TFTC: A Bitcoin Podcast - #365: Luxor Mining and Bitcoin Hashrate Derivatives with Matt Williams

Episode Date: October 11, 2022

Join Marty as he sits down with Matt Williams to discuss Forward Contracts. They dive into the details of hedging strategy, the software of forwards contracts, and the connection between mining companies and the energy industry. Check out Luxor Shoutout to our sponsors: Unchained Capital Braiins HodlHodl Upstream Data TFTC Merch is Available: Shop Now Join the TFTC Movement: Main YT Channel Clips YT Channel Website Twitter Instagram Follow Marty Bent: Twitter Newsletter Podcast

what's up freaks it's your boy marty here to introduce this rip of tftc i sat down with matt williams the head of derivatives at luxor mining to discuss their new non-deliverable forwards contract hash rate derivatives more coming to market very fascinating space something I've been really tuned into on the mining side of things. Hash rate derivatives are something I think are inevitable, I think are extremely important.

And Matt and I dove into the particular product that Luxor has launched and how miners can leverage it, what it will do for the distribution of hash rate, ownership, and a number of other things. He's also on the team

that launched the CME, Cash Settled Futures. so if you want to blame somebody for Bitcoin price suppression go find him and yell at him just kidding we talked about that as well this report was brought to you by our good friends at Unchained Capital right down the hall

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bitcoin mining space it's something that's been talked about for some time And many miners are waiting for a commercial product to come to market. I mean, obviously, there's been many derivatives products that have come to market to date. We've got BitUda building their side of things. We've got the Blockstream token hash rate contract, futures contract, whatever they're calling it. And then you guys at Luxor, you're launching a cash-shettled futures contract, correct? yeah it's not technically a futures contract it's a forwards contract forwards contract yes yeah similar nature though yes so you're the head of derivatives before we get into

the nitty-gritty of this forwards contract what brought you to luxor why why are you the man to build out this product yeah that's a good question um i have a pretty extensive background in tradfi so I used to be an energy trader a long time ago traded on the 9x and then the company I work for sent me back to Chicago where I'm from I was previously out in New York started trading eggs futures and options and then eventually made my way to work for an exchange itself so work to see me group for about five years wearing a bunch of different hats but uh one of which was helping some of their product launches and uh what is it late 2017 we launched bitcoin futures

so i was part of that team that kind of helped go to market with that and then spent two years at a regulator prior to joining luxor so got the trading experience the exchange experience the regulatory experience so you know all the pain points that it takes to launch something like this yeah freak so anybody listening out there matt's the reason why we have bitcoin price suppression because of the cme's futures contract yeah i'm the only one i get that uh i get that all the time at my own job like get ripped yeah there's a guy aaron on my team every time we go to a conference together he's always ride me for crashing bitcoin and what i mean it it's pretty pretty fun to look at the chart the date that that contract dropped

i i am not a subscriber to that theory but well i don't even know there's there's some merit to it if you think about it like before futures were launched my boss used to always say this when i was at cme he was like you can only be longer longer bitcoin you know there's no way to short it you know there's some weird esoteric instruments that existed to short it but nothing real and so you know your choices be longer or longer and so when they came out like people had a chance to to short it and i don't think it was the reason bitcoin crashed but certainly facilitated it yeah it was charlie lee coming out and saying that he dumped all his litecoin and oh charlie's out we everybody else is kind of dumb but i don't know what it what are what

were your thoughts on did you pay attention like bitmex and their their exchange when it was uh when it was riding high at that period too was that a good yeah in your mind no um I don't know I guess we had exchange bias you know we thought CME was definitely gonna be the one to build you know the best product and that some of these new exchanges like BitMax were you know they had poor infrastructure and they're you know they're crashing all the time and so yeah so the instruments we we didn't put much credence into the instruments they were launching which you know in retrospect there was some interesting stuff that came out of there but i don't know i mean cme always had the the infrastructure to kind of have the right to

win for this yeah in my mind the coolest thing about the the bitmex model was that it was pure bitcoin that's all you ever touched you sent bitcoin in if you were using bitmex i've heard stories of people just sending bitcoin in and going 100x long and sending it into the ether that is bitmex's insurance fund yeah well i suppose it depends on the audience right like if if you're talking to crypto enthusiasts it's a different use case and if you're talking to trad five people and you're trying to get people you know institutionals to adopt it it's very different very different argument institutions institutions have been coming for for well over a decade now are they here they're more here than they were yesterday

um but before actually since you traded energy on nimex i'm actually really interested to hear your thoughts on the current dynamics of global energy markets and how they're trading right now because it is this period in time will probably be looked back on as one of the most pivotal points in history as it relates to to the energy sector globally have you been following it i know you're focused on hash rate derivatives now but yeah it's it's hard not to follow it right i mean it's been it's been a high topic for for quite a while now. Um, yeah, definitely following it. There's, there's some interesting parallels to when I was trading, I was a crude oil trader and a net cash trader.

And so like right around, you know, what was it like 2007, 2008, um, you know, crude oil was $150 a barrel. And, and, you know, it, when I first started trading, it was hovering around 50, $55 a barrel for the longest time. And a big move would be a dollar. And then all of a sudden it spiking and you know going up to 150 a barrel and you're looking at it and everyone's panicking and then you know inevitably you get the calls for like well next stop is 300 well that's when you know it's time to short it and so yeah i mean same thing you know you get up to 150 a barrel and then you had a precipitous drop um different economics i think contributed to that than than today but in the in the mining space it's super relevant because this obviously impacts

your revenue um so yeah i mean it's just another input that you have to kind of worry about if you're a miner yeah i mean that'll be interesting to see how the next six months to a year plays out i mean we had the news of compute north north filing for bankruptcy yesterday. There's a lot of lingering questions. What drove that bankruptcy? Was it their inability to spin up infrastructure down here in Texas quick enough and receive revenue to pay back debts that they had accrued? Or was there something on the input side of things from the cost structure, mainly driven by energy prices going up, that sort of made their model uneconomical force them into bankruptcy well yeah i mean it's interesting you know if you look over

