The Financialization of Bitcoin Mining: The Past, The Current, and The Promising Future with AI

The financialization comes to help the Bitcoin mining industry cope with the mathematics of expenses

The cryptocurrency market is facing a convergence of elements pushing Bitcoin mining expenses to all-time highs. This ideal storm has led to the average expense of mining one Bitcoin surpassing its existing market price, marking a pivotal moment for the sector. The untenable financial dynamics of Bitcoin mining have become an undeniable truth, compelling miners to navigate a difficult operational environment. At the same time, the network difficulty has surged by 5%, along with the hashrate.

This indicates that miners are having to deploy more equipment to mine cryptocurrency. Meanwhile, the Bitcoin price has remained extremely volatile for the past six months. The halving event in April, 2024 did not stabilize the situation; in fact, it exacerbated it. Over five months, the cryptocurrency lost 9% of its value.

This series of unfavorable factors has triggered a restructuring process in the crypto market. With current zero or often negative profitability, small mining enterprises are forced to sell their Bitcoins to pay electricity bills and settle debts, as they cannot afford to wait for a higher price. In the worst-case scenario, they may even have to put their companies up for auction.

Market consolidation is already happening in the United States. Several notable developments have occurred in just the last three months: CleanSpark acquired two mining data centers in Mississippi, Merkle Standard came to Tennessee, Bitfarms absorbed Stronghold Digital Mining, and CleanSpark took over GRIID Infrastructure facilities.

A Financialization of Bitcoin Mining

What can help in this situation? New is often forgotten old. Bitcoin mining is the foundation of the functioning of the number one cryptocurrency. However, how developed is the financial infrastructure of this segment of the cryptosphere? In reality, this infrastructure could be more developed than what we currently have. The issue revolves around finding support for the "technical side" of mining in financial instruments.

This topic is not just about derivatives on the price of Bitcoin, which already exist. For instance, in December 2017, the world saw the launch of Bitcoin futures on the CME Group exchange in Chicago, followed in 2018 by the appearance of similar products on the New York-based Bakkt Holdings, owned mostly by the same corporation (ICE) that owns the New York Stock Exchange (NYSE).

The story of Bakkt Holdings is still evolving and it shows how it's not so easy to find the wide road when one engages into the crypto sphere. Total revenues of Bakkt in the second quarter of 2024 rose by 46.7% on an annual basis, but the platform still lingered in net loss.

We also witnessed the arrival of an ETF on Bitcoin futures and then, on 11 January, 2024, the appearance of a spot Bitcoin ETF in the U.S. after such ETFs appeared in Canada.

The time is now to financialize Bitcoin mining on a new level. Financializing Bitcoin mining involves treating mining activities as part of the financial ecosystem.

Hashrate Tokens and More

Currently, financial instruments are emerging both in the realm of mining pools and in cloud mining, from hashrate tokens to hashrate futures and hashrate-backed tokenized notes.

Just to recall, hashrate is the total combined computational power used to mine and process transactions on a Proof-of-Work blockchain of Bitcoin.

For example, Blockstream announced in September, 2024 that it's going to kick off the third round of its BMN2 tokenized notes, offering investors exposure to corporate Bitcoin hashrate for four years. Investors gain a share of Bitcoin mined per petahash per second (PH/s) of hashrate.

Previously, BMN1 attracted mainly European family offices and funds, with some investors rolling over to BMN2. Funds from BMN2 sales will support Blockstream's mining infrastructure. The notes will be tradable on the Bitfinex crypto exchange.

But back to the history of this movement to bring financialization to Bitcoin mining.

Bitcoin Hashrate Tokens (BHTs) represent fractional ownership of mining hardware's computational power, enabling investors to participate in Bitcoin mining without the complexities and capital outlay of direct hardware ownership and operation.

The BHTs are created by companies that produce hash power. The tokens give investors exposure to hash power over a specific period. At the end of 2020, such tokens practically emerged, representing the opportunity to earn income from a certain volume of hash rate. One of them, a hashrate token named pBTC35A, was launched on the Ethereum blockchain. The other, a Bitcoin Standard Hashrate Token (BTCST), was launched on the Binance Smart Chain.

