Why Perpetual Mining Bonds Are Bad

Introduction

I am still pretty new to stocks, securities, etc. so I have been learning as I go. When it comes to Bitcoin and other crypto currencies, obtaining the stocks is pretty easy, and they are somewhat easy to understand. Despite this, however, there are still a lot of misinterpretations regarding things like “perpetual mining bonds.” I would like to start going through my thought process on why I was not planning to buy any, despite people trying to push it off as being a good idea, and why the math just simply does not work out most of the time.

Disclaimer

I am not going to be referring to any specific perpetual mining bond here. Instead, I will use some analogies to help better understand the problem behind them, without necessarily calling out a specific bond. I will, however, be basing all of the information off of real bonds, and their actual values as of this writing.

I also want to go ahead and get in the fact that I am still quite new to this stuff. I mostly deal in the mathematics, and the mathematics just do not add up. With that said, you are more than free to make your own decisions if you disagree with me, and I wish you the best of luck with your purchases. I, for one, will be staying away.

What Perpetual Mining Bonds Are

A perpetual mining bond is basically buying part of a rig's hash rate. Whether this is an ASIC, FPGA or normal rig does not really matter, though, as the bonds usually tell exactly what hash rate it is going to be worth. For example, they will say that each share of the bond is worth 1 MH/s and is there for mining Bitcoins. In case you are not quite understanding, the amount of hash rate a single bond share is worth does not go up. If you buy one right now at 1 MH/s, it will be worth the same 1 MH/s in a hundred years.

This looks like a good investment for some people because you can jump in to a rig's ownership for less than it would cost you to do it normally. If you wanted a 600 MH/s rig, for example, you would be looking at, say $600 (it would be less than this, theoretically, but we are doing this to make the math easier to see). Now, you could either toss $600 in to this rig, or you could start buying in to a perpetual bond at a rate of $1 per share, which would represent 1 MH/s. So now instead of being forced to either invest $600 at once and take that risk or just go without, you can invest the exact amount you want, whether it be the same $600 or even just $1. Your rewards and earnings would be proportional to how many shares you bought, so it would come out to be the same. But wait… there is another benefit.

When you buy in to a share of a bond, you do not need to have the technical expertise to understand how or why the rigs work. All you care about is whether or not they are earning. If they earn, you are happy. If they do not, you are not. This means that people who otherwise do not understand what is going on but still want to invest and take part have the means to do so. The person that starts up the bond is expected to have the knowledge of how to keep everything going at peak performance, and the bond holders simply collect.

With these two explanations it looks like an awesome idea, right? You are able to buy as much or as little as you want in to a mining rig and you do not even have to know what is going on with it, you just have to take the money and be happy. But actually, things do start to go down hill from here.

Mining Difficulty and Its Effect On Bonds

The difficulty of mining determines how much a person earns from it. The theory behind it is that if difficulty increases by 100%, doubling it, you will earn half as much. As time has gone on, the difficulty of mining, at least with coins like Bitcoin, has gone consistently up. This means that from week to week (depending on how long it takes for the next difficulty adjustment) the amount you earn from a stable hash rate continues to drop.

In case you are not following, this means that if you have a perpetual mining bond, you can expect that the first payment you get will be your highest, and they will go down from there. This is simply because that 1 MH/s rate is no longer as good as it was before the last difficulty change.

The Mathematics

Because of the decreased earnings, I would like to take a real perpetual mining bond and help understand the mathematics behind it. So here we go!

  • Current Cost: 0.0045 BTC
  • Hash Rate Equivalent: 1 MH/s
  • Dividend Pay Frequency: Daily
  • Last Dividend: 0.00002357 BTC

Alright, so let us take a look at this. Under the assumption that we stay at a consistent rate of difficulty (which is not going to happen), at the current daily dividend rate and the current cost for the mining bond you are looking at:

  • 0.0045 / 0.00002357 = 191

This means that if we remained constant, it would take two thirds of a year to get return on investment off the earnings. This is not so bad, is it? But wait a minute, we have not factored in the difficulty. As of right now we are looking at a 15.46% difficulty increase only six days from now. So let us see how much it increases as a result:

  • (191 – 6) * 1.1546 = 214

First off, we took the six days off what we have for return on investment, as it will take six days before the dividends start to change. Then we multiply what is left by the increased difficulty. In case you are not following along too closely, this means that in six days it will increase from taking only 191 days from now to get return on investment to 214 days from then. In other words, just based on what we know about the next week, it will be adding 29 days!

Now then, let us take this to the next week. Let us assume there is another 15% increase, which has been about how much it has been going up each time. For argument's sake, let us use a ten day difficulty adjustment.