the last what 12 to 18 months you know my inputs to your your revenue you know in the mining space or people within this space you know you have your energy costs you have your bitcoin costs you know for us we're looking at a hash price it's typically been a space where there there's an aversion to to hedging even though the instruments exist and i find it interesting from an energy perspective because it's a fully mature space from a derivatives perspective you know you could look at nat gas crude oil electricity it's not only is it mature but it's nuanced too so you can look at instruments that are specific to region if you're looking at electricity it's even specific to time frames right like you have peak and off peak and so like

it's customizable to be very specific to your use case but yet you know when you're in the middle of a bull run and everything's going great and bitcoin's going up and energy costs are relatively stable you don't you don't want to hedge because you you're there's this fear of losing out on additional revenue and so it's like a you know i think it was a term like irrational exuberance right so everyone's it's it's only ever going to go up and hedging is a fool's errand until it's it's not. And so now you're seeing the repercussions of the people that didn't have robust hedging strategies. Yeah. We always, we always love a shout out to Alan Greenspan on this show. One of my favorite terms. So as somebody who's built their career around trading these

markets and building a product that will allow people to incorporate a hedging strategy into their mining operation particularly around hash rate i think this is a good topic to dive into and maybe explain because i think a lot of people understand what hedging is and get the concept of de-risking your long-term operations but when it comes to actually employing a hedging strategy from a technical perspective how much do you hedge out what percentage of your treasury or your projected revenue? Do you put into a hedge? I think that's where people get a bit lost and confused. So in your mind for a mining operation and the specific hedging strategy that you were just describing on the energy side, like what would you, if you were developing a hedging

strategy, advise miners to do, particularly on the energy side that we can get in the hash rate as Yeah. I mean, it's a difficult thing to answer because there's no blanket answer for a hedging strategy, right? You have to kind of look at what your business model is. You have to look at what your revenue goals are, what your risk tolerance is, and then kind of come up with a strategy that's right for you. But even before that, you have to understand the risk factors that go into this you have to understand the the tools like the tools meaning derivatives that exist and then you also have to understand like it's not just one tool right so if you're looking at your power costs you might be looking at electricity or net gas hedging if you're you know a hodler

and you're looking at your bitcoin exposure you know what what tools make sense for you for you there i mean right now there's there's lots of people that are you know avert averse to hedging because it's expensive right so like because the tools are being pitched or like buying puts or doing you know collars or whatever like there's a there's these fairly simplistic tools that exist and and the problem is the space isn't very sophisticated so you either have to employ a huge educational effort or hire those kind of people and so you know making the assumption that you have the right people you start looking at your business and and you could say all right look, let's do, you know, let's have a hedging strategy that covers our OPEX and then the rest

will kind of let ride. So you could look at your, you know, your operating expense ratio and just kind of do a hedging scenario based off of that. So let's say your operating expense ratio is 60%, you know, this is very simplistic, but, and you have, I don't know, say, let's say you have 18 or 16 16 or 18 x a hash and you want to hedge so you take 60 of that in our case like you use a hash price derivative and then you could hedge 60 out and have some sort of revenue certainty for that and then you kind of avoid these doomsday scenarios of like goodwill impairment and whatever like accounting you know pleasantly packaged buzzword that exists um you avoid those scenarios and then but you still have 40 upside on the remaining x ash so

that's one you know another one you could look at and say all right i want to reduce my risk exposure by x amount of dollars so let's say you want to take a million dollars risk off your of your sheets that one's simple you just take whatever instrument you have take the million dollars divided by the notional amount of the contract and that gets you to the contracts you want and then to me it's just a time frame thing if you want to hedge out 30 days 60 days 90 days and that you know that comes with some trade-offs depending on how far out you want to hedge but like these are all these are just two scenarios there's dozens of them that could be short-term long-term but the bottom line is you know you need to have a strategy

for your business and certain economic scenarios yeah it's very dependent on the particular operator so large-scale miners and have different way different hedging strategies than in smaller scale miners yeah which is why i'm very excited to see these derivatives products come to market because i do think it gives smaller scale miners the ability to stay afloat and and not get consumed by larger miners at the end of the day who are just looking to scoop up cheap assets if people are unable to hedge just ride the risk too long and run into a beautiful shit show which many miners have experienced this summer and so in terms of to make the hardcore cypherbunk bitcoin case for a developing derivatives market and let me know if you think i'm wrong but i think it

makes sense because giving equipping smaller operators with tools to hedge out and de-risk their their operations could lead to a more distributed uh ownership of hash rate in the future where if things were held equal without these derivatives markets uh coming uh to miners the likelihood of the larger miners consuming the smaller miners is significantly increased yeah no 100 agree i mean again there's some caveats to that statement right like it there's a lot of education that needs to happen for the mid-tier and smaller miners like they have to understand how these instruments work there's some pain points that exist you know from a regulatory perspective too right like they have to sign isda agreements they have to deal with

margin um and then they have to kind of understand how settlement processes work and stuff like that It's, you know, things that like I would take for granted or some of the tier one mining companies that have derivative experts would take for granted. So to me, you know, when I talk about this and we talk a lot to those miners, it's an educational effort. You know, you got to say, look, you don't have to hedge 100% of your hash rate. You can hedge 20% or whatever. And like, and here's how it looks and here's different scenarios.

