thing – however you look at it, DMS.Mining share at any point in time are backed by significantly more than what they sell for and ALL of those funds are available to DMS.Mining investors if difficulty change is favourable.

Your paragraph pretty much states that all they can ever get back is what they paid for the share – that’s a lie when expressed as a generality.  If difficulty immediately stopped rising now then DMS.Mining shares would receive back well over double the price they currently sell at and would probably receive it all within the next few months.  Conversely, if difficulty keeps rising rapidly for a long time then when difficulty finally levels off they WOULD receive a final payment but the dividends by then would be near irrelevant compared to what they receive now.”

You can read the full post here.

Transaction Fees versus Formula

Transaction fees are part of the reward that real mining operations get in return for their services. In short, transaction fees are what users pay to have money sent between each other. The more transactions happen, the higher the total transaction fees paid out to miners.

PMBs do not include transaction fees as part of their calculations because they aren’t doing any mining at all, or simply ignores the transaction fees when calculating dividends. In fact, PMBs that do actual mining or are backed by real mining just keep the transaction fees themselves.

Transaction fees are a large benefit for BFMines because if Bitcoin succeeds and gains widespread adoption, the transaction fees go up and thus yield a higher dividend to contract holders.

Even if Bitcoin fails, however, and transaction fees are low for years ahead, there is no loss to BFMines contract holders over PMBs because the minimum you get from BFMines is the maximum you get from PMBs.

Right now, transaction fees are around 1.1%, but during the boom of April 2013, transaction fees were on average almost three times as high as they are today, and around 3% of the total reward. This would increase the dividends from BFMines by 3% but go straight in the pocket of PMB operators.

Miner’s Luck

Mining is essentially based on the random chance that you find a block at any time. Because of the laws of big numbers, on average, this means that you get a certain predictability in your output.

Even in large mining operations, there is always an aspect of variance due to luck. Sometimes you get less and sometimes you get more. This is called Miner’s Luck.

For PMBs, there is no luck because they pay a fixed amount based on a mathematical formula that doesn’t change. This may be an advantage over normal mining operations, especially unlucky ones.

However, BFMines removes any effect of bad luck by guaranteeing at a minimum the output from a stable operation. Not just that, but BFMines also pays out any good luck, so you can only be better off than a PMB, never worse. In fact, if BFMines doesn’t find a single block or share of a mining operation, you still get the same as you would with a PMB.

Miner’s luck is an uncertain amount, though, but variance can be as high as 10-20% from top to bottom. Because there are no bottoms with BFMines, you will always get half of the miner’s luck paid out. On a very lucky day, you can get 10% or even more over what you’d get from a PMB.

Operational Security

Because BFMines is backed by real mining operations using real hardware, there is always an element of risk that equipment fails, power goes out, or internet connectivity goes down. This isn’t an issue with PMBs because they don’t have, most of the time, any real hardware that can cause issues.

However, BFMines again has protection to prevent disasters. There is always a minimum of 20% excess capacity in the hardware over what is required. That excess capacity goes to pay for operational expenses, but also to protect the operation by building up funds that can be harvested if disaster strikes and until replacement hardware arrives.

Note: During the first 6 months of operation and while the hardware has a warranty, this excess capacity is paid out as a bonus dividend to contract holders.

If the hardware fails and a replacement costs exactly the amount of funds built up, you never notice anything. However, if the excess capacity exceeds the requirements for protecting the operation, the funds will be used to the benefit of contract holders.

At the time of this writing, I have no idea about how stable the hardware is and thus neither the need for backup funds. I have set aside a significant portion, more than I suspect is required, but I cannot guarantee how much will be left over.

However, I am certain that whatever remains after risk has been handled will go to the benefit of contract holders. This can mean increasing the hardware capacity to increase hash rates, bonus payments, or investing into more stable and long-term hardware.

Regardless of how much is in excess, however, this is a clear benefit of BFMines or at the worst (and that would be close to a disaster) has no effect over PMBs.

Fun!

