Empty Block Data by Mining Pool

Abstract: In this piece we present data displaying the proportion of empty blocks (blocks containing only the coinbase transaction) produced by the different mining pools, over time.  We look at the mining methodologies pools could choose and how these policies could impact the proportion of empty blocks.


Empty Block Overview

We recently published a piece describing covert ASICBOOST and we explained the allegation that particular mining pools may be using this methodology.  Some claim that circumstantial evidence supporting this allegation, is that some mining pools produce more empty blocks (or more smaller blocks) than other mining pools.

Readers have asked us for data backing up this assertion, as only limited data has been published on this specific topic, as far as we are aware.  We are not going to draw any firm conclusions from the data on the prevalence of empty blocks, however we present it for your consideration.  We also explain some of the other potential reasons for empty blocks, including SPV mining and SPY mining.


Figure 1 – Summary chart – Rolling average percentage of empty blocks (over 1,000 block period) by pool

Source: Bitcoin Blockchain, BitMEX Research, Blockchain.info (For mining pool name)
Notes: Data up to 25th August 2017. Due to the different frequency with which different pools find blocks, the same dates on the chart could reflect different periods


Charts illustrating the proportion of empty blocks by mining pool


Figure 2 – Percentage of empty blocks by pool – 2017 YTD

Source: Blockchain, BitMEX Research, Blockchain.info (For mining pool name)
Notes:  Data up to 22nd October 2017


Figure 3 – Percentage of empty blocks by pool – 2016

Source: Blockchain, BitMEX Research, Blockchain.info (For mining pool name)


Figure 4 – Percentage of empty blocks by pool – 2015

Source: Blockchain, BitMEX Research, Blockchain.info (For mining pool name)


Figure 5 – Percentage of empty blocks by pool – 2014

Source: Blockchain, BitMEX Research, Blockchain.info (For mining pool name)


Figure 6 – All time percentage of empty blocks by pool – Monthly data

Source: Blockchain, BitMEX Research, Blockchain.info (For mining pool name)
Notes: Data only included if the pool found 300 blocks or more within the month, Data up to 22nd October 2017


Figure 7 – 2016 onwards – percentage of empty blocks by pool – Monthly data

Source: Blockchain, BitMEX Research, Blockchain.info (For mining pool name)
Notes: Data only included if the pool found 300 blocks or more within the month, Data up to 22nd October 2017


Figure 8 – 2017 YTD – percentage of empty blocks by pool – Monthly data

Source: Blockchain, BitMEX Research, Blockchain.info (For mining pool name)
Notes: Data only included if the pool found 300 blocks or more within the month, Data up to 22nd October 2017


Summary statistics by year (top 11 pools ranked by the last 12 months)


Figure 9 – Summary table for 2017 (to 25th August)

Pool # of blocks Average block size % Empty blocks
Antpool 6,298 897KB 1.8%
F2Pool 3,897 919KB 1.3%
BTCC 2,733 896KB 0.7%
Bitfury 2,852 965KB 0.0%
BW Pool 2,034 933KB 0.1%
ViaBTC 1,990 952KB 0.4%
BTC.TOP 3,199 978KB 0.7%
Slush 1,921 947KB 0.4%
BTC.com 2,265 951KB 2.4%
HaoBTC 931 957KB 2.3%
BitClub 1,236 980KB 0.0%
All Blocks 35,899 936KB 1.1%

Source: Blockchain, BitMEX Research, Blockchain.info (For mining pool name)


Figure 10 – Summary table for 2016

Pool # of blocks Average block size % Empty blocks
Antpool 11,479 747KB 4.2%
F2Pool 11,444 772KB 0.9%
BTCC 7,023 718KB 0.8%
Bitfury 5,298 834KB 0.0%
BW Pool 5,373 710KB 2.5%
ViaBTC 1,995 822KB 0.7%
BTC.TOP 27 961KB 0.0%
Slush 2,842 720KB 0.5%
BTC.com 657 976KB 2.1%
HaoBTC 1,443 982KB 1.5%
BitClub 1,662 964KB 0.0%
All Blocks 54,851 776KB 1.8%

Source: Blockchain, BitMEX Research, Blockchain.info (For mining pool name)


Figure 11 – Summary table for 2015

Pool # of blocks Average block size % Empty blocks
Antpool 9,815 484KB 8.2%
F2Pool 10,851 499KB 4.0%
BTCC 5,780 390KB 0.1%
Bitfury 5,459 604KB 0.0%
BW Pool 4,129 495KB 4.5%
ViaBTC 0 n/a n/a
BTC.TOP 0 n/a n/a
Slush 2,445 492KB 1.2%
BTC.com 0 n/a n/a
HaoBTC 0 n/a n/a
BitClub 210 509KB 0.0%
All Blocks 54,311 480KB 3.1%

Source: Blockchain, BitMEX Research, Blockchain.info (For mining pool name)


Validationless mining – SPV mining & SPY mining

SPV mining

In order to build on top of the previous block and extend the chain, mining pools need the hash of the previous block, but not necessarily the full block with all the transaction data.  Mining pools are in a rush to make the chain as long as they can as fast as possible to increase profits.  Therefore miners often have a policy of trying to find the next block before they have even had time to download and verify the previous block.  If this occurs, a miner typically avoids putting any transactions in the block (apart from the coinbase transaction), as the miner may not know which transactions were in the previous block and including any transactions could result in a double spend, resulting in an invalid block rejected by the network.  The term used to describe this type of activity is “SPV mining”.

The efficacy of SPV mining is debated in the Bitcoin community, with advocates claiming this is legitimate profit maximising activity. While opponents of this policy claim it reduces the transaction capacity of the network (since empty blocks still keep the mining difficulty up) and that it increases the probability of an invalid block receiving more confirmations, ensuring the network is less reliable for payments as double spends are more likely.


SPY mining

Another term often used is “SPY mining”.  When a mining pool wants to get the previous block even faster, they often participate as a miner on a competing pool, but instead of adding actual hashpower to the pool, they use the access to the network to get access to the previous block hash even faster and then use this information obtained by “spying” on their own pool.


Pool policies

Different mining pools are said to have different policies.  For example AntPool is said to conduct SPV mining, while Bitfury is said to not engage in this practice.  As figure 9 shows, Bifury produced 0.0% empty blocks in 2017, compared to Antpool on 1.8%.  SPV mining is believed to be the primary cause of this difference.


The ASICBOOST allegation

The above factors may explain the difference in the proportion of empty blocks, rather than covert ASICBOOST.  Alternatively, there could be another factor which we are not aware of, neither SPV mining nor ASICBOOST, causing the variation.

However, those supporting the covert ASICBOOST theory have been able to use the empty block data to generate circumstantial evidence supporting their theory.  For example figure 8 could be said to demonstrate the following:

  • Up until April 2017 Antpool (orange) produced the highest proportion of empty blocks, at a rate far higher than its peers
  • In April 2017 this switched to BTC.com (dark blue) a pool owned by the same company as Antpool
  • In October 2017, unknown miners (light green) started to produce empty blocks, as Antpool tried to conceal its policy even further

In our view this hypothesis is certainly possible, but also reasonably weak. Further evidence may be required to draw any firm conclusions.


The time gap between blocks

Another factor to consider is timing.  SPV mining occurs because miners are keen to get to work on the next block quickly, before they have had time to validate the previous block.  Therefore, in the majority of cases where miners do not quickly find the next block, say within 30 seconds, the impact of SPV mining should be limited, since miners do have time to validate.

Figure 12 below is a repeat of figure 3 above, except this time we have excluded the empty blocks which occurred within 30 seconds of the previous block being found.  This may partially remove the impact of SPV mining.  Although the data with respect to timing may not be reliable.


Figure 12 – Percentage of empty blocks by pool – 2016 (30 second gap or more from the previous block)
Source: Blockchain, BitMEX Research, Blockchain.info (For mining pool name)
Notes:  The time gap may not be reliable


Smaller but non empty blocks

The analysis in this piece only looks at empty blocks.  The ASICBOOST allegation is not only about empty blocks, but also smaller blocks. Smaller but non empty blocks can also assist with covert ASICBOOST due to the smaller size of the Merkle tree.  In a later piece we plan to look at the proportion of these smaller blocks in more detail.

In the below analysis we compared the timing between the previous blocks and the blocksize, for two particular pools.  One which claims to do SPV mining (Antpool) and one which claims not to (Bitfury).

The charts illustrate that the variations between pools are not just about empty blocks, but also smaller blocks.  The charts show that Bitfury has a more “tidy” chart, with smaller blocks only occurring when the time gap between the previous block was small.  In contrast the Antpool chart appears more “messy”, with empty and smaller blocks more prevalent regardless of the time gap between the previous block.


Figure 13 – Antpool (2017 YTD) – Blocksize compared to the time gap between the previous block

Source: Blockchain, BitMEX Research, Blockchain.info (For mining pool name)
Notes: The y-axis is the time gap from the previous block in seconds, the x-axis is the blocksize in bytes.  The time gap may not be reliable


Figure 14 – Bitfury (2017 YTD) – Blocksize compared to the time gap between the previous block

Source: Blockchain, BitMEX Research, Blockchain.info (For mining pool name)
Notes: The y-axis is the time gap from the previous block in seconds, the x-axis is the blocksize in bytes.  The time gap may not be reliable


It is difficult to draw any firm conclusions from these charts.  However one ironic thing stands out to us, from this analysis.  The pools arguing most vigorously for larger blocks, tend on average, to produce smaller blocks.


The Bitfinex chain split tokens

Abstract: In this piece we look at the ten different chain split tokens that could exist on the Bitfinex platform in 2017 and some of the complexities and challenges involved.  There are circumstances in which the policies Bitfinex has chosen are unfair and place a burden on customers, however perhaps this could not be avoided.