and and basically what you're getting with these instruments is revenue certainty for a certain percentage of your operation and you know once you tell people that and you kind of walk through the mechanics it's not super hard to explain what it is and what the dynamics are really for us it's just going to be getting this thing off the ground and getting adoption and you know getting a diverse set of market participants trading these instruments yeah and so let's dive into it with the forwards contract, particularly? What do the mechanics look like? What, from a user experience flow on the miner side,

what does it look like for them when they're engaging in these forwards contracts? Yeah, so it's important to differentiate when you start this conversation between forward contracts. Like, forward's kind of a ubiquitous term in the derivatives space. There's two main forwards that you can have. There's a physically delivered forward, which you've seen,

that's kind of like the bid to do a contract. And to be honest, there's lots of merit for those, but it's a different use case in my opinion. And then there's the cash settled forward, which is what we're launching. So it's technically called a non-deliverable forward, which just differentiates the physical aspect of it. So in a physically delivered forward,

you're getting paid upfront for future cash rate, right? And then in a non-deliverable forward, You're basically agreeing to a price that's settled at the end of the contract. So no money exchanges hands until the end. And so the way the mechanics of this work, at least in our example, we have an index. So Luxor has a number of indexes, one of which is the hash price index. This whole contract or derivative that we're building revolves around that index. so hash price in this term is in petahash so for example like today i think it's like 75

dollars a petahash per second per day and the index reflects changes in that based off the inputs and so you know i guess i gotta keep taking steps back here but like the inputs that go into hash price would be bitcoin price network difficulty block subsidy and transaction fees And those all go into a methodology that prints different prices for petahash per second per day. And so, you know, once you have that index, which, you know, preceded my time here, we decided to leverage that and build this cash shuttle forward around it. So essentially, a miner, you know, using this as a hedging instrument would come in and say, all right, I want to sell X amount of petahash at, say, $75. dollars lock it in for 30 days or 60 days or whatever the contract term is and then at the end of 30 days there's a settlement process and basically the difference between where it settles

and where you executed is settled in cash so if you sold at 75 hash price drops to 70 you made five dollars on that you know times the notional value that would be the the money you capture from this trade which basically offsets any losses you would have had on your mining operation and then vice versa if you're looking for exposure to the upside you know you could be an investor you buy hash price at 75 thinking it's going to go up either due to difficulty changes or bitcoin price yeah so the other end if hash price goes up you set uh you engage in in this contract says you settle it or you enter the contract at 75 at the end of the contract it hits 80 that settlement um like so for a minor if you're locking that in you want to lock in 75 and

maybe um you think that that price is going to go down towards 70 over the course of that you have to pay a little bit of money at the end if it hits 80 but you have your operations that you didn't hedge out that we're capturing that increase in hash price as well. Yeah. I mean, you're essentially locking in revenue certainty for whatever percentage of your hash rate, you know? So if you're worried about a short-term drop in Bitcoin or really just want to, you know, cover OpEx or, you know, if you're even, let's say you're a public miner and you want to get some revenue certainty for your quarterly projections or reporting, you know, this is a great tool to do so and so like i said you're essentially locking in that revenue for

whatever percentage and the rest you you know you let ride as they say yeah and so you mentioned um institutional investors who don't necessarily have mining operations up and live they can interact in this as well take a naturally long position if they want to get exposure to bitcoin yeah i mean yeah for sure i mean we want this market to be as diverse as possible right so if you just have a market that's only hedgers you're just going to have a bunch of people selling it and the price right it's going to be ridiculous and so you need to have a mix of participants so on the buy side you're you're looking at like market makers you're looking at you know crypto hedge funds private equity you know that a lot of like the the markets you would go to in traditional

finance would apply here as well and so for us we want to talk to anybody that'd be interested in getting exposure to this either as a hedging tool or as you know a portfolio diversifier or whatever um there's really only two requirements you need for this and those are regulatory and there's this concept called eligible contract participant which basically says you have to have if you want to use this as a hedging instrument you have to have a million dollars in assets And if you want to use it as a speculatory instrument, you have to have $10 million. If you meet those requirements, you absolutely can onboard with us and trade. Okay.

And is that just simply showing a balance sheet? Yeah. And it's total assets too, so it's not a huge requirement. Definitely will be a barrier for some people, but I think this largely fits with, you know, several tiers and minors. Yeah. And that, yeah, that gets into the question of like, I forget what I was going to ask. I had a question.

There's a fly flying around me right now and I'm like distracted by that. But so this, this non-deliverable. I can make up an answer if you'd like. can you actually swap this fly from uh from chicago but no i remember what i was going to say so like the non-physically delivered forward is what your first product is why this product first because there's uh as you described in other commodities markets there's many different types of contracts but why why is this um a good first step in your mind yeah so um so when i first joined in may actually joined on may 9th which is was the least optimal time to join um but when i first

joined in may um you know i have a good background in trap i i spent a fair amount of time um in the blockchain world too but you know i was at a decent grasp of the mining space but needed to do more homework so i spent two months really just talking to miners and anyone in the community that would you know hear me out and give me feedback and so i wanted to understand a couple things like you know what is what is the unmet needs in terms of hedging instruments and also what had been tried and what existed already and so there's a bunch of weird stuff that had been tried that you know lost traction and a couple things that had you know a modicum of success and and i tried to understand like why there wasn't deep liquidity or a ton of deal flow going through some of these

and part of it was like you know what i alluded to before is this lack of derivative sophistication you know which comes over time but another part of it was you know the miners wanted something you know simpler more approachable you know lower barriers to entry so the problem in my opinion with a physically delivered forward it's complex you know there's a lot of variables that go into it when you're delivering hash rate you know there's there's downtime there's curtailment there's you know unforeseen things that could lead to you not being able to deliver you know the right amount of hash rate um and so i wanted something that kind of took those obstacles out of out of the way you know kept it simple um and something that i could explain

in under 10 minutes to anybody and so this is what we arrived at and again it's not a non-deliverable ford is not something new it's been done in every asset class for you know you know decades um we're just basically taking a traditional finance concept and placing it in a in a nascent derivative market and so so we did so we started pressure testing it with with miners everyone was able to grasp it it's not rocket science and and it leveraged an index which is already pretty widely uh referenced and used and so people are comfortable with it yeah um i do want to say though like i don't i'm not trying to diminish a physically delivered for because i think there's value in those and i think they will grow and there'll be you know there'll be more deal flow

i honestly think this will be complementary to that and help liquidity in those markets as well yeah there's an order of operations to all this and as like you said it's a nation market so yeah just on the execution side of things at the actual actual mining level the industry's still trying to figure out like what the hell they're doing you have i mean public information since they're publicly traded we have monsters like marathon you have tens of thousands yeah of miners sitting on the sidelines and warehouses because they don't know how to plug them in you know that's an interesting use case it's something i would i kind of didn't anticipate when we were doing research is we always get the question like all right so who's the other side of