PMB style assets pays out based on a mathematical construct. You memorize that formula and the only thing you can do is watch the difficulty increase reduce your dividends. In my mind, that’s a somewhat boring approach to investing, but your opinion may differ.

BFMines, on the other hand, is a more dynamic and organic asset. I’ve taken significant measures to ensure contract owners are never worse off than a traditional PMB, but that doesn’t mean I can’t exceed that minimum. In fact, using the excess capacity, the transaction fee addition, the potential for good luck, and there are far more factors that make BFMines an interesting asset merely from the psychological perspective of having a good time.

Will you discuss how to get the most out of any additional profit with your PMB asset operator? Of course not, that additional profit belongs to the operator only. Will you watch with excitement the mining reports from a PMB? Of course not, you get a number each day, and that number won’t change until the next difficulty change.

In short, PMBs are a bit boring. BFMines, on the other hand, may evolve to make your investments even more valuable, profitable, and interesting over time, all the time while ensuring you will never be worse off than a PMB.

In Summary, Then…

Here are the reasons why BFMines is a better investment option than PMB style assets:

  • BFMines benefits Bitcoin as a whole
  • BFMines pays out transaction fees
  • BFMines guarantees only good luck
  • BFMines has surplus capacity that will benefit contract holders
  • BFMines is more fun!

What else would you need to make your decision about whether to buy a PMB or a BFMines mining contract? Let me know in the comments below and I’ll try to answer.

.b

Comparing Bitcoin Mining Contracts and Mining Bonds

Disclaimer: This article talks about investments, and in particular an investment of which I am the issuer. You should assume that I have a vested interest in you making a particular investment decision and always double-, triple-, and quadruple-check everything yourself. Don’t invest anything you cannot afford to lose.

When I designed and launched BFMines, my mining contracts over on BTCT, it became apparent that people didn’t quite understand what that asset was. I thought that the community would be able to relate to it easier if I described it as a mining bond, but apparently, that was just enough to get people to misunderstand when they wanted.

As such, I’m writing this article to clarify what the differences are between a mining contract like BFMines and a Perpetual Mining Bond (PMB).

Before you read on, you should make sure you have read my article on what PMBs are and how they work. If you think mining bonds are scams, you should also read my explanation of why that is not so. I’ll assume you know that and skip the basics. I’ll also name a few competing mining assets in this article; I do so because they are representations of classic PMBs, not because I would vouch for or berate them specifically.

Similarities

When you first look at PMBs and mining contracts, they may look very similar. Both are denominated in some hash rate, both promise regular pay based on Bitcoin mining with that hash rate, and both are simple ways of getting involved in Bitcoin mining without the hassle of owning and operating your own mining equipment.

Further, at least when it comes to publicly traded mining contracts, you can easily buy and sell them through some form of exchange. Have some spare cash you want to set aside? Buy a few extra bonds or contracts. Need some additional funds for the weekend? Sell off some assets and cash out.

You’ll also realize that the price of both PMBs and mining contracts drop as the difficulty of Bitcoin mining increases. Because both asset types represent a certain hash power, the less that hash power can produce, the less return on investment (ROI) the assets yield, so the less people are willing to pay for them. Of course, this also means that if difficulty were to drop, prices should also rise.

Finally, both PMBs and mining contracts pay frequent dividends. PMBs are easier to predict so they most often pay daily dividends, but with either asset type, you should expect to have daily or weekly dividends.

These similarities make it tempting to compare the issues side-by-side. In fact, I’ve done so already when I compared BFMines to other mining assets. However, there are differences between the asset types too, which are important to understand to pick the right asset.

Differences

However, despite being similar at first glance, mining contracts and PMBs are different enough that it can influence your investment decision. I’d like to focus on three aspects that are important; transaction fees, stability, and performance.

Transaction Fees

PMBs are not necessarily backed by actual mining like I explained in the article on whether PMBs are scams. In fact, most of them are not, and that’s quite OK.

This also means that they never actually do any mining, and your coupons/dividends are based on a formula that has a fixed output based on a fixed block reward.