Chain split token overview

Bitfinex chain split tokens – 2017

Source: Bitfinex, BitMEX Research
Notes: It is not known if the Bitcoin Unlimited chain will exist as a different coin to Bitcoin at the time the contract is due to settle in December 2017


The above diagram illustrates the 10 chain split tokens which could exist on the Bitfinex platform in 2017.  During the year various groups created spin-off coins of Bitcoin and Bitfinex provided its customers the opportunity to trade these tokens.  Typically each spin-off can result in three new tokens.  For example SegWit2x resulted in:

  • BT1 – The futures contract token redeemable for BTC after the fork
  • BT2 – The futures contract token redeemable for B2X after the fork
  • B2X – The SegWit2x token itself

As we explain below, allowing the trading of all these tokens results in operational problems for Bitfinex, places inconvenient burdens Bitfinex customers and results in various scenarios which are “unfair” for customers.  However, avoiding any of these issues is difficult and perhaps potentially impossible, given the complexities involved.  In many ways Bitfinex has done a service to the community by rising to the challenge and supporting these tokens.

A full timeline of the events related to the 10 chain split tokens is provided in the table below.


Bitfinex 2017 Chain Split Token Timeline

Date Event From To Margin longs receive tokens Margin shorts owe tokens BTC lenders receive tokens* BTC borrowers owe tokens*
 18/03/2017 Optional Split BTC BCC + BCU n/a n/a n/a n/a
 01/08/2017* Distribution BTC BCH    
 06/10/2017 Optional Split BTC BT1 + BT2 n/a n/a n/a n/a
 23/10/2017 Optional Split BTC BG1 + BG2 n/a n/a n/a n/a
 24/10/2017 Conversion BG1 BTC n/a n/a n/a n/a
 24/10/2017 Conversion BG2 BTG n/a n/a n/a n/a
 24/10/2017 Distribution BTC BTG  
 27/10/2017 Buy back BTG BTC n/a n/a n/a n/a
 16/11/2017* Conversion BT1 BTC n/a n/a n/a n/a
 16/11/2017* Conversion BT2 B2X n/a n/a n/a n/a
 16/11/2017* Distribution BTC B2X  
 XX/12/2017* Distribution BTC BTU  ?  ?  ?  ?
 31/12/2017 Conversion BCC BTC n/a n/a n/a n/a
 31/12/2017 Conversion BCU BTU n/a n/a n/a n/a

Source: Bitfinex, BitMEX Research

  • The BCH distribution had a coefficient of 0.85 for lenders
  • 16/11/2017 is the expected date of the SegWit2x hardfork
  • The date of the Bitcoin Unlimited hardfork is not known, its not easy to define if the fork occurs due to some of the nuances in Bitcoin Unlimited and it may not occur at all
  • With respect to BTG and B2X distributions, lenders only receive the token when BTC is in “use as financing collateral”
  • We apologies for any inaccuracies in the above table


Margin positions & lending

As we mentioned in our previous piece on the SegWit2x hardfork, the spin-off token distribution decision for financial platforms is not straight forward.  There are essentially four options:


Potential financial platform policies regarding the distribution of spin-off tokens

Policy A Policy B Policy C Policy D
Split user Bitcoin deposit balances into BTC & spin-off  
Split user Bitcoin margin long positions into BTC & spin-off long positions
Split user Bitcoin margin short positions into BTC & spin-off short positions    
Bitcoin lenders are due back BTC & spin-off
Bitcoin borrowers owe BTC & spin-off  

Note: It is also possible to have a different policy with respect to Bitcoin lending and Bitcoin margin positions, which is not illustrated in the above chart.


BitMEX may choose policy A (or perhaps B in some circumstances), however Bitfinex typically chooses policies (or variant of the policies) C or D. While Bitfinex’s policies can be considered “fairer” in many respects, it can lead to some problems.  Supporting additional tokens can not only put additional burdens on the exchange, but also on customers, as the situation with Bitcoin Gold below illustrates.


Bitcoin Gold (BTG)  – The forced buyback

Bitfinex clients who were short BTC on margin at the time of the fork had a BTG liability added to their account when the fork occurred.  This needed to be done to balance out the impact of users who were long BTC on margin at the time of the fork and benefited by receiving BTG.

This places a burden on customers who were short, as they now have to go into the market and buy BTG to cover their positions, despite potentially having no interest or knowledge in BTG.  This may frustrate some customers as they were not given much notice in this particular case (perhaps under 24 hours).  Since margin trading may not be enabled on BTG, customers have been given three days to cover their BTG shorts, or Bitfinex may buy back the BTG for them in the market with their BTC.


Anyone with a negative balance resulting from being a BTC borrower at the time of the fork will need to buy back into BTG within 3 days or risk having the system do it for them

Source: Bitfinex


The issue may be of particular concern to Bitfinex customers, since the BTG token does not exist yet, nor is the client ready to be released, as further development work may be required.  The date Bitfinex enabled trading, 24th October, was only the date of the snapshot of Bitcoin balances, not when the token actually launched.  Therefore Bitfinex customers who were short BTC at the time of the snapshot will not be able to deposit BTG to the platform to cover their short positions, as the token does not yet exist and instead they appear to be forced to buy it on the market at Bitfinex.  There may be insufficient liquidity, which could cause problems.

Although this is “unfair” and likely to frustrate some customers, it is easy to criticize and there are no perfect policies.


The chain split tokens do not consider the impact of the other chain split tokens

The above contracts do not fairly reflect each other.  For example there was a distribution of BCH tokens in August given to holders of BTC.  However, holders of BCC never received any BCH. This problem is illustrated by the overlapping nature of the contracts in the chart above.

If Bitfinex wants to increase the complexity of the above even further, the following additional distributions could be conducted:

  • When the SegWit2x hardfork occurs, distribute BTG to holders of BT1
  • On 31 December 2017, the Bitcoin Unlimited contract settlement date, distribute BCH, BTG and B2X tokens to holders of BCC

Bitfinex may actually make adjustments for these events and even eluded to this possibility in a recent post.  It would be interesting to see if any of their customers actually demand this.

Bitcoin Economics – Credit expansion and the characteristics of money which make it possible (Part 1)

Abstract: In this piece on economics, we look at misconceptions with respect to how banks make loans and the implications this has on the ability of banks to expand the level of credit in the economy.  We analyze the inherent properties of money which ensure that this is the case and the impact this could have on the business cycle.


Click here to download the pdf version of this report


Dynamics of Credit Expansion

The core characteristic of the traditional banking system and modern economies, is the ability of the large deposit taking institutions (banks) to expand the level of credit (debt) in the economy, without necessarily needing to finance this expansion with reserves.

An often poorly understood point in finance, is the belief that banks require reserves, liquidity or “cash”, in order to make new loans. After-all where do banks get the money from? It is true that smaller banks and some financial institutions do need to find sources of finance to make new loans. However, in general, this is not the case for the main deposit taking institutions within an economy.

If a main deposit taking institution, makes a new loan to one of their customers, in a sense this automatically creates a new deposit, such that no financing is required.  This is because the customer, or whoever sold the item the loan customer purchased with the loan, puts the money back on deposit at the bank.  Therefore the bank never needed any money at all. Indeed there is nothing else people can do, the deposits are “trapped” inside the banking system, unless they are withdrawn in the form of physical notes and coins, which rarely happens nowadays.

Please consider the following simplified example:

  1. A large bank, JP Morgan, provides a mortgage loan to a customer, who is buying their first home, for $500,000
  2. JP Morgan writes a check to the mortgage customer for $500,000
  3. The mortgage customer deposits the check into his deposit account, at JP Morgan
  4. The mortgage customer writes a new check, for $500,000 and he hands it over to the seller of the property
  5. The seller is also banking client of JP Morgan and as soon as she receives the check, she deposits it into her JP Morgan bank account


Illustrative diagram of a new home mortgage with one dominant bank in the economy

As one can see, the above process had no impact on the bank’s liquidity or reserves, the bank never had to spend any “cash” at any point in the above example. Of course, the seller of the property does not necessarily have to have an account with the same bank as the one which provided the loan.  However large deposit taking institutions, such as JP Morgan, HSBC or Bank of America, have large market shares in the deposit taking business, in their local markets.  Therefore, on average, these large banks expect more than their fair share of new loans to end up on deposit at their own bank. Actually, on average, new loans in the economy actually increases the liquidity for these large banks, rather than decreasing it.

The accounting treatment of this mortgage, for the bank, is as follows:

  • Debit: Loan (asset): $500,000
  • Credit: Deposit (liability): $500,000

The bank has therefore increased its assets and liabilities, resulting in balance sheet expansion.  Although from the point of view of the home seller, she has $500,000 of cash.  The above transaction has increased the amount of loans and deposits in the economy. From the customer’s point of view, these deposits are seen as “cash”. In a sense, new money has been created from nothing, apart from perhaps the asset, which in this case is the property.  In the above scenario, M0 or base money, the total value of physical notes and coins in the economy, as well as money on deposit at the central bank, remains unchanged.  M1, which includes both M0 and money on deposit in bank accounts, has increased by $500,000.  Although the precise definition of M1 varies by region.

Cash reserves from the point of view of a bank are physical notes and coins, as well as money on deposit at the central bank.  The ratio between the level of deposits a bank can have and its reserves, is called the “reserve requirement”.  This form of regulation, managing the reserve requirement, leads to the term “fractional reserve banking”, with banks owing more money to deposit customers than they have in reserves. However, contrary to conventional wisdom, in most significant western economies, there is no regulation directly limiting the bank’s ability to make these loans, with respect to its cash reserves.  The reserve requirement ratio typically either does not exist, or it is so low that it has no significant impact.  There is however a regulatory regime in place that does limit the expansionary process, these are called “capital ratios”. The capital ratio, is a ratio between the equity of the bank and the total assets (or more precisely risk weighted assets). The bank can therefore only create these new loans (new assets) and therefore new deposits (liabilities), if it has sufficient equity.  Equity is the capital investment into the bank, as well as accumulated retained earnings.  For example if a bank has $10 of equity, it may only be allowed $100 of assets, a capital ratio of 10%.


The credit cycle

To some extent, the dynamic described above allows banks to create new loans and expand the level of credit in the economy, almost at will, causing inflation. This credit cycle is often considered to be a core driver of modern economies and a key reason for financial regulation. Although the extent to which the credit cycle impacts the business cycle is hotly debated by economists.  These dynamics are often said to result in expansionary credit bubbles and economic collapses. Or as Satoshi Nakamoto described it:


Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve


Ray Dalio, the founder of Bridgewater Associates (a leading investment firm), appears to agree that the credit cycle is a major driver of swings in economic growth, at least in the short term, as his video below explains:



The view that the credit cycle, caused by fractional reserve banking, is the dominant driver  of modern economies, including the boom and bust cycle, is likely to be popular in the Bitcoin community.  This theory is sometimes called Austrian business cycle theory, although many economists outside the Austrian school also appreciate the importance of the credit cycle.