there's no question that miners need this as a hedging instrument but who's the buy side of this and i spoke a minute about that in a lot of it's you know people market makers looking for alpha or ways to arbitrage or generate some synthetic yield but what are the true natural short hash rate use cases and you just kind of talked about one of them so this would be an interesting instrument for people that you know let's say they have asics and can't find hosting or they're trying to you know procure ASICs but can't this would be a synthetic exposure to hash rate where you could buy this product get your short-term exposure to it and still participate in upside on hash price you know there's use cases in tier ones where they're trying to piece shareholders

and show that you know they're putting capital at use this is a great uh this is a great use case for that yeah so with this non-physically delivered contract i guess the onus is on you guys to do your due diligence right like you mentioned the capital requirements um from somebody uh in the mining industry and institutional investors want exposure um but focusing in on on the miners i guess if you guys want to feel comfortable engaging in these contracts you do pretty significant due diligence on these individual operators yeah so this is the part where i encourage your listeners to get coffee because it's boring but i will uh hey don't tell people to leave the stream oh sorry we're trying to get our like average views view minutes up okay

we can't have you telling people to go get coffee i was absolutely not telling to leave i'm saying bring your phone into the into the kitchen and fill up um so there's several regulatory components that go into this right and so i spent two years the national futures association have a good grasp on how this this stuff works and so you know when you do when you talk about due diligence in order to even trade uh ndf so non-deliverable ford it's technically called a swap so you're you're under, you know, certain Dodd-Frank obligations. And so in order to do this, and this is the pain point, you know, that's unavoidable, is you have to sign a bunch of what are called ISDA agreements. And so an ISDA agreement basically is a long set of terms that

basically, you know, show what will happen if you're in default or you do certain things that would go against the nature of the trade. It's basically guidance for how to execute these transactions. And so part of that is what I said before was the ECP, the eligible contract participant requirements. You have to attest that you have those funds. You have to, you know, agree to the terms with the person you're trading with. And you sign these, you know, 90, 91 pages documents. But, you know, fortunately it's an upfront thing. So you go through these terms, you sign it and then you're able to go. But part of that is, as you said, due diligence. So counterparties are kind of on their own to do credit profiling of the people they're trading

with. We'll have a concept of that. But fortunately for this market, the way we're structuring it is Luxor sits in the middle. So we will be buying from the seller and selling to the buyer. So all the people that are trading these instruments will only interface with us. They won't have to worry about doing the credit profiling with the other counterparties. so we kind of remove that burden so you know if you do your due diligence on Luxor and you trust Luxor that's all you have to worry about and for us you know we'll have our risk modeling and our credit profiling and then if you're familiar with it there's a concept called initial margin and variation margin and that's basically the money you take up front as collateral you know to protect

yourself in case of default and then you manage it during the cycle of the trade as well that's called variation margin so again like this is the boring stuff that has to happen in the back office but you know it helps you get comfortable with these trades i don't know why you call boring it's very interesting people like to know the details matt yeah you're describing them yeah there's there's probably a bunch of back office people are going to be listening to this be like why is he calling my job boring and so in terms of building like a risk analysis for for individual operators from luxor's perspective what's that um what's that spectrum look like what type of things are you looking at you mean like how are we getting comfortable with those yeah yeah so

i mean it's usually you know a combination of how well we know them plus what their financial statements look like because part of that is the process you have the exchange like w9s and financial statements so you can get comfortable that way um the public miners obviously you know what their financials look like so you go through that kind of process and to be honest like the way this is structured and we can get in more like mechanics if you want but it's very similar to an electricity contract in terms of settlement so you take what's called a floating price which is essentially like an average of all the prices that print during the duration of the contract so really what that means is like a lot of your your price risk is in the beginning of the contract

and as you get closer to the end there's less and less risk so you know our model accounts for that the 30 margin really it protects us from pretty much everything except for tail risk and then the variation margin which is basically whenever you get outside of a certain threshold that's you know that protects you from your tail risk too so long story short there's a bunch of math and modeling and honestly, like, you know, relationship management that goes into your credit profile. And then there's one last piece from the regulatory perspective that's worth mentioning. As part of trading a swap, you have this obligation to report the details of the trade to what's called the swap data repository. So that's another barrier that's kind of a,

you know, it's a pain. Luxor takes on that burden. So for anybody that interacts with us, We'll do all the reporting. In fact, we've just recently integrated it with a new swap data repository called Core Financial. They'll be handling all the reporting needs. And so it's another one of those like things you have to do. It's not super fun, but we'll take on that burden for people. Yeah.

And you mentioned it like diving into the mechanics of the contract, like how it actually works. Let's do that. So sorry, I'm trying to get out of the sun here. It's OK. Yeah. I can't believe you didn't have the guitar. Well, it's next to my bed, and I wasn't sure if my bed was made. It's a beautiful bed.

All right, sorry, what was your question? I mean, you mentioned we can dive into the mechanics of how this actually works. Let's do that. Yeah, so a couple of months into my tenure at Luxor, we had a really fun brainstorming session where we kind of locked ourselves into a house in Seattle for two straight days with all the founders. And I was like, I went and I presented and said, look, here's 12 different options you could have for launching a new derivative. And so let's walk through each one, see which one

makes most sense for this community, and then kind of build a roadmap from there. And so we really tried to start thinking about what makes Hashrate unique. And there's a lot of things that hash rate unique if you think about it in terms of a commodity you know it's a it's a compute power commodity which you know you don't doesn't really exist in tradfi world um it's continuously delivered right so like if you have hash rate it's it's continuously pumping out trillions of hashes yeah exactly and it's producing a monetary thing called bitcoin and so you know there's not a whole lot of tangential use cases in trad file that exists like that but there is one um you know electricity electricity is very similar like electricity is a continuously delivered product

um and it's unique in that like if you don't use it it goes away and so and it's specific to region like there's all sorts of nuance to it and so we looked at it like you know this is extremely similar in nature to electricity so we structured you know some of the mechanics that way and so when i was talking about how the settlement process works you know in a typical index if you're trading a derivative around it you basically you buy it on day one at whatever price and then it's settled at the end of the contract and it's usually whatever that price was that day or some volume weighted average at the end of that day and then the delta between those two is how your cash settled that doesn't really work for this because you know it's