This is a great benefit in predictability because you know weeks in advance what return you will get. It is easier for the PMB operator too because when there is a difficulty change, they can just schedule all the dividends up to the next change. No fuzz, no checking of actual output, no suspicion of manipulation.

However, the downside is that you also lose out on transaction fees. In short, what a miner earns is based on two parts; the block reward and any transaction fees accrued since the previous block.

Right now, the transaction fees are around 1.1%, which is income you lose if you have a PMB. If Bitcoin grows in popularity, however, the transaction fees will go up, and you’ll lose out even more. As such, you can say that investing in a PMB is better if Bitcoin does not grow too much.

BFMines specifically pays out everything that the miner produces, both transaction fees and block rewards. If Bitcoin succeeds and grows large, that’s a benefit to you as a contract holder.

Stability

Every miner knows that mining is a fluctuating business. There are good times and bad times, and operating and monitoring hardware is a lot of work, often resulting in downtime and lost income. The stability of the operation depends on continuous work, but even in the best of times, hardware, power, or internet connectivity may fail.

Because a PMB does not have hardware backing its operation, or at least is completely independent of any hardware, there’s no stability issues to talk about. You get a certain dividend based on the hash rate, and that’s it. Whether there even exists hardware is irrelevant, and if there exists hardware and it breaks down, that’s not your concern.

Mining contracts like BFMines, on the other hand, are backed by hardware. That means that if the hardware fails or power or connectivity is lost, the miner does not produce any output. Similar to mining companies, this risk is carried by the investors.

For BFMines, there are some plans in motion to mitigate this risk. What everyone knows, or can find out, is that BFMines is backed by more hardware than is required to pay out the promised dividends. The surplus mining power will be used to cover expenses but also be set aside to fund contingency plans if something goes wrong.

Note: During the first six months, while the hardware is still under warranty, the surplus mining power  in BFMines is paid out as a bonus to contract holders, meaning that for half a year, contract holders get more dividends than guaranteed.

Performance

Mining assets based on physical hardware have a fluctuating output to some extent. Mining is essentially based on luck, so with physical hardware, there’s always an element of chance. If you’re lucky, you can have higher output than what a PMB will yield because the PMB is based on a fixed difficulty and reward.

However, this also means that the miner may suffer streaks of bad luck. All mining operations are essentially based on a certain randomness, so at times, the luck will cause dividends to be lower and sometimes it will be higher. In theory, this means that you can end up with zero output, but can also mean you get incredible output, at least in the short term.

On average, however, this luck should balance out and have a negligible effect on the total output. You should be aware that for PMBs, you always get the same output whereas for assets backed by hardware, there will be slight fluctuations in return over shorter periods.

If the predictability of output is vital to you, PMBs offer that, but if you like a slight gamble, mining contracts offer a bit of entertainment and excitement waiting for the results.

Note: For BFMines, I’ll be announcing a mitigation against the risk of zero output as we get closer to the release date.

Which to Pick?

What type of asset you should chose depends on the investment profile you like. Both assets give you a piece of Bitcoin mining without the need to buy, operate, and manage physical hardware, worry about hosting options, stability of power or internet connections, noise, heat generation, or theft. Both assets should appreciate or depreciate based on the same factors. Both assets on average provide a similar output.

Here are some scenarios that may help you decide.

If you are depending on predictable output, PMBs are more stable at the cost of the possibility of higher output.

Do you feel lucky? Mining contracts offer the chance of higher output at the cost of the possibility of lower output.

Are you laying awake at night wondering whether the hardware will keep working? PMBs avoid that by not being dependent on underlying hardware (if it even exists) at the cost of transaction fees.

Do you feel safe that the hardware will work or that its operator has backup plans available? Mining contracts offer transaction fees at the cost of the risk of catastrophic failure.

Do you think that Bitcoin will rise in popularity and gain widespread adoption? Mining contracts give you transaction fees that increases as Bitcoin gains traction, at the cost of the risk of hardware failure.

Are you more concerned that Bitcoin will fail and want at least a certain stability and no risk out hardware, power, or internet failure? PMBs will yield a steady income at the cost of any benefit from rise in Bitcoin popularity.