However, there are alternative views.  For example another successful investment firm, Marathon Asset Management, identifies the “capital cycle” as the main driver of the business cycle, rather the credit cycle.  In their view a cycle emerges with respect to investment in production, as the below diagram illustrates.


The capital cycle

Source: Capital Account


The fundamental cause of the credit expansionary dynamic

The above dynamic of credit expansion and fractional reserve banking, is not understood by many. However, with the advent of the internet, often people on the far left politics, the far right of politics or conspiracy theorists, are becoming partially aware of this dynamic, perhaps in an incomplete way. With the “banks create money from nothing” or “fractional reserve banking” narratives gaining some traction. The question that arises, is why does the financial system work this way?  This underlying reasons for this, are poorly understood, in our view.

Individuals with these fringe political and economic views, may think this is some kind of grand conspiracy by powerful elite bankers, to ensure their control over the economy. For example, perhaps the Rothschild family, JP Morgan, Goldman Sachs, the Bilderberg Group, the Federal Reserve or some other powerful secretive entity deliberately structured the financial system this way, so that they could gain some nefarious unfair advantage or influence? Actually, this is not at all the case.

The ability of deposit taking institutions to expand credit, without requiring reserves, is the result of inherent characteristics of the money we use and the fundamental nature of money. This is because people and businesses psychologically and for very logical practical reasons, treat bank deposits in the same way as “cash”, when they could alternatively be considered as loans to the bank. This enables banks to then expand the amount of deposits, knowing they are safe, as customers will never withdraw it, since they already think of it as cash.

Bank deposits are treated this way for perfectly reasonable and logical reasons, in fact bank deposits have some significant advantages over physical cash. Bank deposits are simply much better than physical cash.  It is these inherent and genuine advantages that cause fractional reserve banking, not a malicious conspiracy, as some might think.


Advantages of bank deposits compared to physical notes and coins

Factor Bank deposit Physical cash

Keeping money on deposits in financial institutions, increases security

The money is protected by multiple advanced security mechanisms and insured in the unlikely event of theft

Large physical cash balances at home could be vulnerable to theft or damage

Physical cash cannot be insured and storage costs can be expensive

Electronic transfers Using the banking system, it is possible to quickly send money effectively over the internet or by phone, across the world at low cost and at high speed If physical cash is used, then a slow, inefficient, insecure physical transfer must take place

Using a banking system to manage your money, can result in a convenient set of tools. For example the ability to use money using your mobile phone or on your computer

Precise amounts can be sent so there is no issue with receiving change

Handling cash is often a difficult and cumbersome process. Precise amounts cannot be specified and one may need to calculate change amounts
Auditability Traditional banks offer the ability to track, control and monitor all transactions, which can help prevent fraud.  This improves reporting and accountability With physical cash, effective record keeping is less automated, increasing the probability of fraud


Bitcoin Economics – Credit expansion and the characteristics of money (Part 2)

Abstract: In this piece we look at why Bitcoin might have some unique combinations of characteristics, compared to traditional forms of money.  We examine the implications this could have on the ability of banks to engage in credit expansion.


Click here to download the pdf version of this report


The main features of the different types of money

Despite the strong advantages of bank deposits mentioned in part 1 of this piece, namely the ability to use it electronically, physical notes and coins do have some significant benefits over electronic money.  The following table aims to summarize the main features of the different types of money, bank deposits, physical cash and Electronic Cash (Bitcoin).


Features of electronic bank deposits, physical notes & coins and electronic cash

Feature Bank deposit Physical cash Electronic Cash
Advantages of physical cash
Funds are fully protected in the event the bank becomes insolvent or inaccessible*
It is difficult for the authorities to confiscate funds
Funds can be effectively hidden from the authorities
Transactions cannot easily be blocked
Transfers can be highly anonymous
Transfers can be irrevocable
Transfers can occur instantly ? ?
Payments can occur 24×7 ?
Transaction fees are zero ?
Payments work during power outages or when communication networks are unavailable
Money can be used without purchasing or owning a device
Anyone can use the system, without seeking permission
Advantages of electronic systems
Payments can be made over the internet
Change does not need to be calculated
Payments can easily be recorded
Funds can easily be secured to prevent theft ?

Note: * Physical cash still has a potential problem with respect to the solvency, related to the policy of the central bank which issues the currency


Due to the strengths mentioned in the above table, physical cash will always have its niche use cases. However, on balance, banking deposits are superior to physical cash, for the majority of users.  The ability to use bank deposits electronically is particularly compelling, especially in the digital age.  As we explained in part one of this piece, it is this ability to use the money electronically that ensures there is always high demand for bank deposits, giving banks the ability to freely expand the level of credit.


The unique properties of Bitcoin

Bitcoin shares many of the advantages of physical cash over electronic bank deposits.  Although Bitcoin does not have the full set of advantages, as the table above demonstrates.  However the key unique feature of Bitcoin, is that it has both some of the advantages of physical cash and the ability to be used electronically.

Bitcoin aims to replicate some of the properties of physical cash, but in an electronic form, an “electronic cash system”.  Before Bitcoin, people had to make a binary choice, between physical cash or using a bank deposit.

Although technically physical cash is a kind of a bank deposit, a deposit at the central bank, physical cash still has unique bearer type properties which could not be replicated in an electronic form.  For the first time ever, in 2009, Bitcoin provided the ability to use a bearer type asset, electronically.  The simple table below illustrates this key unique feature of Bitcoin and blockchain based tokens.


The binary choice in legacy finance & the new option Bitcoin provides

Bearer type instrument Electronic type instrument
Physical Cash (Notes & Coins)
Electronic money (Bank Deposit)
Electronic Cash (Bitcoin)


Therefore Bitcoin can be thought of as a new hybrid form of money, with some of the advantages of physical cash, but also some of the advantages of bank deposits.


Bitcoin’s limitations

Although Bitcoin has inherited some of the strengths of both traditional electronic money systems and physical cash.  Typically Bitcoin does not have all the advantages of either electronic money or physical cash, however it is uniquely positioned to be able to have subset of the features of each.  This provides a new middle ground option.

For example, Bitcoin may never have the throughput of traditional electronic payment systems or the ability to use without electricity such as with physical cash.  Although as technology improves, Bitcoin may slowly develop more strengths and gradually improve its capabilities, to narrow the gap.


The implications of these characteristics on credit expansion

Understanding the dynamics of these characteristics, can be useful in evaluating the potential economic significance of Bitcoin, should the ecosystem grow. Bitcoin has at least six properties which provide some level of natural resilience against credit expansion, which traditional money does not have. This is because the advantages of keeping money on deposit at a bank are not always as pronounced in Bitcoin, compared to the alternatives.  However, Bitcoin is certainly not immune to the same credit expansionary forces which exist in traditional systems, indeed people can keep Bitcoin on deposit at financial institutions just like they can with physical cash.  Bitcoin may merely have greater resistance to the same credit expansionary forces.

At the core of our reasoning, is looking the advantages of bank deposits compared to physical cash, which are the characteristics that enable large banks to freely expand credit and evaluating to what extent they apply in Bitcoin.  As the table below shows, the advantages of keeping money on deposit at a bank are less significant in the Bitcoin world, therefore we think Bitcoin does have some unique resilience against the forces of credit expansion.


Physical cash vs bank deposits compared to Bitcoin vs Bitcoin deposits

Factor Physical cash compared to deposits Bitcoin compared to Bitcoin deposits
1. Security

Keeping money on deposits in financial institutions, increases security relative to keeping large physical cash balances at home, where the cash is vulnerable to theft or damage

Bitcoin can potentially allow a high level of security, without putting the funds on deposit at a bank

For example Bitcoin can be concealed or encrypted

2. Electronic transfers

Using the banking system, it is possible to send money effectively over the internet or by phone, across the world at low cost.

If physical cash is used, then a slow, inefficient, insecure physical transfer must take place

Bitcoin can allow users to efficiently transmit money over the internet, without using deposits at financial institutions
3. Convenience

Using a banking system to manage your money, can result in a convenient set of tools. For example the ability to use money using your mobile phone or use your computer.

Precise amounts can be sent so there is no issue with receiving change

Bitcoin can allow users to make payments on a mobile phone or without manually calculating change amounts.  Deposits at financial institutions are not required
4. Ability to redeem deposits In the traditional banking system, withdrawing physical cash from a financial institution is a long administrative process which takes time.  Banks therefore do not need to worry about keeping large quantities of physical cash in reserves Bitcoin can allow users to withdraw money from deposit taking institutions quickly, which may encourage banks to ensure they have adequate Bitcoin in reserve at all times
5. Auditability

Banks offer the ability to track and monitor all transactions, which can help prevent fraud and improve accountability.

Physical cash cannot offer this

Bitcoin’s blockchain or other electronic databases can allow users to effectively audit and monitor transactions, without using third party financial intermediaries
6. “Hybrid banking”

In traditional banking models there are only two fundamental choices:

1. Physical cash which provides full user control of the money

2. Money on deposit at a financial institution

This is a binary choice with no middle ground options, forcing consumers to make a difficult choice with no compromise option available

Bitcoin allows a wider spectrum of deposit and security models, resulting in a more complex credit expansionary dynamic.

For example:

1. 2 of 2 multi-signature wallet, where the bank holds one key and the user holds another key; or

2. 1 of 2 multi-signature wallet, where the bank holds one key and the user holds another key


The economic consequences of less credit expansion

The consequences of the lower level of credit expansion this analysis implies, does not really say much about whether this potentially new economic model will be more beneficial to society, nor does it say much about whether Bitcoin will be successful or not. The former is something that has been heavily debated by economists for decades and the latter is a separate topic, in our view.  Although, despite decades of economic debate, perhaps Bitcoin is sufficiently different to the money which came before it, such that the debate is required again, with new very different information.  For example inflation  or deflation, caused by cycles of credit expansion, may have very different consequences in a Bitcoin based financial system, than on one based on bank deposits and debt.  A key problem with deflation in a debt based money system, is that it increases the real value of debt, resulting in a downwards economic spiral.  For non debt based money systems like Bitcoin, it is less clear what the implications of deflation are.