continuously delivered and you have to account for that so that's where this concept of a floating price comes in so you basically have to take all the price prints that occur create an average to show you like exactly what you're getting for the duration of the contract and that's how they do electricity contracts and so when you say all the price prints that have been printed um over the duration of the contract are you guys like doing like a 5 p.m eastern weekday is there multiple data points per day like what yeah snapshot of the price are you taking yeah so we've refined the index in a number of ways but one of which is it prints a price print every 15 seconds okay so let's say you're talking day one you execute the trade let's say i don't

know 75 dollars um 75 petash at the end of day one all those 15 second price prints are average and that will give you your mark to market so whatever that average is for day one that's kind of your mark to market and p and l for the day and then you for the duration of the contract let's say it's 30 days you would take an average of all those and so that's essentially how the settlement process would work and i'm not exactly sure how the electricity markets work because because you have like peak demand pricing and off-demand pricing so i imagine they run 24 7 2 yeah that's correct and so you know again there's a lot of nuance that goes into electricity contracts like but i'm talking more from like a full listed like forward perspective so if you look at like a pgm

contract on cme group you know their settlement process is almost identical to how we would do this and that's you know to account for the nuanced continuous nature of electricity yeah and bitcoin's 24 7 365. trades on the weekends trades after markets close so yeah exactly you're not settling at you know you know it's not like old greater room days where it closes at 1 115. this is a utc day so it's like a 24-hour day yeah that's another i mean that was always i've had many conversations about these derivatives markets and one common theme that has come up throughout the years is settling contracts based off of block height do you have any particular thoughts on that we're sitting at block height 755 369 nice right now um do you have that on a chalkboard or

it's right here on the block clock oh yeah it sure is look at that um i was like that's impressive man um yeah no this topic has definitely come up um the it's not a great answer why i'm not doing it that way the problem with this market is you're trying to cater to two very different backgrounds so you have these these bitcoin mining people that need to hedge that aren't very well versed in derivatives on one side and then the other side you're trying to build you know buyers that are very well diverse in derivatives and so you have to kind of tread the line between the two in terms of where they're comfortable and what they want to do to trade and so that piece was a bit of complexity i wasn't willing to add just yet um i'm not saying we wouldn't rule it out and do

something similar down the road but you know i'm trying to attract uh not stratify people but you know buyers to this that would be more comfortable with you know bring more liquidity yeah exactly because in order for this to be successful you have to have liquidity hey markets are if you break down markets at a very high level commodities markets they're typically hedgers and speculators right and speculators for lack of a better word and so in order to bring in the speculators you have to incentivize them so they have to be comfortable with the product there has to be some concept of alpha you know they're there's expectations that come with it and if it's too nuanced and too complex or outside their wheelhouse they're not going to participate

they'll go elsewhere no so i mean to at luxor you know we they hired me as a head of derivatives plural like not head of derivative right so we wanted to this should be the first like i want to build liquidity here and then start building other derivatives that are complementary and i think that would be a good use case yeah and so what a top of your mind for next type of derivative that would be launched after this contract? Yeah, I mean, we get, there's a number of ways you could go here, but I think the logical step

after having something like this is creating options to add some more options, I guess, to your hedging strategy. And then, you know, there's the physically delivered for, that was definitely something that, you know, Nick and Ethan on our team were keen to do,

But I said, you know, let's start here and then we can tackle that next. There's more complexity to it. Just keep Ethan in the corner. Just keep him over there. It's impossible. If you've met Ethan, you can't keep him in a corner. Ethan, what's up, dude? Yeah, what's up, Ethan?

Going back to, I mean, it makes sense that you would do this type of contract first. get your counterparties who can provide liquidity comfortable um by creating a product that they get and it's settling in um meet space time and not blockade time yeah but again going back to the blockade that's like it's always at some point there is an order of operations this is what i'm trying to order of operations one of my favorite phrases on this show um this seems like the first uh the correct first operation in this order of operations but eventually as you've described and what we as i've discussed on this show throughout the years at some point it does make the most sense if bitcoin becomes a widely adopted monetary good and hash rate markets mature

more than they are right now the the block height settlement does make more sense at some point down the line maybe not right now because people aren't comfortable with it but the idea of being able to settle contracts instead of going like um three month yeah uh six month nine month year out contracts instead you do like 2016 block contracts you do having contracts you do um other uniquely suited contract durations off a block height due to the nature of uh bitcoin's blockchain and particularly um the difficulty adjustment yeah i mean honestly Yeah, I think that makes perfect sense. And if you look in the TradFi world, this concept exists.

So, you know, a lot of futures contracts will be monthly contracts, but there's dailies, there's weeklies, you know, there's quarterlies. Like a lot of it's nuanced to, you know, to kind of be purpose fit for that asset class. And I think that this example makes perfect sense. There's no reason you couldn't have both. when we first started this the thought was it being a otc product you could basically start whenever and end whenever so you could start october 14th and finish october 21st or or

whatever you you decided and i thought naturally that's how it was going to go but after shopping this around and getting feedback the more you know depending on who you're talking to so like if you're talking to energy firms that are are starting to get into mining they want monthly contracts right so they wanted to start on the 1st of October and end on the 31st and that kind of aligns with their energy hedging needs because that's how you know like their net gas or their their crude oil or electricity contracts work so you know again it becomes kind of like all right who you trying to appease here so I think the answer is is you have to have multiple right you have to have your monthlies you have to have your your block height you know and maybe weeklies

core release who knows like whatever the market needs is what you should develop yeah and so are you bullish on on your product yeah absolutely i mean i don't think i would come to your podcast and say hey man it might be all right i don't know we'll see like i mean the truth is is i spend a vast majority of my time you know trying to validate this product and build market participants. We're actively onboarding customers through that ISTA process. And there's so much enthusiasm around it from both sides.