Feel free to let me know if you have comments or questions.

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Comparing BFMines to Alternatives

Disclaimer: The BFMines asset is my own asset, so assume I’m trying to influence your decision into buying. Always do your own research, verify claims, run your own numbers, and so on. This should not be seen as financial advice.

Earlier this week, in preparation for the IPO of BFMines, I published an article outlining the risks I saw as most relevant to my BFMines mining contracts. That article sparked some comments in various forums, including one comment from Bitcoin investment luminary Deprived where he requested that I posted a comparison between BFMines and other mining investment opportunities.

Note: Deprived also requested that I added a risk factor regarding the BTC/USD exchange rate. However, that risk is not specific to BFMines but applies to any cryptocurrency investments, so I’m not going to address that specifically.

I’ve been hesitant to post specific numbers on both comparisons to other investment opportunities as well as difficulty speculations. The reason is that both of these numbers will be relevant only at the very minute the article is written, and changes almost on a daily basis. This is why it is very important that you run your own numbers.

However, as more and more people are requesting this, I’m going to comply with the following disclaimer: The numbers presented in this article are current as of this moment and change on a daily basis.

Make sure you review the numbers when you plan your investment.

Assumptions and Method Used

In this comparison article, I’m comparing numbers only. I’ll write a brief statement about each asset compared, but those statements have not been taken into account beyond what is explicitly stated.

For example, I may say that “Asset A has a risk of default” or “Asset B has a larger than normal volatility”. These statements focus on opinions only, and you should review them as part of your investment decisions. However, they may or may not make a favorable impact on the asset or on BFMines, depending on how you evaluate the statements.

For east asset, I’m focused on one number only; the price per mhs. BFMines is effectively denominated in mhs, so to have a reasonable comparison, this should be your main focus.

I’m providing some additional figures as well to give you some indication of the profitability potential. I am also using the highest sale price over the previous 24 hours as reported by BTCT.

Finally, I’m basing the price of BFMines on that everything goes according to schedule and that there is an average difficulty increase of 15% per month from now and until mining begins. After that, every asset denominated in hash power will have the same profitability evolution, so difficulty speculation beyond that should not affect which asset in which you invest (only whether you invest in mining at all).

Note on Bonus: BFMines has a bonus dividend which will be at a minimum 15% and likely more for the first six months. However, difficulty is expected to increase, so the ‘likely more’ is removed and I’m using 16.6% for six months to make it easier to calculate.

I am accounting for this by subtracting 1 month of September dividends from the price, and do the same for other mining contracts for the expected dividends paid until September 1.

Mining companies are assumed to keep their current percentage so dividend calculations are based on today’s dividends from mining. This means that although ASICMiner and Cognitive will increase their hash rate, I’m using the decline in profitability due to difficulty increase to counter this. As such, I have not included price adjustments for the mining companies.

Asset Comparison

I’ll compare BFMines to two classes of assets; mining contracts and mining companies. The difference may seem subtle, but mining companies may have better protection against difficulty increases as they may increase the hash rate to stay at the same relative rate, whereas mining contracts in general will not.

I have chosen two mining companies and two mining contracts from BTCT. The mining companies are ASICMiner and Cognitive and the mining contracts are TAT.VirtualMine (TAT.VM) and PAJKA. For Cognitive and PAJKA I have included their projected upgrades as well, as these may affect your calculations.

Note: One asset, called DMS.Mining is currently cheaper than all mining assets. However, this is a somewhat different asset that carries additional price volatility risk to holders, so I’m not including it here. Read more about the DMS assets in this article.

The conclusion, if you’re impatient, is that BFMines is right now the second cheapest mining asset when comparing yield from mining alone. TAT.VM is slightly cheaper at the moment, and the break-even point today (and this goes down every day) is 0.00483BTC for TAT.VM. If TAT.VM goes up to 0.00483, BFMines is again the cheapest mining you can buy.