Although Bitcoin may not necessarily result in a superior economic model, we think this analysis may suggest that Bitcoin may have some properties that make the economic model somewhat unique or perhaps interesting, compared to the possible models that came before it.  Therefore it does look like an area worth examining.

To many, the ultimate objective of Bitcoin is to become sufficiently dominant, such that there is a significant decrease in credit expansionary forces, which can neutralize the credit cycle and therefore the business cycle.  Although, this should be considered as an extremely ambitious objective, which we consider as extremely unlikely.  And even in the remarkable circumstance that Bitcoin grows to this scale, other  unforeseen economic problems, particular to Bitcoin, may emerge.

The SegWit2x (B2X) Hardfork – Protecting Yourself and Your Coins, Part 1: Coin Splitting

Abstract: The upcoming SegWit2x hardfork lacks replay protection.  In this piece we look at what you can do to protect yourself, by analyzing various ways you could split your coins.



SegWit2x (B2X) is a proposal to double Bitcoin’s capacity limit. This is an increase in the maximum block weight to 8MB from 4MB.

The upgrade is an incompatible with Bitcoin’s current consensus rules (known as a hardfork), which means it is likely to result in a new coin, such that Bitcoin holders prior to the fork will receive both original Bitcoin (BTC) and SegWit2x coin (B2X) after the fork. In many ways this is similar to the recent Bitcoin Cash hardfork (also an increase in the blocksize limit to 8MB). A key difference is that unlike Bitcoin Cash, B2X does not include strong transaction replay protection. Therefore many users could lose funds, on the other hand, those that do successfully protect their funds could make positive investment returns.

The hardfork is expected to occur on around Saturday 18th November 2017. (Block number 494,784)


Why bother splitting?

The SegWit2x split will result in two coins, the existing Bitcoin (BTC) and a new “spin-off” coin SegWit2x (B2X). This is likely to lead to significant price volatility, which may present investment opportunities. Due to the lack of replay protection, whatever your view on the situation or your investment strategy, it is sensible to split your coins as soon as possible, to ensure as much flexibility as possible and also to protect your coins.  Many users are likely to intend to send only one of the two coins in a transaction, but accidentally send both, which may result in an irrecoverable loss of funds.  If you do not split, you could be one of these users incurring losses.

Unfortunately the lack of strong replay protection may also present an opportunity for scammers/attackers. For example scammers could repeatedly deposit and withdraw from exchanges, hoping to find any weaknesses. If any exchange has not implemented replay protection, attackers are likely to exploit this quickly, which could make the exchange insolvent. In addition to this, individual users could be targeted by scammers. Scammers could sell the victim Bitcoin, knowing their wallet is following the wrong chain or scammers could acquire Bitcoin from a victim who is expected to replay coins on both chains to the buyer.

These kind of losses and attacks could damage the reputation of the ecosystem, therefore a contentious hardfork without strong replay protection is a high risk event with potentially significant negative consequences. However, there are actions you can take to protect yourself.


Splitting your coins

When the hardfork occurs, your Bitcoin will exist separately on both chains BTC & B2X, in the same output. Since the B2X hardfork does not contain transaction replay protection enabled by default, when spending your coins, in either chain, the transaction could be replayed on the other chain.  Therefore the prudent thing to do is split your coins, so that your BTC and B2X exist on different outputs on each chain, which means that your transactions can no longer be replayed.

Unfortunately this is not a simple process and many people are unlikely to be able to achieve this. You cannot split your coins prior to the hardfork, however a prudent strategy may be to prepare how you plan to split beforehand, for example moving your coins to a different wallet before the fork occurs. For many users this is not likely to be easy, however if you act fast, there could be investment rewards, if you are able to sell the spin-off coin before others have a chance to do so.


Which wallets to use

In order to split your coins, you would either need to manually construct your own transactions or use two wallets, one for BTC and one for B2X, since most wallets will not allow you to broadcast two conflicting transactions. You will then need two separate wallets, to receive the coins on each side of the split.

Unfortunately two full node wallets are likely to be necessary to protect your coins, for example Bitcoin Core for BTC and BTC1 for B2X. A full node wallet means it verifies all the consensus rules on the entire blockchain. Two fully verifying nodes may be needed because:

  • On the BTC side you may need a wallet that enforces the 4 million unit weight limit (which B2X plans to breach), and;
  • On the B2X side you need a wallet that enforces the coin wipeout protection rule, which requires non witness data in the first B2X block to be greater than 1MB.

You need to ensure each respective wallet enforces each of these rules, to make sure your wallets do not follow a different chain to the one on which your coins are located on.  Otherwise your coins could disappear from your wallet.

In order to prudently prepare for the hardfork, it might be a good idea to run full nodes of each client on a separate computer. The syncing process can take several days, therefore perhaps you could start to run the nodes before the fork, as you may want to be ready to split your coins and spend them as soon as possible.


The splitting methods

Method 1: The trial and error approach

The most basic way of splitting is to run a BTC client and a B2X client, import your private keys, and then try to send your coins to yourself, to two different outputs on each chain. Either both transactions confirm, in which case you succeeded, or the same transaction occurs on both chains, and you simply try again.

The trouble with this method is that it could be expensive, in terms of both time and money. Many people may try this approach and therefore network congestion could be high, and the more failed attempts occur the more one needs to pay in fees. In addition to this, at least one of the two chains is guaranteed have minority hashpower, which could increase the block interval in the short term, resulting in more transaction congestion and you would need to wait for your transaction to confirm on both sides of the split to ensure you are protected.

Unfortunately, the trouble with B2X, is not only did this fork not implement strong replay protection, so that BTC transactions are valid on B2X and vica versa, but B2X also uses the same network magic as BTC. Therefore, by default your B2X wallet will broadcast its transactions to the BTC network, making transaction replay likely.


Method 2: Locktime

Locktime is a transaction field, which ensures a transaction is only valid after a certain block height. By default some wallets, including Bitcoin Core, add the current block height to the locktime field for their transactions. There are several motivations for this transaction type, one of which is to reduce the incentive for miners to orphan the current leading block, in order to get more fee income, by scooping up the fees from transactions already confirmed in the last block and the transactions in the memory pool. This is expected to be a potential problem in the future when the block reward is low.

One could try to use this feature to split BTC and B2X coins. For example, if the BTC chain has a 5 block lead over the B2X chain, you could send a BTC transaction with the current block height as the locktime, therefore this transaction will be invalid on B2X for the next 5 blocks. If the transaction confirms on BTC, you could then send another different transaction spending the same output on the B2X network, before the 5 block period is over. This could also work the other way around if B2X has the block height lead.

This method sounds complicated, and involves monitoring both chains. However, using the Bitcoin Core wallet this may happen by default and can be combined with the trial and error method described above. In theory, all you need to do is see which chain is in the lead, with respect to block height, and then send your transaction on that chain first.


Method 3: The “official” opt in replay protection

The B2X chain is considering adding opt in replay protection. This essentially means B2X client defines a subset of existing valid transactions and then prohibits these transactions on the B2X chain. Therefore you could send a transaction in this format on the BTC network and it would be invalid on B2X, resulting in a successful split.

However, this could be technically challenging to do, as it is not clear if any BTC wallets will support this feature and there may not be enough time for wallets to implement this for ordinary users. In addition to this, it is not known what type of opt in replay protection B2X will use or if this feature will be enabled at all. The official B2X client appears to have gone through the following iterations:

  • Initially there was no opt in transaction replay protection
  • A method of replay protection using OP_Return was merged into the codebase
  • A new replay protection method, banning transactions with an output to a particular P2SH address was merged
  • Problems were found with the latest method, which could apparently result in the loss of funds. Therefore a few days ago this opt in replay protection was removed from the B2X client

Therefore it is not clear what the opt in replay protection for B2X will be and it’s possible there could be no option here at all.


Method 4: Taint the coins with already split coins

Somebody else may have successfully been able to split their coins. They could then send you an output from their split coins. You could then use this output as an input for your new transaction. Since this input only exists on one chain, your transaction would be invalid on the other chain. Ideally this could be the coinbase reward from a block mined after the split, that way you can be sure your transaction can only occur on one side of the split, regardless of any potential re-orgs.

This process seems easier than the above methods, although you must ensure you get your coin control in your wallet arranged correctly to ensure you spend the desired transaction input. This method requires waiting for somebody else, therefore it could be slow, which may be a problem if you want to split as soon as possible.


Method 5: Let an exchange do it

You could send your coins to an exchange which supports both BTC and B2X, the exchange could then handle the split for you. You need to check if the policy of the exchange is to split your coins before the split or to also split coins sent to them after the split.

A disadvantage of this policy is that your need to take counterparty risk, which you may not want to do with your long term savings.  Taking such a risk could be particularly problematic during a high risk, high volume period such as a chain split without strong replay protection, which may present operational challenges for the exchanges. This method also goes against a common narrative or mantra in the Bitcoin community, which is you should always control your private keys, especially during a hardfork.

Although an advantage of sending your coins to the exchange before the fork, is that you may be able to trade the two coins very quickly, perhaps even faster than those doing the above split methods. This could provide you better investment opportunities.



Perhaps the best strategy is to combine the above methods. After reviewing the policy of the exchanges, you could send some of your coins to an exchange of your choice before the fork and then attempt to split the remainder of your coins using method 2 explained above.

However, despite all this advice, it’s probably likely that the overwhelming majority of Bitcoin holders will take no preparatory action for the split. Therefore if you do any above, you are probably well ahead of the majority, which could hopefully lead to some financial rewards or at least help you avoid losses.

The SegWit2x (B2X) Hardfork – Protecting Yourself and Your Coins, Part 2: Investment Strategies

Abstract: The upcoming SegWit2x hardfork is likely to lead to price volatility.  In this piece we look at some potential investment strategies which could allow you to capitalize on the event.


Strategy 1: Do nothing

The most popular investment strategy following the split is likely to be to take no action and remain a holder of both BTC and B2X. This is probably the most prudent approach, as your assets may be protected whichever coin becomes more valuable. Most people may pursue this strategy out of laziness rather than choice.  However, even if this is your preferred investment strategy, it may still be sensible to try and split your coins anyway; to increase the flexibility of your investment strategy and protect your funds in case you need to make a transaction.