People wanna be part of it in the beginning just to see it because they feel like there's a need. There's people that are like, we really need this for our hedging operation. There's people that are trying to get financing and the financiers are looking for robust hedging strategies

to facilitate the loans that they're put out like this this tool is needed right now and it has been for a while and so yeah super bullish yeah and what i mean what you just mentioned right like that's something i've dealt with in my four years of being involved in the mining industry as well it's like yeah you have an operation it's up and running it's successful you want to go raise some debt you don't want to dilute your your company and you go to try and get some debt and they're like are you hedging it's like no it's like all right your cost of capital just went up by five percent right it's now 18 okay and so that's i mean in terms of again letting smaller miners expand and stay alive this is massive because if you have the ability to hedge out and you can like

you like we've just discussed you can go to finance or say yes we have a hedging strategy and then they feel more comfortable lending you money and you can get a lower cost of capital actually get access to that capital in the first place a lot of times you just wouldn't even get access to the capital yeah i mean yeah and to use a poor analogy you know this is a tool in your tool belt like if you're a miner you have a number of risk exposures and this you know for bitcoin there's a bunch of derivatives that exist to hedge for energy same thing there's nothing well i shouldn't say there's nothing but there's a small growing amount of derivatives for this space and and it needs more um you know i get asked this question a lot like you know how is this

defensible like are you going to be the only hash price hash rate derivative out there like we don't want to be like we think it's better for the community if there's numerous derivatives and if you look at any asset class there's you know fully mature asset classes thousands of derivatives that you choose from and they're all they provide liquidity to each other so you know yes i'm bullish and i'm bullish for the the industry as well as it comes to derivatives i think there'll be more and more of these yeah you guys aren't looking to come monopolize the uh no space it's a co-op competition the more competition the more liquidity why do you hate that word jameson lopp's not gonna like that i don't like when people munch words together man it's just like

it's laziness laziness so you're not you're not a big fan of uh somebody who's hangry no i'm not oh man uh no but um the in the back to the derivatives talk i'm not hangry right now i'm not projecting anything on onto the listeners right now i didn't skip breakfast or anything but um yeah like you said like that's talking about that like do you see you guys delivering this contract and hopefully it has a certain amount of success enticing other people who may have been thinking about launching these derivatives into the market giving them more confidence to to launch their own products yeah i think so and honestly we've talked to a few of those people as well um we're certainly not the only one thinking about this at the moment

it's been a topic that's existed for a couple years now um you know it's always i hate to say this but it's always the best time to launch a hedging instrument in times of when you've just learned that you needed one and so here we are there's a there's a huge need for it um but yeah we we're talking to other people that are trying to do something similar and giving them the feedback we've got because i think as i said there's plenty of room for for multiple instruments and i think it'd be beneficial to the community yeah you you launched the the derivatives in the middle of the bloodbath that is the uh summer and fall of 2022 for the mining industry yeah but i mean think about it if you looked if you launched this during the bull run

would anybody have used it no i might get the out of here yeah exactly i mean it's we're going to 100k it's interesting though like going back to the irrational exuberance it's not unique to this world like you know back in the day and even still you you talk to any farmer or commodity producer they're always irrationally bullish you know everyone thinks it's always going to go up farmers will hold on to crops as long as they can this isn't a new use case it's just a new market with an old use case so a lot of it's educational you know cme spends a lot of time going out and talking to farmers to tell them how futures can be used to hedge like this is the same thing you just have to paint a picture of how this can be beneficial to your your company and your

solvency yeah and this gets into i mean going back to education and helping to facilitate better knowledge around hedging strategies available to to miners which is something we actually touched on last week when um we hopped on the call to talk about this product and what we're going to discuss today and this is something i've been really fascinated about the last two years particularly as i've watched those in the traditional energy sector begin to have the light bulbs go off with bitcoin mining um is who becomes who first do miners become energy companies do energy companies become miners i think it's going to be a mixture of both but in the context of this conversation and derivatives i mean you mentioned it earlier um these energy companies have very

robust trading desks that are that are um applying these hedging strategies so do you do you see somewhat of a flood of intellectual capital from the hedging strategy side of things coming to bitcoin in the form of these these energy companies getting more into the mining sector Oh, yeah, absolutely. I mean, we talked to lots of energy companies that are getting into or have already gotten into this. It's, you know, it's interesting if you look at, you know, net gas, crude oil, electricity, there's so many different ways that you can hedge. you know you have futures you have options you have swaps forwards ppas offtake agreements you know what do you have in this space you know outside of the you know bitcoin derivatives you don't have much and so but they come with a level of sophistication they have to you know in order to be successful because again it's it's regional it's time specific um you know so when i

start talking to them about this product they're like oh yeah i get it like because it's a pretty simple product you know not this doesn't take a math degree to understand how this works um but yeah so you know as they're getting into this space yeah they're bringing that knowledge with them and then some of the mining companies we've seen are starting to hire that expertise as well yeah that's actually where i was going to go do you think the energy sector just comes in and steamrolls the incumbent mining operators i mean i suppose you can make an argument for it i mean they have they have the right to win when you think about it from understanding the impact of energy costs but i think you have to make some assumptions and in terms of long-term energy costs

before making that statement yeah well not you don't even have to make assumptions in the long term i mean you just have to hone in on today's costs and energy producers inarguably have the cheapest cost of energy no they do they do but like if you get like a huge price correction and any of these you know energies that are used for mining and it levels off and you know there are periods in history where you had cheap level you know consistent energy costs if you get back to that and we'll give them the right to win well this that's good that's a good point but also like god this is so fucking fun to be alive right now matt because as somebody who's been uh deeply falling down the rabbit hole of mining upstream on oil and gas

operations specifically for the last four years like and considering your experience trading nat gas and crude oil at nymex like what does adding a mining component to an oil and gas operation do for those businesses and how does it affect their strategies right because you're essentially adding a new revenue stream that many would argue is completely disconnected from the supply and demand drivers of oil and natural gas like what is what does this do for for these businesses in your mind well i think you hit it right it's just a new revenue stream that would have previously gone to waste you know i guess it depends on if you're talking you know an electricity producer flare gas or you know crude oil it depends on what the use case is