Update, July 8, 2013: Due to a miscalculation in my initial model, I’ve updated the chart below and included updated numbers based on the situation as of July 8, 2013 at 7:43 PM CST. I have also included DMS.Mining in the comparison, but please not that this is neither a mining contract or a mining bond, so the price paid behaves differently.

The full overview is here, and note that in the final column, a lower value is better:

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BFMines

Type Price Adjustment Price Adjusted Hash/Share Price/mhs Div/share Yield/year Cost/BFMines
Contract 0,004000 0,000479 0,003521 1,00 0,0035209 0,000016 165,54 % 100 %

Statement: This is the baseline to which I compare other assets. Note that the adjustment is based on one month of dividends in September as explained in the note.

ASICMiner

Type Price Adjustment Price Adjusted Hash/Share Price/mhs Div/share Yield/year Cost/BFMines
Company 5,170000 0,000000 5,170000 155,00 0,0333548 0,002475 17,47 % 947 %

Statement: The engine of Bitcoin stock markets is ASICMiner. ASICMiner has plans to keep their current percentage of overall mining, but will likely not exceed 35% of the total network. Note that dividend estimates are based on mining alone, not hardware sales. I have based returns on their purchased 62THs, not today’s rate (which is just 30THs)

Cognitive

Type Price Adjustment Price Adjusted Hash/Share Price/mhs Div/share Yield/year Cost/BFMines
Company 0,400000 0,000000 0,400000 10,50 0,0380952 0,000168 15,30 % 1082 %

Statement: Cognitive is a mining company with more incoming hash power, but also with some issues related to the trust in the issuer. Will likely increase hash power further and has a dedicated fund to support such increases.

Cognitive Upgraded

Type Price Adjustment Price Adjusted Hash/Share Price/mhs Div/share Yield/year Cost/BFMines
Company 0,400000 0,000000 0,400000 58,00 0,0068966 0,000926 84,51 % 196 %

Statement: See also Cognitive above. This calculation is based on the ordered hardware (7xBFL 60GHs miners) which should arrive in two weeks (and that’s a joke playing on BFLs continual promise to deliver in two weeks; I have no idea when it will arrive).

TAT.VirtualMine

Type Price Adjustment Price Adjusted Hash/Share Price/mhs Div/share Yield/year Cost/BFMines
Contract 0,004680 0,001308 0,003372 1,00 0,0033719 0,000016 172,86 % 96 %

Statement: TAT.VM is slightly cheaper than BFMines at present. The price adjustment is to account for the expected dividends paid from today and until September 1. Note that this adjustment goes down every day, so the difference goes down each day.

Update July 4: A forum user commented that mining contracts do not pay transaction fees. This is not true for BFMines as this is a real mining operation, not a virtual one, so all income, both block rewards and transaction fees, are paid out. I asked TAT about his asset, and he confirmed that TAT.VM pays only block reward. This gives BFMines a slight advantage equivalent to the transaction fee, which right now is somewhere between 0-2%.

PAJKA

Type Price Adjustment Price Adjusted Hash/Share Price/mhs Div/share Yield/year Cost/BFMines
Contract 0,062000 0,003924 0,058076 3,00 0,0193585 0,000048 30,11 % 550 %

Statement: PAJKA has been a long-running mining contract that got a recent price adjustment due to a certain investor getting panic an selling a large portion of the shares. Note that PAJKA also is scheduled for an upgrade so check below.

PAJKA Upgraded

Type Price Adjustment Price Adjusted Hash/Share Price/mhs Div/share Yield/year Cost/BFMines
Contract 0,062000 0,019622 0,042378 15,00 0,0028252 0,000240 206,31 % 80 %

Statement: When PAJKA gets its new hardware in two weeks (that’s still a joke), the issuer will upgrade the contract to 15mhs. At that point, the current price will compete with both BFMines and TAT.VM. Note that the adjustment is based on receiving the hardware today (which isn’t likely) and thus that the final adjustment will likely be lower and thus less competitive.

BFMines Bitcoin Mining Contracts – Here’s How You Should Evaluate Investing

Disclaimer: I am the asset issuer of BFMines and have a direct interest in selling as many shares as possible. Keep that in mind while reading this. Do you own research. Listen to other voices, especially those that disagree with me. There is a large risk that you may lose money, with this investment as with any investment.

