They forgot to hedge
With the run up in prices of every cryptocurrency in 2018, everyone wanted to be a miner. Who doesn’t like found money? Now it seems like the new year’s resolution of some crypto mining firms is “no more mining”. At least the ones in Japan anyway.
The problem with a lot of businesses, and it’s not peculiar to crypto miners alone, is their refusal to hedge their income. We see this problem with firms that have significant F/X exposure. They are all too happy when the F/X rate pendulum is going their way. It’s like icing on a cake that already has icing. You can’t have too much sugar and you can’t have too much profit.
Unfortunately, pendulums have this nasty habit of swinging in the opposite direction. When that begins to happen, most businesses don’t react because the motion is slow and there is still additional icing, albeit a reduced amount.
When the pendulum hits the center point, they still hang on. After all, they are still making the full profit from the business even if nothing extra comes along. But then the pendulum continues its motion and starts eating into profits. Businesses resort to hoping the good times return. They focus on reading articles that are optimistic and quickly delete any negative article.
Pendulum keeps swinging.
Eventually, businesses that can’t weather the storm get shaken out. Those that survive do so with some serious bruising. Every firm that didn’t hedge suffers needlessly.
Here’s the deal. If F/X speculation is not an explicit part of your business model, you should be hedging. If you are a crypto miner and price speculation is not an explicit part of your business model, you should be hedging. In fact, if price speculation is part of your business model and you suck at it, you should hedging. If you are fantastic at price speculation and you never hedged, you will soon suck at it, so guess what? you should be hedging.
So what should you be doing? Altogether now,
YOU SHOULD BE HEDGING!
As a crypto miner, your business model is making money from verifying transactions on the crypto blockhain. Figure out what your breakeven number is and then project your growth and profit from there. At a minimum, you want to hedge at your breakeven number. That way you don’t have to keep checking the market price at every tick. To offset the cost of the downside risk, you can sell part of your upside risk. Alternatively, you can hedge only part of your portfolio, say 80%.
Smart firms have been doing it for years. Southwest airline had a sophisticated jet fuel hedging desk that allowed them to focus on the business of flying rather than worry about the volatile costs of jet fuel. It was so sophisticated they used heating oil as a proxy for jet fuel when the liquidity for the jet fuel and kerosine contracts weren’t sufficient. The result was smooth earnings for years. By the way, hedging didn’t help the southwest cabin crew improve the quality of their jokes. Some things have no workable solution.
Energy firms do the same. Multinationals with huge commodity exposures do the same. Time for crytpo miners to grow up.
Yes, it’s a bit of a downer to watch the price rallying in your favor and not being able to take advantage of it but be comforted with the knowledge that the pain is worse if the price goes against you and are bleeding cash.
