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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6 thoughts on “Comparing Bitcoin Mining Contracts and Mining Bonds

    1. The contract so far states Metabank, but I’m working on alternate plans in case they are delayed, so the real answer is “I don’t know yet, but whatever I can get as soon as possible”.

      .b

  1. I think you have your terminology wrong.

    You’re making a comparison between two types of assets. You call them “bonds” and “contracts”, but that’s not the real distinction. The correct term is that one is “deterministic” (payments are predetermined by a formula and external parameters), and one is not (payments are determined by issuer’s actual operations).

    A bond is a publicly traded loan, so a deterministic contract which is not publicly traded is not a bond.

    As you may know, I coined the term “mining bond” in defining PureMining as an infinite-term, deterministic mining bond. Infinite-term because coupons are perpetual, deterministic because payments depend on external factors only, bonds because they are publicly traded loans and mining because unlike traditional bonds tied to a specific amount of $ or BTC, these ones are tied to a specific amount of MH/s used in mining.

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