After a few weeks of delay, BFMines is finally ready for trading. If you don’t know, BFMines is my first publicly listed mining contract. You’ll be able to buy these mining contracts from July 3, 2013 at 6PM UTC.

I’ve worked very hard to design an asset that would be fair to all parties based on the risk we’re all taking. As much as I think I have succeeded, however, I would like to let you know about how you should evaluate this asset so you know what risks you are assuming.

What is a Mining Contract?

Lots of people want to get involved with Bitcoin mining but don’t know where to start. Mining contracts are a way to take all the hassle out of doing Bitcoin mining yourself, by essentially purchasing a stake in the future profits from a mining operation.

A mining contract gives you one ‘share’ of the stated profit, usually denominated in a certain amount of hash rate. You can buy multiple such contracts so you can invest in as much or as little hash power as you like.

This is different from buying shares in a mining company, however. A mining contract gives you a predefined number of hashes where a mining company’s hash power can change depending on several factors (buying more hardware usually increases hash rates while hardware or connectivity issues can decrease hash rates).

Further, a mining contract gives no votes or control of the operation whereas shares in a company may. Further, most mining contracts either run perpetually (to the extent it is practical) or for a fixed time, whereas shares in a company exist for as long as the company exists.

The TL;DR version, though, is this: You pay me to mine Bitcoins for you. Every day (or other periods for other assets) you get whatever amount of Bitcoins the mining operation has yielded that day.

Sounds too good to be true? Well, read on and I’ll explain why you should think carefully before you jump in.

There are three major factors you need to consider to understand the risk of this asset; difficulty, scams/fraud, and non- or late delivery.

How Difficult Can it Be?

As with any mining investment, however, the key deciding factor in whether you make money is how much difficulty increases in Bitcoin mining. It does not matter whether you buy shares in a company that in turn yields 1mh/s or you buy a mining contract that yields the same. The decline in profitability for the same hash power is the same no matter which investment option you choose.

However, that difficulty can render the investment completely unprofitable and you may never get your investment back. Nobody knows how much the difficulty will increase because it depends on far too many uncertain factors. It is safe to say, however, that it will increase over the next years.

So how do you determine how much difficulty will rise? Well, you need to know how much hash power comes online in the future. We do know that at some point, there will be a lot more hash power, but we also know that there are always issues with delivery, older equipment going offline, and people just getting fed up with working for diminishing returns.

I encourage you to explore the Bitcointalk forums and read up on the various projections, but let me give you a few key factors to consider:

  1. What is the total scheduled hash power coming online and when?
    We know that around 1-1.5 PH/s is scheduled to come online this year.
  2. Will perpetual proportional growth be possible and if so, how much is reasonable to expect?
    Perpetual proportional growth means that hash rate increases by a certain percentage each month forever.
  3. What is the life cycle of mining investments and at what point will older equipment be retired?
    We know that CPU and GPU mining is already unprofitable due to maintenance and electricity cost. Early FPGA and ASIC miners may also approach unprofitability over the next months.
  4. Will the announced hash power actually be delivered and would you bet that it does or does not?
    We know that traditionally ASIC equipment has been delayed, often for months.

So What Will the Difficulty Be?

Like everyone else, I have no idea. There are predictions all over the board, so in the future, you can be sure there will be a lot of “I told you so!” no matter what happens.

I’ll tell you what I don’t think will happen, though. I don’t think all the scheduled hash power will come online. For that, the history of ASIC mining power is far to volatile. We may reach 1,000TH/s by the end of the year, or it may take 12 months.

I don’t think the perpetual proportional growth theory has any merit either. For this to happen, deployment needs to accelerate perpetually, and there is just not enough money to fund such an expansion. For example, to support perpetual proportional growth of 20% per month until February 2014 (just 8 months from now), the community would have to invest $200 million worth of the most powerful mining rig available today (the KnC Jupiter), more if KnC can’t deliver that many.