Strategy 2: Invest in your favored coin

Many investors may support either the BTC or B2X coin for ideological reasons or because they feel their chosen coin has the best characteristics.

  • Supporters of BTC typically prefer the consensus rules to be robust, as they feel this results in superior or more unique monetary characteristics. Also they typically value the cautious and meticulous approach of the current development team. BTC supporters may want flexibility and innovation to come from other layers in the system above the consensus rule layer.
  • In contrast to this B2X supporters may value a more flexible consensus ruleset to ensure the system is dynamic and able to cater to user requirements more quickly. B2X supporters typically value the user experience over the monetary characteristics of the system. Typically they draw less distinction between changes in the consensus layer and other types of changes to the system.

If you agree with one of these visions more than the other, it might be a good idea to invest in the coin that matches your vision, this may not only help you obtain larger returns if your vision is correct, but may also help ensure your favoured token is the “winner”, as it may contribute to the value of the coin.

Alternatively you may not care which vision “wins”, but want to back the winner. In this case it’s important not just to gage opinion, but also the level of conviction those on each side of the debate have. Somebody slightly favouring one of the visions but also wanting to hedge their bets may have less of an impact than a die hard supporter of one of the visions, who is willing to sell all their coins on one side of the split no matter what. This factor could favor the BTC side, since many die hard “large blockers” may have already sold some BTC to invest in Bitcoin Cash.

The most common investment strategy after the fork may be to do nothing. However, of the tiny minority of people that do act, many of those people may be sellers of B2X. This is because the section of the minority that took action in favor of the large block chain in August, will not be allocated either BTC or B2X for the coins they sold for Bitcoin Cash. In contrast, the minority that quickly sold Bitcoin Cash in August, will be allocated BTC and B2X this November. Although, obviously this is highly speculative and nobody really knows what will happen.


Strategy 3: Invest in whichever coin is the cheapest/the “bad” coin – The Joel Greenblatt strategy

The top investment tip in one of our favorite books on investing, Joel Greenblatt’s “You can be a stock market genius” (bad title but a great read), appears to be that if a stock split occurs, one should buy the less favored company, the spin-off.  In this case B2X is the spin-off token.

Joel Greenblatt’s Gotham Capital achieved annualized investment returns of 50% from 1985 to 1994. One of the core strategies of the fund in this period was to invest in “bad” spin-off companies. As Greenblatt explains:

There are plenty of reasons why a company might choose to unload or otherwise separate itself from the fortunes of the business to be spun off. There is really only one reason to pay attention when they do: you can make a hole of money investing in spin-offs. The facts are overwhelming. Stock of spin-off companies, and even shares of the parent companies that do then spinning off, significantly and consistently outperform the market averages. One study completed at Penn State, covering a twenty five year period ending 1988, found that stocks of spin-off companies outperformed their industry peers and the S&P 500 by about 10% per year in their first three years of independence.

Greenblatt mentions that spin-offs tend to be driven by a “desire to separate out a bad business so that an unfettered good business can show through to investors”. The bad company or spin-off company is typically sold by investors, with the negative narrative around the bad company dominant at the time of the split, causing negative sentiment. As Greenblatt explains:

The spin-off process itself is a fundamentally inefficient method of distributing stock to the wrong people. Generally, the new spin-off stock isn’t sold, its given to shareholders who, for the most part, were investing in the parent company’s business. Therefore, once the spin-off’s shares are distributed to the parent company’s shareholders, they are typically sold immediately without regard to the price of fundamental value. The initial excess supply has a predictable effect on the spin-off stock’s price: it is usually depressed. Supposedly shrewd institutional investors also join in the selling. Most of the time spin-off companies are much smaller than the parent company. A spin-off may be only 10 or 20 percent the size of the parent. Even if a pension or mutual fund took the time the analyze the spin-off’s business, often the size of these companies is too small for an institutional portfolio.

Greenblatt goes on to cite four spin off case studies, Host Marriott/Marriott International, Strategic Security/Briggs & Stratton, American Express/Lehman Brothers and Sears/Dean Witter, where this thesis applied.

In many ways there are some analogies between the opportunities which may arise from Bitcoin spin-offs such as B2X and stock spin-offs. Perhaps B2X is being distributed to the “wrong people”. Bitcoin investors typically value robust rules and the resulting highly resilient monetary properties. Perhaps, some of the Bitcoin investors who value other characteristics such as flexibility and user experience may have already divested into Ethereum or Bitcoin Cash, therefore the remaining investors may “dump” B2X. The risk for B2X proponents is they allocate their new coin to the “wrong people” and the price becomes “depressed”.  However, this could provide contrarian investors an opportunity.

The price of B2X could fall to cheap levels and there could be significant amounts of negative sentiment with some people writing the coin off. This could then be a good time for contrarians to invest in B2X. This investment philosophy seems to go against a common narrative in the Bitcoin space that “network effect is king” or “the most work chain wins”, meaning a minority chain has limited prospects. However, there may be little investment basis for this view.

However, whether the Greenblatt spin-off philosophy really applies to Bitcoin spin-offs such as B2X is not clear. Greenblatt still does fundamental analysis on the bad spin-off company, and whether one can take this type of fundamental approach to Bitcoin or its spin-offs, is not obvious. It’s certainly more risky. Although, in my view, after the hardfork, if B2X is trading at c5% or less of the price of Bitcoin and the prevailing narrative is that B2X is dead, then the “bad” coin may be worth a small punt.


Strategy 4: Take advantage of different policies on different exchanges

During the Bitcoin Cash hardfork, different financial platforms had different policies. For example BitMEX essentially ignored Bitcoin Cash, and the futures price just followed Bitcoin. However, Kraken for example, supported Bitcoin Cash, in such a way that those with long margin positions on Bitcoin were also given Bitcoin Cash. Critically on Kraken if you were short Bitcoin at the time of the fork, you were then automatically short Bitcoin Cash. These different policies between exchanges provide asymmetry, which in theory can be used to earn free money.

For example going into the Bitcoin Cash hardfork, an interesting strategy was to open a margin long position of 1 BTC on Kraken and then hedge the position by taking a margin short position of 1 BTC on BitMEX. Thereby after the hardfork, you receive one Bitcoin Cash token on Kraken, essentially for free, since there was no corresponding Bitcoin Cash liability on BitMEX associated with the short.

When it comes to the upcoming fork, there are four relevant potential exchange policies one needs to consider, when trying to engage in this type of arbitrage.


Potential financial platform policies regarding the B2X spin-off token

Policy A Policy B Policy C Policy D
Split user Bitcoin deposit balances into BTC & B2X
Split user Bitcoin margin long positions into BTC & B2X long positions
Split user Bitcoin margin short positions into BTC & B2X short positions
Bitcoin lenders are due back BTC & B2X
Bitcoin borrowers owe BTC & B2X  

Note: It is also possible to have a different policy with respect to Bitcoin lending and Bitcoin margin positions, which is not illustrated in the above chart.

An interesting investment strategy to engage in before the B2X fork could be to open long Bitcoin positions with exchanges with policy C and D, and potentially open short Bitcoin positions on exchanges with policies A, B and C.  In theory, this should allow you to get B2X tokens for free.

One may think that policy C may seem a slightly inappropriate choice, as it results in an asymmetry. However some exchanges did have a policy similar to this with respect to Bitcoin Cash. The rational for this was that the burden on customers who were short Bitcoin, to go out into the market and buy Bitcoin Cash may have been too high, particularly if the liquidity of Bitcoin Cash was low.

As the B2X fork approaches, we may write a piece summarizing the policies of the main exchanges and how one could engage in this type strategy. Although, if you wait for it to be clearly explained, it could be too late and spreads could have already opened up, reflecting the opportunity. On Bitfinex, B2X is already trading at over $1,000, therefore there could be money to be made by engaging in these types of strategies. Perhaps a good idea, if you really like taking risks, may be to review the policies exchanges took with respect to Bitcoin Cash, to get an idea of what their policies might be with respect to B2X and then open your positions before the policies are officially announced.

ICOs – Part 1 – An Interactive Visualization of the ICO Space

Abstract: In this week’s piece, we look at the world of ICOs.  We present an interactive visualization, that illustrates the entire ICO landscape and the interconnections between people officially affiliated with each ICO.


Interactive ICO team member network map

Source: BitMEX Research, ICO websites, icoHunt own and provided the raw data (Do not use the data without their permission)

Network map notes

  • Blue circles represent ICOs
  • Yellow circles represent ICO team members, advisers or backers
  • Circle size is weighted by number of links to other ICOs
  • Data includes around 500 ICOs &  around 4,900 team members
  • We apologies for any errors, omissions or spelling mistakes

ICO network map viewing tips

  • Modify the number of nodes to around 1,000
  • Alternatively, start with 5 nodes, then gradually press the up arrow to add 10 nodes at a time
  • Displaying all 5,388 nodes may use up significant amounts of system resources
  • An illustration of the type of visualization which can be produced is provided here


The negative implications of the extent of ICO team member interconnections

The above network visualization illustrates the high degree of interconnections between the ICOs, with a few dominant individuals involved in many projects.  Skeptics may therefore argue that it is not feasible for any one individual to be involved in this many ICOs, and this is an indication of misleading marketing, bad practice or inadequate disclosure.


Comparing ICOs & IPOs

Many of the individuals listed in multiple ICOs are often listed as a backer or adviser, rather than as an individual involved in day to day management.  In some ways they may be more of an ICO “sponsor” than someone actively involved in project development.  For example, as the chart below illustrates, the concentration of individuals involved in multiple ICOs compares reasonably well to financial advisers or book-runners involved in IPOs.

Vitalik Buterin is the most prolific person when it comes to ICO involvement.  Our analysis shows he has involvement in at least 13 projects, around 2.5% of the total.  Although if you think of Vitalik’s role as more of a sponsor, then Vitalik has a lower market share than Citibank when it comes to IPOs, which has been the lead bookrunner in 3.7% of the IPOs in the last 12 months.


Market share of advisers (Top 20) – ICO/IPO comparison

Source: BitMEX Research, icoHunt, ICO websites, Bloomberg IPO database
Notes:  The above dataset is from around 520 ICOs and 3,266 IPOs which have occurred in the last 12 months.  The market share is based on the number of offerings, not value of the offerings.