Currently, pBTC35A has a market demand that tends to be around zero, and its price has decreased by 99.59% from its historical maximum. BTCST still exists, but its market capitalization is currently $3.16 million; however, Binance has halted its listing on the platform. Meanwhile, BTCST has lost 99.72% of its price from its all-time high.

An important aspects has been overlooked in the lifecycle of these tokens; however, these digital assets were built around innovative ideas. One such idea is that these tokens allow investors to access cryptocurrency mining without needing to purchase miners.

Tokens are "perpetual," meaning they generate income through staking as long as the token owner keeps them staked, regardless of the diminishing productive effect of each hash rate unit. A fair market price for such tokens can be calculated using the Discounted Cash Flow (DCF) model.

In addition to hashrate tokens, the market has also seen the launch of hashrate futures. For example, the now-defunct cryptocurrency exchange FTX introduced such instruments in mid-2020; however, marketing for hashrate futures has not been efficient due to a lack of sufficient demand.

The unpopularity of such futures can be explained by another way. These instruments tried to "cover" only one issue of cryptocurrency mining - the hashrate, although Bitcoin mining is determined by the luck of finding a block, the size of commissions, and the price of Bitcoin. Thus, futures cannot hedge all the risks that cryptocurrency miners have. Another point: miners can influence what the hashrate will be at the time of execution of a futures contract for the purchase of hashrate, making such futures too uncertain and risky.

What Can be Done?

Anyway, financialization allows some of the risks associated with mining activities to be shared with traders in the cryptocurrency financial market, allowing them to buy and sell specialized financial instruments. By spreading the risks of mining, it lowers the barriers to entry into the cryptocurrency mining sphere. This instrument can significantly help medium and small mining companies, as large businesses in this sphere, which also benefit from financialization, have access to inexpensive and large loans from traditional financial institutions.

There are significant growth prospects for hashrate tokens, but they should not be mostly "perpetual" but rather time-limited, since it is very difficult to plan the hashrate over a long period.

It can be imagined that in the future, classic derivatives (futures or in the form of swaps) on commission for Bitcoin transactions and hashrate will be popular. The derivative on hashrate is based on the economic value of the hashrate for the miner. It can imply either actual settlement or cash settlement. This derivative is focused on institutional clients with a greater degree of customization in the terms of the deal.

Sure, these tokens need the exchanges where they can be traded, and it could be not only centralized and DeFi crypto platforms or some so-called hashrate exchanges, but classical exchanges. Without such infrastructure for infusing liquidity, the market for Bitcoin mining derivatives will be still low.

AI and the Financialization o Bitcoin Mining

The advent of AI to this sphere can be a game-changer. While early attempts to arrange the “life” of BHTs faced challenges, with the rise of artificial intelligence (AI), BHTs could potentially play a significant role in the future.

With the evolution of AI technology, the prospects for BHTs have expanded considerably. AI can be employed to:

• Enhance mining efficiency: By evaluating market trends and hardware performance, AI enables miners to optimize their operations and boost profitability.

• Forecast market dynamics: AI can predict fluctuations in the cryptocurrency landscape, empowering investors to make better-informed choices.

• Innovate financial instruments: AI facilitates the creation of novel financial products linked to Bitcoin mining, including derivatives and structured financial offerings.

Currently, hashrate tokens may attract renewed attention as Bitcoin mining grapples with reduced profitability stemming from heightened competition and escalating operational expenses. Despite the Bitcoin blockchain's hashrate hitting unprecedented levels, miners are facing decreasing returns.

But it's essential to stress that the future of BHTs is closely tied to the development of AI. As AI continues to advance, we can expect to see more innovative projects and a wider range of financial products for Bitcoin mining. AI is destined to play a crucial role in stabilizing the financial effectiveness of Bitcoin mining and thus prop up the critical infrastructure of the first digital asset on a public blockchain in the world.

AI is capable of helping bitcoin miners to decide effectively how to allocate financial and technical resources and how to maintain the balance between Bitcoin mined and accumulated and Bitcoin sold. Derivatives on the "technical" side of Bitcoin mining are an integral part of this AI job that will be necessary for Bitcoin mining in the years to come.