Finally, BFMines and other mining contracts are now cheaper to buy than most current generation hardware (for example ASICMiner blades). Because BFMines comes out just a couple of months later than the first sale of AM’s blades, if this asset isn’t going to be profitable then the blades bought then or even now certainly won’t (because they are more expensive and has the over head of owning hardware, see below).

That also means that mining investments will become unprofitable for new hardware buyers. At that point, investing more would be throwing money out the window and thus the increase will stop.

On the other hand, it is virtually impossible for difficulty to stagnate in the short term. For that to happen, every single ASIC vendor must fail completely, which is not even considered as an option, even if one or more of them do get delayed.

So, the most likely scenario for difficulty evaluation in my opinion is somewhere well below the perpetual proportional growth theory but also well above current levels. Difficulty will likely rise for a bit and then likely flatten out and remain flat for a long time. Perhaps the difficulty will rise to 500THs by the end of the year, perhaps more, but remember that at that point, for a perpetual growth of 10% per month to continue, you have to deploy a third of what the entire Bitcoin network is today.

Then There is Trust…

Nothing prevents me from taking your money and running. You give it to me in return for something in the future. I hold it, own it, and I can disappear overnight leaving no trace but a group of angry investors. You have no recourse; this is an unregulated market after all.

This applies to any security in an unregulated market, though. Imagine a company such as ASICMiner, which is run by someone known only as friedcat, in a country that is not exactly famous for its rational handling of legal issues, holding a value of close to $200 million.

There hasn’t been a lack of scams and outright thefts in the history of Bitcoin investing either. Millions of dollars have been stolen, and all investors had to show for it were bruised wallets and possibly a bit of wisdom.

Still, people trust friedcat with their money. Truckloads of it every day. Perhaps the possibility of infinite riches clouds people’s eyes so that they are willing to risk someone running away with their money.

My response to this is very simple. You know who I am. You can probably very fast figure out where I live. I’m a well-known person in several communities, Bitcoin not withstanding. I am open about who I am, what I do, why I make the claims I make, and have done so for more than a decade online.

I would have a lot to lose if I ran away with your money; far more than the funds I would possibly get from an IPO of BFMines. In fact, the business in which I work when I need to pay bills, hourly rates of $200 is about as common as grains of sand on a beach. I would utterly kill my opportunities in that business if I was to run away (or even grab your money and hold it).

Finally, the funds you invest are not mine until the mining begins. They are held in escrow, and I can’t access them. BTCT makes sure of that. If the mining equipment fails to start, you get your money back, and that’s completely out of my control. I can beg and plead as much as I want, but BTCT will ensure you get the listing price back.

I can’t promise, though, that you’ll be rich from BFMines or that you’ll even make money. I’ve designed the asset to be fair to investors and give a reasonable return for a reasonable risk. It can go very bad and you may lose everything and it may turn into a gold mine of epic proportions. More likely, however, it will be somewhere in the middle.

What If the Hardware Doesn’t Work or Arrives Late?

The BFMines security is designed around hardware that doesn’t exist yet. Because of this, dividend generation does not start until that hardware arrives and has been tested as working. The contractual arrival of the hardware is by October 2013.

The obvious risk here is that the hardware does not work at all or even worse, that the hardware I’ve bought is part of an elaborate scam. If so, there will be no mining, no dividends, and no rolling in virtual cash. Slightly better, but still bad is that the hardware arrives too late.

To mitigate the risk of non-delivery, all funds that are paid into the IPO are held in escrow like I explained earlier. If, for any reason, the hardware fails or the manufacturer runs off with my money, you get your IPO investment back.

Note that you get back what the listing price of the contract is, regardless of what you paid for it. In other words, if you pay more for your contracts than the IPO price, you risk not getting your entire purchase price back. If you pay less, well, there’s also a chance you get back more than you paid if the hardware fails.

The second risk, however, that of late delivery, is more difficult to mitigate. The scheduled arrival of the hardware is somewhere in September. Because mining does not commence until the hardware arrives, any delays will cost you money.