The role of a lead bookrunner in an equity IPO, may be to do the following:

  • Underwrite the offering,
  • Ensure the offering complies with regulations,
  • Ensure price stability and liquidity after the stock lists,
  • Prepare marketing materials for the IPO,
  • Bring management of the company on a tour to see potential investors in a roadshow,
  • Use its investment sales staff to promote the offering to its clients,
  • Assist in the allocation of the shares to the offering participants.

In many ways these responsibilities are similar to the roles of some of the most prominent individuals in our ICO analysis above, certainly with respect to marketing and promotion. However, in the world of ICOs the role of the “sponsor” is a lot more murky.  The individual in question is sometimes said to be the person who originated the idea, is involved in management or even the development of the product.  The ICO market therefore lacks clarity with respect to the roles and responsibilities of the individuals involved.


The initial allocation

The initial allocation of shares during an IPO is often an opaque process.  Typically the bookrunner/adviser decides the allocation on a discretionary basis, with the largest institutional and hedge fund clients favored first, rather than a fair random process or auction driven mechanism.  It is somewhat surprising that financial regulators have not clamped down on this practice. Although a counter argument to regulation is that listing companies should have the freedom to decide who their new shareholders are, if their are multiple bidders.  Unfortunately the bookrunner/adviser seems to have a significant influence on the allocation process.

Despite the opportunity to improve on what IPOs do in this area, the initial allocation process when it comes to ICOs does not appear to be much better.  The initial allocation of ICOs is also a murky process, but in some ways even worse than for IPOs, since earlier or better connected investors sometimes get lower prices. The allocation process can be based on who is friends with the people in the team or other industry connections.  Therefore on balance, despite poor practice, IPOs appear to have a somewhat fairer process when it comes to allocation than ICOs.

Although one could cynically say there is a key difference in the offering process between ICOs and IPOs, this time we are the ones in control.

ICOs – Part 2 – Investment Returns

Abstract: Although the reliability of the data is limited, in this piece we look at the investment returns one would have achieved  by investing in ICOs.  We compare the returns against the amount each ICO raised and look at the historic investment performance of the most prolific ICO advisers.


ICO investor returns (log scale)

Source: BitMEX Research, Coinmarketcap, ICO websites, Reddit comments
Notes: A return of 10x means the investor made 10x their money.  Prices up to 25th September 2017


The integrity of the data

  • In general the quality of pricing data for ICOs is poor, we are likely to have made significant errors in many cases.  We apologies for any inaccuracies.
  • ICOs often have particular circumstances and conditions, for example multiple ICO rounds or offerings in different currencies.  Unfortunately due to a lack of transparency and a high degree of complexity, in some cases, we have not been able to account for all of these particularities in a consistent basis.
  • In some circumstances we may have been unable to determine the ICO price and therefore may have used the price on the first day of trading.
  • There may be some selection bias in our analysis, for example we may be more likely to have investigated the investment performance of ICOs which subsequently turned out to be successful.
  • Unfortunately, in a small number of cases we obtained the ICO price from Reddit comments, due to the lack an alternative source.


ICO investor returns compared to the amount raised in the offering (log scale)

Source: BitMEX Research, Coinmarketcap, ICO websites, Reddit comments, Coindesk
Notes: A return of 10x means the investor made 10x their money


In the above chart we compare the amount raised in the offering with the investment returns of the ICOs.  From looking at the chart, it appears that there is a slight negative correlation, although the correlation is not strong enough to pass rigorous statistical requirements.


ICO investor returns of for the top 20 ICO advisers (log scale)

Source: BitMEX Research, Coinmarketcap, ICO websites, Reddit comments, ICO Hunt
Notes: The numbers in brackets represent the number of ICOs we were able to obtain return data for compared to the total number of ICOs the adviser is involved in


Finally we look at the investment returns of the top 20 most prolific individuals in the ICO space, by number of ICOs.  In many cases, the ICOs occurred very recently and therefore pricing data is not yet available.

The SegWit Transaction Capacity Increase – Part 2 – The First Month After Activation

Abstract: SegWit adoption has grown at a steady pace since activation one month ago and this has surprisingly coincided with a large reduction in transaction fees.  Although we think this drop in fees may be a coincidence, as the absolute level of SegWit adoption in the first month is reasonably low

The first month of SegWit data

As the chart below (figure 1) shows, in orange, SegWit adoption has increased steadily since activation, in a somewhat linear fashion.  Adoption has now reached around 4.5% of transactions.  This should represent a small theoretical c1.6% capacity increase for the network, after just one month.

As figure 1 illustrates, the activation of SegWit does appear to have coincided with a sharp reduction in average transaction fees.


Figure 1 – Transaction fees compared to SegWit adoption

Source: BitMEX Research
Note: Data based on daily averages, up to 20th September 2017


As figure 2 below shows, Bitcoin denominated transaction fees do somewhat correlate with the Bitcoin price and Bitcoin price volatility.  This relationship is probably due to higher Bitcoin prices causing increased levels of transaction demand. The first month since SegWit activation was a period of large Bitcoin price increases and high price volatility, which makes the large transaction fee drop appear somewhat unusual.  The drop is transaction fees appears to start during the period when the price was still rapidly increasing.


Figure 2 – Transaction fees compared to Bitcoin price

Source: BitMEX Research
Note: Data based on daily averages, up to 20th September 2017


As figure 3 below illustrates, SegWit usage is still low compared to non SegWit usage.  Although markets and the price elasticity of demand can be very difficult things to quantify and it is possible that the small 1.6% implied capacity increase caused a reduction in transaction fees, we believe this is unlikely.  Therefore the sharp reduction in transaction fees is likely to be an odd coincidence.

It is therefore too early to tell if SegWit was successful in increasing transaction throughput and lowering transaction fees.


Figure 3 – SegWit adoption compared to old format transactions

Source: BitMEX Research
Note: Data based on daily averages, up to 20th September 2017


An alternative explanation for the fee reduction is that not all of the historic demand was “genuine”.  A spammer could have been attempting to inflate transaction demand and increase transaction fees.  Perhaps the activation of SegWit or launch of Bitcoin Cash meant this spammer now has less reason to continue the expensive attack.  Although there is no direct evidence to support this theory.

The SegWit Transaction Capacity Increase – Part 1

Abstract: SegWit replaces the old 1MB blocksize limit, with a new more complicated 4 million unit blockweight limit.  This should double the transaction throughput of the network, but only after wallets upgrade to send new SegWit style transactions.  This piece analyzes how the network throughput could increase, as users gradually upgrade to SegWit

Overview of the capacity increase

Segregated Witness is an upgrade to the Bitcoin protocol, which may increase the level of transaction throughput.  In order to benefit from increased transaction throughput, users need to upgrade to the new transaction format.  This may make the throughput increase slow and gradual.  Although those that do upgrade, may experience the benefit of a reduction in transaction fees reasonably quickly.

Higher transaction throughput is achieved by replacing the old blocksize limit, with a new blockweight limit.  The old 1MB blocksize limit (shown below), has been removed from the code:


The new, more complex, blockweight limit is determined by the following formula:

4 * non witness data (in bytes) + witness data (in bytes) < 4 million units

This new limit should approximately double the transaction throughput of the network, once users and businesses upgrade to the new transaction format. Miners trying to maximize transaction fee revenue, will attempt to include as many transactions as they can, with blockweight being the new limiting factor.


What is the witness data?

The witness data is the digital signature, authorizing the spend of the payment.  The below diagrams attempt to illustrate the transaction structure before and after SegWit.  The witness data can take up around 54% of the data in a typical transaction and is represented in the green rectangles in the 2nd diagram below.

Pre SegWit – Illustrative transaction structure (percentage data usage)


SegWit – Illustrative transaction structure (percentage data usage)

Fixing third party transaction malleability

It is often mentioned that SegWit “splits” the witness and non witness data up, into two separate places.  This is not really true, the witness and non witness data still exists together.  As the diagram above illustrates with the green arrows, the key difference with SegWit is that the witness data is no longer needed when calculating the transaction ID (TXID), which is later used to spend the funds in the next transaction.

This is the solution to the third party transaction malleability problem.  If the signature changes, from one valid signature to another valid signature, the transaction ID remains the same.  Therefore it is reasonably safe for transaction 2 to be created and broadcast to the network, before transaction 1 has been confirmed in the blockchain.  This should improve the user experience, as there is now less need for users to wait for confirmations, which can be slow.


The throughput benefits of upgrading to SegWit style transactions for individual users

Assuming the witness data makes up 54% of transaction space, when one upgrades to SegWit, transactions should take up around 41% less blockweight that old style transactions, as the following formula illustrates:



Therefore, assuming fee market conditions are unchanged (i.e. transaction fee levels are the same as before SegWit), by upgrading to SegWit, the user should benefit by paying 41% lower fees than before.  This benefit occurs before other users upgrade to SegWit.

Users who do not upgrade to SegWit, should pay the same fee levels as before.  However, there is a theoretical “side benefit” which they may experience, caused by other users freeing up space by using SegWit.  This may improve fee market conditions and result in lower fees, even for users that have not upgraded to SegWit.  Estimating the magnitude of this so called “side benefit” is almost impossible, since it depends on fee market conditions.


The throughput benefits of SegWit on the entire network

Below we analyse what the network throughput dynamics could look like, if users and businesses decide to opt in to SegWit style transactions, such that there are high adoption levels.

The chart below compares how the blockweight and blocksize could vary, as the amount of witness data in a block increases.  The left hand side of the chart illustrates low levels of SegWit adoption (where we are now), whilst as we move to the right, higher adoption rates are assumed.

If we achieve high adoption rates, the blocksize may be around 2MB, consisting of 1.3MB of witness data and 0.7MB of non witness data.  The block weight would be 4 million units.  This would mean the throughput of the network increases by around 100%.


Blockspace dynamics assuming “normal” SegWit usage


Theoretical blocksize problems

Sceptics of SegWit often mention some problems.  A common claim is that:

SegWit enables 4MB blocks, with only 1MB of transactions

Perhaps the people who are making this claim are visualizing something similar to the below chart. This chart is similar to the one above, except instead of assuming “normal” transaction patterns, we assume the block weight remains at 4 million units, while the witness data grows to 4MB.