  • (214 – 10) * 1.15 = 235

From this, we now find that instead of needing another 204 days after that ten day period, it has gone up even more to 235. If we base the increase from today, we are now at:

  • 29 + (245-220) = 54 days

In other words, in just two and a half weeks, you have increased the time in which it will take to get return on investment by almost two entire months. Does this not seem a bit backwards? Usually when you go for things with a return on investment you are expecting for the time frame to shrink as time goes on, since you get closer to the goal. Instead, with the perpetual mining bond referred to above (which is a real one with the exact data!) you are increasing how long it will take for you to earn back what you put in to it.

When it Would Pay Off

There are actually two periods in which a perpetual mining bond might pay off. The first is if you jump in to it in the very beginning, and the second is if you consider the market value of the bond as well. I would like to hit on each of these separately now, as they are pretty different and both of them need to be fully understood in order to make a good decision on whether or not to jump on.

Joining From the Start

If you jump on to one of these bonds right after it gets going, or at least soon after, you will have the best chances of actually seeing a real return on investment. This is because, generally speaking, the prices at which the bonds will be sold for originally is going to be less than the market values them at. In other words, while our calculations above were based on today's value (or, rather, the value right that minute), that is likely much higher than what they went for when they were first released.

This leads to a couple of things that impact whether or not you will see a return on investment:

  • When dividends start paying off
  • How often the dividends pay off
  • How much the first dividend is

All three of these things are very important to know and follow. If, for example, you are not going to see any dividends for a few weeks after you buy in, this is not a good idea as it has a lot of risk. You always want to wait until you can start collecting the dividend payments, as the more of them you get the better chances you have of getting at least the return on investment back.

How often the dividends pay off is also important. I would argue that daily is better than weekly in this case, although in a lot of other situations it would not make much of a difference. If I got in to one of these I would want daily because it allows two things to happen:

  • You know from day to day, at least until the next difficulty jump, how much you are going to be earning
  • Since difficulty jumps can happen any time in a time period (depending on how much the hash rate has increased or decreased, since the difficulty adjustment is based on blocks found, rather than time), having daily dividends I think makes the accounting a lot easier

As for how much the first dividend is, this is important to know because it is more than likely going to be the highest one you ever get. If you are already seeing a return on investment time period of, say 160 days, it is probably a bad idea to get in as that is going to be increasing.

A good thing about knowing each of these things is that it also makes calculating the return on investment time period a lot easier. For example, use this formula if you are looking in to a bond that pays daily:

  • (Bond Price Paid – Total Dividends Received) / Current Dividend = Return On Investment Period

This will tell how many days are left before you even out at the current difficulty. If you want to take it further and see a more accurate number, you can take the value above and use it to see what it will be like in around ten days:

  • (Return On Investment Period – 10) * 1.15

This will show, based on your percent (if you want to do, say 20%, you would multiply by 1.20 instead of 1.15), about how long you would be looking at waiting 10 days from now.

It is entirely possible that you will find some perpetual mining bonds that actually do reach a return on investment, but as I can tell none of them I am seeing right now are going to. Except for possibly factoring in the market value of the bond as well, as we are now going to look at.

Selling the Bond at Market Value

One of the things that calculating return on investment does not take in to consideration is what the bond can be sold at. Really, this should be part of the value process, although it is really hard to know what is going to happen. With the bond above, for example, the market price has remained fairly constant for quite a while, so although the return on investment has a long time to go in terms of its dividends, you could, for example, take a couple weeks worth of dividends and then sell the bond at its original value (if it is still that high) and you would have made a profit.

My problem with this is that the mining bonds are pretty much like pyramid schemes. I still can not understand why the market value of bonds stays at a pretty consistent rate when the dividend value is always getting lower and lower and has no real chance to recover. Basically when you buy in to one of the bonds you are not doing it for the dividends themselves, but for the hope that someone else is not doing the mathematics and helps keep them afloat. The reason that I consider this as being like a pyramid scheme is because while there is income coming in (which appears to be what catches a lot of people off guard), they will never earn back their value. Therefore, unless someone else buys in at a loss, you are going to be the one to lose out.

Because of this nature, a lot of people find that selling perpetual mining bonds is immoral or unethical. I really do not want to get in to any of that debate myself, though, as I think it really depends on how you look at it. Much like people think that buying items and selling them for a profit is wrong (although that is how every business in the world makes its money, and is the only reason businesses can hire people. So without that, nobody would have jobs).