To mitigate this and the fact that mining does not commence immediately, I have added a bonus dividend period of 6 months. The bonus works like this:

The BFMines asset will be backed by at least 120% of the hardware required to pay the dividends you get. In other words, if all 100,000 initial contracts are sold, I have 120,000mh/s of hardware to back that up.

The surplus hash rate (20,000mh/s if all contracts sold) are used to cover the running costs of the hardware. I’m anticipating the running costs to be in the area of 5-10% ongoing, so I have to keep the extra hardware to pay for those expenses. Any surplus of the 20,000mh/s minus expenses goes straight into my greedy pockets to cover the risk I’m assuming for hardware failure and things like that.

However, for the first six months, those greedy pockets will be emptied out and given to you as a bonus dividend. How much you get depends on two things; the final hash rate of the hardware and the final running costs. Most ASIC hardware is rated at one level but perform better in real life, but there’s no guarantee of that. I also want to add some insurance against power failure and internet connectivity problems, so I’m spending a bit of the surplus on that.

The rest is yours for six months, as a consolidation for not getting dividends from day one.

Why Not Just Buy Hardware?

For some people, investing in their own hardware is a reasonable alternative. However, it is a far stretch to compare it directly to owning mining contracts.

It is very true that owning hardware costs much less than buying mining contracts. This isn’t any different from other industries; it is more profitable to own a pineapple farm than to buy pineapples in the store. It is cheaper to dig your own gold than to buy a gold ring at a jeweler.

This comparison isn’t directly applicable, however, because there’s a limit to how many pineapples you can consume. You wouldn’t buy a pineapple farm just because you wanted a single pineapple, even though the price per pineapple would be a fraction of the store price. You simply couldn’t consume all the pineapples yourself.

In Bitcoin, you’re mining money, and money you can always consume. A better comparison would be the gold mine because you can consume as much gold as you want.

When you buy hardware, there are several things to consider.

First of all is risk. Your hardware may break at any time, and even if you have a warranty, you will at the very least lose income while the hardware is repaired. You can mitigate this by having insurance, but I have yet to find anyone willing to insure Bitcoin mining equipment for its real income.

Then there is electricity cost. Mining equipment consume electricity and you have to pay for that, something you avoid in a mining contract. In effect, you are getting free electricity for your Bitcoin mining for as long as the mining contract lasts.

There is also the plain overhead of having mining equipment running. You need a place to host it and you need to protect that location. Already people have had break-ins in their houses after someone realized they had ASIC mining hardware. Hardware also makes noise and generates heat, and that may not be worth it for small apartments or if your spouse does not approve.

You also need to be online 24/7 with your mining equipment, or you lose money. Is your power always stable? Mine certainly isn’t, and if your power or internet connection goes down, you’re not making money.

And of course time is also valuable, depending on your situation. Monitoring and supporting hardware, even your own, takes time. Are you ready to take a few hours off work to fix an issue with your electrician, your mining pool, or your ISP?

But you’re right, buying hardware is a lot cheaper than buying mining contracts. If you prefer to run a mining operation yourself, then you can save a lot of money (in my case the ratio of cost to price is about 1:4, meaning my cost is around 100BTC to get the 400BTC in value from a fully sold IPO, not counting the work involved).

To Sum Up

Consider most of all the following:

How will difficulty evolve? Do you believe in the perpetual proportional growth theory? Are you willing to bet that at least one, preferably more ASIC vendors are not able to fulfill their promises? Are you willing to bet that Bitfury and Metabank deliver on their promises? Do you trust me not to run away with your money?

Buying mining contracts is effectively a bet that the following are true:

  1. Hash rate does not increase more than what will allow you a good return on investment, likely because one or more of the ASIC vendors fail to deliver quickly.
  2. Bitfury and Metabank do deliver on their promises. Even better if they deliver quicker than projected.
  3. I do not steal your money.

If, after reviewing this article and having done your research regarding the factors affecting the BFMines asset, you are still willing to purchase these contracts, then don’t wait and head over to the official exchange and pick up your BFMines mining contracts today.

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