On the right hand side, the chart shows that a block could theoretically be 4MB in size (containing only witness data), which a spammer could produce for the same fees as producing a 1MB block (containing only non-witness data). Since both blocks contain 4 million units of weight.


Blockspace dynamics when blocks always contain 4 million units of weight


It is true that a spammer could produce such a 4MB block, which would cost the same in fees as a 1MB block.  This is a potential problem.

However, this is not a change to the security properties of the system, because the 4MB block is not cheaper than the 1MB block, it merely costs the same. A spammer can always outbid legitimate users, regardless of SegWit. Indeed an attacker could simply produce 1MB of non-witness data, to compete with “legitimate” users, and this attack vector is no cheaper than before.  SegWit does not and cannot change the security dynamic, that if an attacker wants to outbid users with spam data, they can.

There is still a potential problem here.  There is now a “worst case” block of 4MB, even though the expected capacity benefit may only be slightly more than 2x the old 1MB limit, rather than 4x.

There is some merit to this criticism of SegWit.  However, due to the scaling properties of the witness data, the situation may not be as bad as one would think.  In some ways the witness data has better scalability characteristics than the non-witness data.


We discuss some of these characteristics below:


  1. Signature verification: SegWit mitigates the quadratic hashing of sighash operations problem, by changing the calculation of the transaction hash for signatures so that each byte of a transaction only needs to be hashed at most twice. Therefore a block containing a large amount of witness data, will have a large amount of data with this linear hashing characteristic, reducing potential signature verification times and improving scalability.
  2. The impact on the database on unspent transaction outputs (UTXO): The witness data relates to signatures for transaction inputs. If one wants to create new transaction outputs, this would not be included in the witness data. Therefore a theoretical 4MB block contains no new outputs. A large block block therefore has a neutral or even positive impact on the size of the UTXO set.
  3. Long term storage costs: The worst case 4MB blocks can have a negative impact on long term storage costs.  However, when segregating the witness, the witness is no longer used in the calculation of the the transaction ID (TXID). This means one can calculate the TXIDs, the merkle root hash and block hashes, without the witness data. All one needs is the witness commitment and the block hash can be calculated without the witness data. A wallet can therefore get “proof of work (PoW) assurance” over the security of payments, while discarding the witness data. Although if one wants to verify all the witness data on restart of the node, the witness data must be stored.
  4. Block propagation/latency: In the worst case scenario, these theoretical 4MB blocks will have inferior propagation characteristics. However, technologies such has compact blocks have mitigated some of these risks.  Although the recent apparent crackdown in China may illustrate that this is a potentially serious problem.
  5. Bandwidth: 4MB blocks could increase the bandwidth burden on nodes/wallets, compared to 1MB blocks of non witness data. This is therefore a potential disadvantage to these larger blocks. Although, perhaps some light wallets could only download the witness data for their own transactions, they would therefore never need to download the rest of the witness data, but they could still link the block hashes to the transactions and therefore obtain “PoW assurance” over the payments and wallet balances.

Mining incentives, part 2: Why is China dominant in Bitcoin mining?

Abstract: This piece explores why China appears to dominate the Bitcoin mining industry. Chinese Bitcoin mining could be the inadvertent beneficiary of a massive boom and over-investment in hydro power, linked to aluminum production, in remote regions in China over the last 10 years.

China globally dominates most energy related fields

One question often asked by some in the Bitcoin community is Why are so many mining pools and miners based in China?

The most basic response to this question is: why not? China is not just some random country. It is a global economic powerhouse, dominant in most industrial and energy sectors. For instance:

  • China accounts for roughly 68% of the world’s imports of iron ore.1
  • China produces roughly 54% of the world’s aluminium.2
  • China consumes roughly 50% of the world’s coal.3
  • Of the 60 nuclear plants under construction across the world, 22 are in China, and China has accounted for about 183% of the world’s growth in nuclear-power consumption in the last 10 years (this number exceeds 100% because Japan shut down its reactors following the Great East Japan earthquake of 2011).4
  • China consumes about 30% of the world’s hydro power and accounts for 76% of the world’s growth in hydro-power consumption in the last 10 years3

China is unquestionably already the dominant driver of the global energy industry, and perhaps it is no surprise that China is dominant in Bitcoin mining, an industry that is strongly related to energy generation. Indeed, new, efficient power plants, particularly in the field of hydro power, may partially explain China’s dominance in Bitcoin mining.

Reasons typically cited for Chinese dominance

One of the largest and most discussed advantages for China is the local infrastructure and expertise that enables mining farms to quickly set up as soon as the mining chips are available. This setup process is said to be much slower in other regions. Being able to quickly set up can be crucial, as new more efficient chips are developed all the time. China also has geographical proximity to where the specialist chips are manufactured.

Another alleged advantage is corruption in the power industry in China, with some Bitcoin miners perhaps able to pay power-plant owners for the right to place mining equipment inside or near to the power facilities.

Other factors may also contribute to China’s dominance, but these are not widely discussed within the Bitcoin community. Most notable is China’s surplus captive hydro-power capacity, constructed for the loss-making aluminium industry.

China’s hydro boom

Global hydro-power consumption by region in units of million tonnes of oil equivalent from 2006 to 2016. (Source: BP Statistical Review of World Energy June 2017)

As the chart above shows, China has been the dominant driver in world hydro-power growth in the last 10 years. Hydro power is a good energy source for Bitcoin mining, since the marginal cost of power generation is very low, with most of the costs related to the initial investment. In addition, hydro power is reliable and stable.

The largest of China’s hydro-power facilities under construction is the Baihetan project on the Jinsha River. The facility will have 16 turbines of 3.6 TWh each, producing a total of 57.6 TWh. The project began in 2008 and is expected to be complete in 2021. The Wudongde project on the Jinsha River in the southwest is the most recent large project and will provide 36.7 TWh of capacity. It began construction in 2014, and the first generator is scheduled to be complete in 2018. The whole Wudongde project is expected to be complete in 2020. It will be the sixth-largest hydro-power facility in the world.

As a point of comparison, the Three Gorges Dam, the world’s largest hydro-power project (with the possible exception of the Itaipu Dam in South America), produces around 100 TWh.

The Three Gorges Dam on the Yangtze River in 2009. (Source: Wikipedia)

The projects mentioned above are far too large for Bitcoin mining. Bitcoin’s total electricity consumption is believed to be around 15 TWh.

In January 2017, China’s ministry of water resources issued guidelines on promoting the development of small hydro-power plants. The guidelines outlined plans to develop and grow the small-scale hydro-power industry in China by 2030. Because smaller facilities are more likely to power Bitcoin mines, this could be an interesting development.

Aluminium production

Typically, hydro power is associated with aluminium production. The Bayer process and the Hall-Héroult process, the principal industrial means of refining bauxite to produce aluminium, involve electrolysis and require a massive amount of electrical power. Steel making does not require electrical energy to the same extent.

Energy costs make up a significant proportion of the cost of producing aluminium, perhaps around 30% to 65% of the total, depending on the producer and market conditions.

In the competitive aluminium industry, it’s vital to keep costs as low as possible to remain competitive throughout the economic cycle. Canada is the number-two hydro-power producer in the world, behind China, and much of that country’s hydro power supports Rio Tinto’s (previously known as Alcan) aluminium refining.5 Similar to Bitcoin mining, aluminium smelting will follow the cheapest, most reliable energy source, which is often hydro power.

According to the International Aluminium Institute (IAI), about 80% of Canadian aluminum smelting uses hydro power. In China, only 10% of smelting relies on hydro power, with the remaining 90% powered by coal.6 Yet due to China’s massive scale, China’s 10% consumes roughly the same 50 TWh of hydro power as Canada’s 80%. Power plants constructed specifically for aluminium smelting are often called “captive plants”.

Over-investment in hydro power and the aluminium market cycle

One could argue that China has over-invested in the development of hydro power. In recent years, this investment has slowed down, as most major sites have been identified and explored. Despite this, China still commissioned more new capacity in 2016 than any other country.

Although aluminium is less vital for China’s hydro power infrastructure than it is elsewhere, it is still significant. China invested considerably in aluminium-related hydro power in 2011 to 2013, a period that was followed by significant weakening in the price of aluminum in 2014 and 2015, as the chart below shows. As a result of this price drop, many aluminum smelters became uneconomical and stopped production — and the associated captive hydro-power facilities often suffered from limited local demand for their electricity. Many of the facilities  often had been constructed in remote rural regions whose infrastructure may have been unable to send the power to a major city, due to long distances and a lack of ultra-high-voltage (UHV) electricity transmission infrastructure in China.

Bitcoin mining may be one of the only suitable consumers of the energy in such circumstances. Without UHV lines, much energy is lost to resistance during electrical transmission. Bitcoin mining can, in theory, transfer the equivalent value of the energy to the main cities in the east of China, avoiding loss due to resistance in the lines. Bitcoin miners with access to this cheap electricity from captive plants may demand and receive lower prices of power than they could find in urban areas. Of course, this process only works if there is demand for Bitcoin in the cities, which in the last few years appears to have been true.

As the chart below shows, the price of aluminium has recently recovered, although this is partially due to China’s reduction of aluminium production by shutting down loss-making smelters.7 The Chinese government’s strategy is to reduce subsidies to loss-making heavy industries in order to shift the economy towards technology and consumer areas. This is also part of a wider push to protect the environment and improve the air quality in China.

Aluminum spot price. (Source: London Metal Exchange)

Capacity utilization of aluminium producers

The chart below indicates that China has undergone a massive boom in aluminium production, from almost none of the global market 20 years ago to being globally dominant. Although production growth has slowed in recent years as a result of massive over-investment and significant under-utilisation, as the second chart illustrates. The third chart indicates the scale of the overcapacity in China, with China having the least utilisation apart from the United States, which is also reducing production.

Global aluminium production by country from 1995 to 2016 in million tonnes of aluminium. (Source: BitMEX Research, US Geological Survey)


Surplus aluminium production capacity by region from 1995 to 2016 in million tonnes. (Source: BitMEX Research, US Geological Survey)


Aluminium production capacity utilisation. (Source: BitMEX Research, US Geological Survey)

Canada’s lower structural costs have allowed Rio Tinto to achieve strong aluminium-related net profit margins of around 10%8 in the last three years despite the lower aluminium price, which explains Canada’s high capacity utilisation, approaching 100% in 2016.