but a lot of times you know some of that energy is just going to waste or it's not fully maximizing your potential so this is just another revenue stream for them could mining be viewed as somewhat of a hedging strategy for them i think yeah revenue hedging for sure like you know if i definitely see that um although i don't know i'm trying to think that through because the upfront cost is pretty significant the upfront cost is significant and if what are you hedging against because if theoretically if prices are going higher you're doing better anyway right so and if they decline it doesn't make it that much more advantageous from a revenue perspective so i don't know if hedge is the right word i think it's an additive revenue stream

yeah yeah but but either way i mean it's super interesting um you know just taking taking something you're already proficient at and just adding more money because you know here's this thing where we plug this into our to our energy and it starts producing this wonderful monetary value and we can do you know all the stuff with it i think it's think it's an interesting development and uh that's what i love about this space is it's just constant innovation yeah so you're very technical very trad fi do you ever wax poetic about this stuff and think about like how it changes humanity like obviously you worked on the the price futures at cma where you just thrust into that position and that was like your job or were you drawn to

because you like bitcoin and what it what it represents in terms of providing humanity with some form of utility moving into the future well i think it maybe before i even answer that i can tell you how i got into the tradfi world because this is never a goal of mine i was all i wanted to be was like a forest ranger i was uh my whole family's been in trad fly so like both my grandfathers traded at the chicago board of trade i had three uncles that were traders and soybeans so they were in the pits they were in the pits my stepdad was a currency trader um one of my grandfathers was actually on the board of the board of trade so like this was a thing that i started doing summers after high school and then between college

they threw the uh they threw the vest on you oh dude i could tell you we could have a whole podcast on stories about the pit um i mean i told you i worked at uh i worked at a managed futures fund on west jackson and all of our our analysts were former pit traders and their stories are some of the funniest i've ever heard in my life it's nuts like i couldn't believe it when i was going down there you know this is like the late 90s you would go into work there's this infamous bar in chicago called series and so all the all the old traders would be there in the morning drinking screwdrivers and getting ready to work and then they'd go to the floor floor to open at 9 30 they'd work their ass off from 9 30 to 1 15 and then immediately go back down to

the bar and then do it every day maybe you stop at the billy goat tavern for for a burger or something cheeseburger yeah um actually funny story i took uh ethan and guzman to billy goat weather yeah um i have to get i don't know what their impression was it can be off-putting to some people when you walk down the lower whacker just start screaming at you as soon as you walk in yeah but um to get back to your question so yeah i never got into this industry to be like a world changer but you know over time like it became super interesting to me just from like a market structure perspective and how these instruments work and you know obviously i stuck with it for my whole career but you know getting into the mining community has been a

whole different thing for me I get when I was at CME it was set on the ventures team for a couple years and I was on the board of a couple of blockchain companies so I got exposed through that but never like you know like the the nitty-gritty of where bitcoin starts which is the mining community and and the world-changing component of it is you know when you're going back to this energy conversation and some of these like you know climate issues um that are super relevant today the innovation that's happening in this space you know around like how you use energy and like using renewables and you know mining with cow farts and you know like whatever you can come up with you know using hydro solar electricity you know it's like

super cool like i never would have guessed that until i got here like to see that and so to me though like the world changing stuff that's happening is like how people are using creative ways to mine and turn that into some monetary value so it's it's super different from my background but it's been a pleasant surprise do you want to end the fed yeah i don't know that's a that came out of left field um no yeah yeah kind of hard questions here i was in favor you know when when they started when they started doing these regular raises of ripping the band-aid off and just kind of seeing what happens but uh yeah i don't know i mean that's that's a whole question all right he's a shit coiner freaks he doesn't want to add the fed i'm not a shit

coiner i'm messing with you no i'm not you don't have to you don't have to uh do you conformed Do you want to add this? Oh, of course I do. What's your main reason behind it? I mean, it's just driving all the shit that we're experiencing in our world. You can't micromanage a monetary system. Monetary systems are supposed to be complex, right?

Human action drives economic activity and the tool that helps coordinate economic activity, money, should not be micromanaged by 12 people in a boardroom and then more broadly their counterparts across the world. I will say I'm a big proponent of free market. So if that contributes to your... Yeah, we don't have a free market for money. Bitcoin gets us back to that.

No, you're... It's micro-batch. 100% agree. So he does want to end the Fed. He just won't say it out loud because of the... Well, it doesn't really matter if I do or don't. It's not going our way. Any time soon.

We're going to end the Fed. no i mean look what's going on you've been following treasury markets yes recently it's all fucked it is fucked you're right it's all fucked i'm not gonna call the end you never want to be the guy that calls the end because then you wake up 10 years later oh yeah it's like yeah it's like calling the top of crude oil or saying bitcoin it's gonna go to 143 000 we had 200k by conference day a couple years ago oh really didn't hit that no um that was not me That was Matt O'Dell, my counterpart on Rabbit Hole Recap. My counterpart, my co-host.

I probably shouldn't tell the story, but when I first started at Luxor, Nick came down to Chicago, and he took me down to go see a hosting facility. And on the board was everyone's price predictions for Bitcoin. And granted, I joined May 9th, right? So May 9th was a huge drop. and so it was super relevant at the time and and there were all these you know the list of

everyone's projections and there's a former luxor um guest of yours that predicted 143 i believe 143 000 and so ethan you shithead i wasn't ethan um nick no ah i know who yeah and so i thought that was hilarious um but everyone's everyone's projections were ridiculous no one was no one was anywhere near where we are now obviously grammar was bullish shit yeah um yeah no irrational exuberance does exist here it's hard yeah well it exists everywhere man like it's interesting from a bit i mean like irrational exuberance kind of makes sense when you think about limited supply um you know it's the same thing in crude right at the

time it was going 150 dollars a barrel everyone was pushing this like it's fossil fuel there's only so much blah blah but there's other factors obviously that go into it yeah yeah but back to like fed policy the global macro landscape right now they just raised 75 bps oil prices i'm going down here in the united states but arguably because we're draining the strategic petroleum reserve which may be fully drained in the next month or two um at which point we'll be rolling into winter uh they're still decommissioning nuclear power plants one in belgium yeah in the next month or two which is 10 of belgium's grid which is insane

and doesn't seem like Ukraine's getting fixed at any time so I think the Fed is in again I'm not going to predict end games but if the Fed has ever been in a bad position this is the worst position they've ever been in where you have inflation running hot jacking up the Fed funds rate

