Pricing ASICs for Cryptocurrency Mining

TL;DR

This paper models cryptocurrency mining as a financial option, providing a novel pricing method that accounts for volatility and risk, revealing that mining hardware may be undervalued and that returns can be replicated through trading strategies.

Contribution

It introduces a new option-based pricing framework for mining hardware, highlighting the impact of volatility on value and exposing mispricing compared to traditional methods.

Findings

Volatility increases mining hardware value, contrary to popular belief.

Current tools overlook the risk due to cryptocurrency exchange-rate volatility.

Trading portfolios can imitate mining returns and have historically outperformed actual mining revenues.

Abstract

Cryptocurrencies that are based on Proof-of-Work (PoW) often rely on special purpose hardware to perform so-called mining operations that secure the system, with miners receiving freshly minted tokens as a reward for their work. A notable example of such a cryptocurrency is Bitcoin, which is primarily mined using application specific integrated circuit (ASIC) based machines. Due to the supposed profitability of cryptocurrency mining, such hardware has been in great demand in recent years, in-spite of high associated costs like electricity. In this work, we show that because mining rewards are given in the mined cryptocurrency, while expenses are usually paid in some fiat currency such as the United States Dollar (USD), cryptocurrency mining is in fact a bundle of financial options. When exercised, each option converts electricity to tokens. We provide a method of pricing mining hardware based on this insight, and prove that any other price creates arbitrage. Our method shows that contrary to the popular belief that mining hardware is worth less if the cryptocurrency is highly volatile, the opposite effect is true: volatility increases value. Thus, if a coin's volatility decreases, some miners may leave, affecting security. We compare the prices produced by our method to prices obtained from popular tools currently used by miners and show that the latter only consider the expected returns from mining, while neglecting to account for the inherent risk in mining, which is due to the high exchange-rate volatility of cryptocurrencies. Finally, we show that the returns made from mining can be imitated by trading in bonds and coins, and create such imitating investment portfolios. Historically, realized revenues of these portfolios have outperformed mining, showing that indeed hardware is mispriced.