Rio Tinto’s modernised Kitimat hydro-powered aluminium smelter in Canada. (Source: Rio Tinto)

The implied hydro-power over-capacity

After analyzing the aluminium production overcapacity data, we multiplied this by the percentage of aluminum smelting powered by hydro power in each region to calculate an approximation of the surplus hydro-power capacity related to aluminium. This may be an overestimate, as the coal-powered smelters may have been disproportionately shut down.

The results, in the chart below, show that China has a huge surplus, despite the fact that only some 10% of its aluminium smelting is powered by hydro power.

Implied under-utilized hydro-power facilities from 2004 to 2016 in million tonnes of aluminium equivalent. (Source: BitMEX Research, US Geological Survey, IAI)

Although the chart shows China has by far the largest surplus of hydro-power capacity related to aluminium, this doesn’t paint the full picture. Much of the non-Chinese surplus capacity is concentrated in North America and Europe near regions of higher population density with stronger UHV transmission-line infrastructure.

A significant amount of China’s energy sources are located in the west of the country while most of China’s population, and resultant energy demand, resides in the east.

China has several UHV transmission-line projects underway, which will deliver energy from rural regions to cities in the east. The State Grid Corporation of China aims to invest US$88 billion on UHV lines between 2009 and 2020. Many lines are due to be complete in the coming years and it will be interesting to see if this has any impact on Bitcoin mining.

Global electricity consumption

Global aluminum production consumes about 804 TWh of electricity, around 3.2% of the total global consumption. Based on the latest estimates, Bitcoin mining consumes around 2.1% of the electricity used in aluminium production.

However, because of its greater flexibility with respect to where it needs the electricity, aluminium electricity is expected to cost far less than 3.2% of the global cost. Similarly, Bitcoin mining is expected to cost even less than 2.1% of what aluminium producers spend on electricity.

Global electricity consumption (TWh) 2016 %
Bitcoin mining* 16.7 0.07%
Aluminium production 804.0 3.22%
Other 24,179.0 96.72%
Total 25,000.0 100%

*Bitcoin annualised projection based on latest figures. (Source: BitMEX Research, BP, IAI, Digiconomist


The confluence of under-utilised hydro power due to over-investment in subsidized loss-making aluminium production, the construction of these facilities in the remote west of the country, and a lack of UHV transmission infrastructure have contributed to China’s Bitcoin-mining success.

We appreciate that the situation can be looked at from many angles and perhaps other explanations have more direct relevance to Bitcoin mining.


World’s Top Exports
US Geological Survey
BP Statistical Review of World Energy June 2017
Nuclear Energy Institute
Rio Tinto
International Aluminium Institute
Bloomberg: “China’s Metals Curb Plan Seen Risking Shortages in Biggest User”
Rio Tinto Annual Report (p. 199)
Chalco 2015 Annual Report (p. 11)
10 Reuters: “Chinalco plans shutdown of biggest aluminum smelter”

Mining Incentives – Part 1 – The Economics of the Difficulty Adjustment

Abstract: This piece contrasts mining economics between Bitcoin and traditional resource mining. We look at how the difficulty adjustment can impact profitability in the mining industry and some potentially perverse incentives.


Bitcoin’s Mining Difficulty Adjustment

Mining is the random process by which new Bitcoin blocks are found, such that transactions are confirmed. This is a necessarily competitive and energy intensive process.  In order to ensure a smooth and reliable network, every two weeks, based on how many blocks were mined in the period, the mining difficulty adjusts.  There is an average target interval between blocks of 10 minutes.

A two week period is split into 2016 sections of 10 minutes.

  • If more than 2016 blocks were mined in a two week period, mining becomes more difficult, such that if the hashrate remains constant, blocks are expected to be found every 10 minutes in the next two week period.
  • If fewer than 2016 blocks were mined in a two week period, mining becomes less difficult, such that if the hashrate remains constant, blocks are expected to be found every 10 minutes in the next two week period.
  • The maximum adjustment in any one period is a factor of 4 (i.e. a range of 25% to 400% of the old difficulty).

The below chart shows the difficulty adjustments (red line) and the calculated rolling two week hashrate estimate (green line), over the last 2 months.



Mining Equilibrium and the Misconception This Means Miners Cannot Make Profits

In theory, the difficulty adjustment keeps the system in check, in an equilibrium position, when external inputs change.  For example consider the following scenario of a sudden increase in the Bitcoin price:

  1. The Bitcoin price increases
  2. Mining profitability increases, since miners are rewarded in Bitcoin
  3. More miners join the network to take advantage of higher profit margins and there are limited mining entry barriers
  4. The network hashrate increases and the average block interval falls below 10 minutes
  5. After a few weeks, the mining difficulty increases and therefore mining profitability decreases
  6. The average block interval increases back up to 10 minutes

The same kind of logic can be applied to an increase in Bitcoin transaction fees or the release of new more efficient mining hardware.  The theory can also be used in reverse, for a sudden Bitcoin price decrease.

Contrary to a popular misconception, this short two week period combined with the theoretical ability of anyone to quickly enter the mining industry, does not mean mining industry profit margins tend to zero every few weeks.  What the difficulty adjustment may mean is that the profit margins of the most marginal miner quickly tend to zero.  However, not all miners are the same, for example some miners may benefit from structurally lower costs, such as lower electricity costs, more scale or an effective maintenance regime.  These more efficient miners may be able to produce stable profits throughout these cycles.

In addition to this, it is no longer true that there are limited barriers to enter the Bitcoin mining business, at a particular cost level. For example perhaps a large capital investment is required, there may be large time lags before the mining farm is active, cheap electricity may be difficult to source and the latest specialist mining chips may be hard to get hold of. Therefore the assumption that there are limited entry barriers may no longer hold anyway.


The Gold Mining Industry as an Analogy

The below chart illustrates total world gold mining production, by mining company.  The x-axis displays the proportion of global gold production by company, while the y-axis is a measure of the cost to produce one troy ounce of gold.  The cost measure is called “All In Sustaining Costs” (AISC), which includes both the marginal cost of production (variable costs) and annual depreciation of the capital investment incurred to construct the mine (fixed costs).  The straight red line represents the spot gold price.


Gold mining industry cost curve


As the chart illustrates, miners on the left hand side are able to generate profits, despite moderate reductions in the spot gold price.  In contrast miners on the far right hand side, can be classified as the most marginal miners.  The profit margins of these most marginal miners does tend to zero over the cycle.

If the gold price increases, over the long term, more gold miners may join the industry on the right hand side of the chart, increasing the supply of gold, eventually causing downward pressure on the price of gold.  This type of equilibrium cannot occur in Bitcoin since the supply is fixed, therefore the difficulty adjustment is an alternative equilibrium mechanism.

Starting up a new gold mine takes many years (currently much longer than in Bitcoin) and the miner may want a large price buffer before deciding to invest in a new mine, therefore Bitcoin’s equilibrium mechanism can be thought of as occurring much faster than in traditional mining.

The grey bar on the far right hand side of the chart shows a miner making a loss.  However, since the AISC includes depreciation, it may be rational for this loss making miner to remain open, to make a contribution to the capital investment initially made, although the original investment decision turned out to be a bad one.

The same logic could be applied to Bitcoin mining, the fixed costs are items such as acquiring the mining equipment and building a mining farm, while the variable costs are items such as electricity bills and maintenance.  Therefore, just like in traditional mining, it could be rational for a loss making Bitcoin miner to remain open, as long as it’s making a contribution to the initial fixed costs.  One could call this a free cash flow (FCF) positive miner. This could help ensure the mining hashrate and Bitcoin network conditions are more stable than they otherwise would be.


How the Mining Adjustment Impacts Industry Economics

When the mining difficulty increases, the cost for the miners to produce one Bitcoin should shift upwards.  Incidentally this is a not necessarily a parallel upward shift in costs.  An upward difficulty adjustment by 10%, should in theory only increase the variable costs needed to produce one Bitcoin by 10%, while leaving the fixed costs, such as depreciation, unchanged.

Each miner may have a different breakdown between fixed and variable costs.  The fixed costs should remain unaffected by a difficulty adjustment, such that miners with a higher proportion of fixed costs, perhaps due to very low electricity charges, may comparatively benefit from an upwards difficulty adjustment, compared to its peers.

This dynamic is different from traditional resource mining (e.g. gold mining). If the gold spot price changes, this neither impacts the variable or fixed costs, of producing one troy ounce of gold.  Therefore in gold mining, the actions of other miners cannot directly impact the costs in any one mine, whilst in Bitcoin difficulty adjustments, driven by the actions of other miners, can directly impact the cost per unit production. If the spot price of gold increases or decreases, all gold miners take a parallel hit with respect to  sales and therefore profits per troy ounce.  This dynamic is different in Bitcoin mining. As a result of this, in Bitcoin, the mining industry could be more stable than for gold mining. However the downside to this stability is that the Bitcoin spot price may be more volatile than gold, as production volume doesn’t adjust to reflect price changes.


In theory, Some Bitcoin Miners Could Even Profit in Absolute Terms from Falling Bitcoin Prices

We have explained how some Bitcoin miners can comparatively benefit from a lower Bitcoin price, however it may also be possible for some miners to get an absolute benefit from a falling Bitcoin price, in the short term.

If the spot price of Bitcoin falls, initially all miners take a parallel revenue hit per Bitcoin produced, just like in traditional mining. However, should miners on the right hand side of the cost curve leave, depending on the shape of the costs curve, some miners could actually see the absolute level of their profits increase.  In some ways this could make the Bitcoin mining industry earnings more resilient to price crashes, but in other ways it could produce perverse incentives.

As the contrived and perhaps unrealistic cost curve below demonstrates, if the Bitcoin price were to fall to $800 form $1,000, the large chunk of miners with costs just below $1,000 could shut down their machines.  The difficulty could then adjust downwards and miners on the left hand side of the curve could, in theory, increase the absolute level of their profits.  A similar analysis could be conducted, but instead of miners leaving, it could apply to the absence of miners entering the market.


Contrived mining industry cost curve (variable costs)


Therefore, perhaps some miners may benefit from falling Bitcoin prices, in some time periods.  Who knows, we may already be seeing this phenomenon, to some extent, with larger lower cost miners wanting the price to remain low such that new miners do not enter the market.  Although this is probably somewhat unlikely.