as high as they can and yet inflation doesn't seem to be taming down at all it's a supply side issue it's not really being driven by demand we fucked up the energy then we fucked up the food so you have a situation treasury markets are going insane right now because japan decided to intervene in their currency markets and so they're dumping all these treasuries to to support the yen um yeah it's just fucking chaos out there

thank god we have bitcoin um you know i don't know i mean like look everything you said i agree with largely i think what people forget though is you know yes we're raising rates but they're still low historically speaking and i mean they were ridiculously low 12 months ago and and yes it's painful and yes you're trying to get a point where you know your your interest rates outweigh inflation but you know you have to fine-tune it you don't get there day one no but again that's why the fed's in a very precarious situation like because they held interest rates low for that long we have this crazy debt now what we're saying that like 375 to 4 400 bps of the fed funds rate and just the simple interest payments on the debt we've accrued are approaching like a trillion

dollars which we're not going to back up for in taxes and we're like the only option if it gets to that point sort of lower rates begin printing again to pay back that debt to re-exacerbate the problem yeah it's it's systemic for sure yeah let's talk about roads here let's talk about solutions okay let's do it bitcoin mining i mean i mean is there anything with this non-deliverable forwards contract that we haven't covered i think we've been pretty thorough i think we've been pretty thorough too um you know we're as i said we're we're onboarding lots and lots of participants that would be ready you know and wanting to make markets in this um we anticipate it being a very liquid market even from day one um yeah we're super excited it does we're starting with some

smaller size trades so like around the 50 petahash size just to kind of get people comfortable with the mechanics and then just scale as the year goes on and and build it out and are we allowed to discuss the software oh yeah no people yeah yeah god man guys would have killed me if i didn't bring this up um yeah so yeah so they brought me in to you know to kind of build the mechanics of this and then shore up the regulatory pieces and get it to launch but you know luxor as a company we're not up until now we're not a derivatives company right we're a software company we we do we operate a mining pool we do asic brokerage like we do a lot of things but a lot of what we do is um you know around software so when we we're launching these derivatives we're also

going to have what's called a derivatives ui so it'll be a platform for you to be able to kind of check your positions do mark to mark check your p l and then eventually initiate new positions so you know otc markets by nature are a bit manual so you know if you look at like nat gas and oil markets people still operate quite a bit around telephone calls and chat messages to initiate trades this will be similar except using you know telegram and stuff like that but you know as this evolves we want to build an rfq platform to make price discovery more transparent and kind of to facilitate the depth of liquidity for this. So that'll be ready. We'll be launching, you know, the position piece of it where you can monitor your position. The next step would have that RFQ

component. And then we're also developing some tools for the miners. So, you know, a lot of getting comfortable with these derivatives is educational. So we're putting out a hedging calculator. So essentially what that does is allows you to put different inputs in. So let's say you could put your total hash rate in, the percentage of it that you want to hedge, what your electricity usage is, what your electricity costs are, the time frame over which you want to hedge. And then basically what it'll tell you is how much you need to hedge in terms like the amount of contracts, what the notional value is that you have to put forth, and then run through different scenarios. So if hash price goes up, here's what your P&L looks

like and if hash price goes down here's what it looks like so it's a you know in tradified terms it's a slider so where you can see like where where your position is based on certain uh events and so basically it's just you know it's a nice tool for you to kind of plug in your specific use case and get comfortable with what different scenarios would look like and so all those will be ready um pretty much next week i believe and so um yeah just another piece to kind of help people what they're trading so we're gonna be able to launch this episode next week yeah i'm not gonna have to embargo your favorite word embargo um i'm gonna hedge god i can't believe you just did that yeah you did it

i did it yeah and use tool belt another tool in the tool belt you're using product puns now it's like i'm an old tradfi guy or something are you gonna are you gonna grab the guitar and play a tune before we leave here too yeah i'm gonna whatever dad move i can come up with like i am a dad so i might as well embrace it hey here's to being a dad yeah rock on brother um so yeah um we're still we're still working on a launch date but it's imminent oh yeah well i'm excited for the launch thank you uh for dedicating your intellectual talents to this space because like i said in the beginning of this episode these products are desperately needed as a minor myself as a relatively small miner myself uh i think this would be massive for uh just again going back to

the bitcoin cypherpunk ethos if you're out there and you're like oh we don't want tradfi guys coming in we don't need these products like actually if you want a sufficient distribution of hash rate ownership these products will help drive that yeah yeah i think that's an important point like this is designed to be additive to the community not not detrimental and so it's not like the cash federal cash shuttled uh futures price that crashed the price it's suppressing it down we would be at 143k brammer would have been right yeah it's my fault if matt didn't do what he did at his former job so yeah yep you heard it here folks it is my fault I'll take the blame

well when I mean by the time this comes out the product will be launched and where could anybody any minor any institutional investor looking to participate where are we sending them yeah so if

you want to go to hashrateindex.com they'll definitely be landing pages for you to either get a hold of me or the right people to initiate these trades if you want to reach out to me on telegram at matt williams one i'm always happy to answer questions and get on the horn and talk to people put your telegram out there bold look man like i said this is an educational effort and i want to extend myself where i can yeah you're just gonna

have you're gonna you're gonna get a lot of like hey how's your trade going yeah i already get messages um well matt thank you for your time again thank you for doing what you do i think it's desperately needed and uh excited uh pumped for you guys congratulations it's pretty quick joined may 9th sitting here september 23rd i believe that's a it's pretty quick get to market yeah we're pretty proud of it and i gotta credit the co-founders at luxor for backing me on this one and help me move fast yeah and thank you for not including like some token thank you those already exist man a lot of other people do that token tokens aren't my thing not yet you heard it here first he wants to end the fed tokens aren't his thing um go check out hash rate

index.com and uh if you're a miner there's more uh hedging opportunities for you there's more tools that you can put in your tool belt god damn it thanks for that because of that matt enjoy your friday go have a burger at the billy goat tavern for me i'm gonna have one in yours i'll send you one we'll see how i don't know i don't know i don't know about that um that's all we got today peace and love