Finding a Median

Based on all the research I have done, most people that buy in to these bonds say that the idea behind them is to find a median between what you are getting off dividends and what you are going to get from selling them, and then figure out when you need to jump ship, so to speak. The goal is to maximize profits, and to do this you have to pay attention to not only what you are earning, but also what you have earned total and also what the market value is like (and what the recent and long term fluctuations have been like). It is a lot of math and keeping up with data, but it is the only real way to be sure whether or not you are making the right choice by continuing to hold.

It is also worth noting that prices could rise or tank at any point, even within a few minutes from each other, so reacting quick and speculation is necessary to make the most of it (although generally with these types of bonds you are looking at tanking, rather than rising; but for some reason they do still rise sometimes).

Avoiding Flat Hash Rates

It is highly recommended that if you want to invest in something, you do it in a company that is offering up shares that represent a fractional portion of the entire company's hash rates. You also want to find one that does reinvesting. This means that, in the scenarios mentioned earlier, things would be going a lot different.

Let us say that you go with a company with 50% reinvestment. This means that 50%, minus costs and fees, is paid back every so often as dividends. The rest is used towards purchasing new equipment. As a result, while the amount you get back per dividend may be a little lower from time to time, it is much more stable. For example:

  • With flat rate, after a year you will still be at that same 1 MH/s you were at when you started
  • With a reinvesting company, that 1 MH/s could be 30 MH/s

This is very important because it means that the difficulty will have much less of an impact. Whereas flat rate only goes down, with no chance to go up (unless the difficulty somehow started to drop), these others will stay about equal all the way through and sometimes might even raise (for example when new ASIC's are received). This makes a massive difference in dividends alone, but it also means that the stocks will retain a lot more value.

The down side to this is that it makes figuring out your return on investment that much harder. Whereas with flat rates you can estimate it since you already know about how much you will get from day to day, with these others you never really know. You may get more in the next dividend than you did in this one or you could get less. Or even the same.

Overall, though, these are significantly more safe to invest in because you own a part of a company that is actually growing, rather than remaining stagnant. Especially in an area like crypto currencies, where we are still trying to find out where things are and where they are headed, this is an awesome thing. Think of it as riding on a train in to the future where you do not know what it holds, but you know that you own a part of it.

Conclusion

I am not really going to say whether or not you should be investing in perpetual mining bonds. They have definitely worked out in the favor for some people, but have not worked out for many others. If you run the mathematics behind them you will find that they in most cases are never going to be profitable, but for some reason they often maintain their market value on a per bond basis. This does not make any sense to me, other than to assume that others jump on them thinking that the daily payments are a good thing and that they are earning. Past that, I do not see how anyone could justify purchasing them.

I will say that as long as the market stays the way it is (where a lot of people appear to not have any idea what is going on with their investments), you can usually make at least a little profit, although in a situation where people wake up and realize they are losing money by holding the bonds long term, the prices would tank to a point where everyone still holding one would have lost. This is why some people consider them as “scams,” although I would not take it that far. As long as the people that run the bonds are legitimate and are open as to how they work and fees and such (which, based on what I have seen so far, they have been very transparent about) I do not see any problem with them selling them.

As for why I wrote this up, it is to hopefully help enlighten others as to how these things work and why they are a bad idea to get involved with. It is a huge gamble getting in to one, and the reward in this situation does not outweigh the risk. When I originally started looking at one (mostly because it was very cheap and I only had a portion of a Bitcoin – I am still poor now too) I had questioned many people as to why they were still buying in to them. After reading post after post for about a week and hearing people's opinions, I decided that my own intuition and understanding must have been off. For me, the math just did not add up. No matter how I tried to run it, it was never going to make a profit.

After a week or so of this I had finally gotten to the point where I was ready to make an investment, but I had to hold off so I could try to get some funds converted to Bitcoins. Within a day of making my decision to invest (though I could not do it at that point) it came to light that the prices of some bonds were going down and people started throwing out scam accusations to the people running them. Much like I had been saying all along, the bonds just do not work out. But for whatever reason, I had finally hit the point where I figured if I was the only person out of a large group that felt that way, and all of these others were investing, then I must know a lot less about how they work than I thought.

Well, after that situation I feel a lot better about having done all the research, calculations and brainstorming. Had I not done that, I could have been sucked in much earlier and lost quite a bit in the process. I, for one, will never invest in a perpetual mining bond regardless as to if I think I can get a profit off of it or not, simply because I disagree with the principle behind them. To me, they are created to take advantage of people that either do not want to do the math themselves, do not understand how the mining process works or simply do not care. In any case, this is not something I can join in on with a conscience, as the only way for me to win would be to feel like I ripped someone else off.

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