Formerly known as the Chicago Mercantile Exchange Group, CME Group is the largest, most diverse derivatives marketplace in the world, handling an average of 3 billion contracts worth approximately $1 quadrillion annually.
The company recently published a US Patent & Trademark Office (USPTO) application describing a comprehensive system for a derivative contracts system allowing cryptocurrency miners to offset risk.
“While there is financial risk involved in mining operations, because of the potential rewards, Bitcoin miners undertake these risks hoping that the value of the mined Bitcoins will exceed the miners' costs and provide a reasonable return on investment.”
- CME Group
While mining costs are generally known upfront, estimating income generated by a mining operation can be extremely difficult. There is uncertainty involved in predicting how many bitcoins a given mining computer will mine over time, uncertainty in terms of how much the mined bitcoins will be worth in terms of legal tender (e.g. USD), and uncertainty in trying to predict what the Bitcoin difficulty factor will be in the future.
Derivative contracts allow investors to hedge these risk by providing offsetting compensation in case of an undesired event, and can be used to allow miners to hedge risks associated with a virtual currency's difficulty factor or with the expected yield of a computer performing mining operations.
“Because the long-term growth rate of the difficulty factor is impossible to know in advance, by taking a long position in the contract, or being long a call option on the contract, a miner can lock in a projected growth rate of the difficulty factor,” the patent filing explains. “If the network hash rate grows faster than anticipated, the income from mining may fall, but the variation and settlement of the futures or the funds received by exercising a cash-settled call option contract would cover the loss. On the other hand, if the difficulty factor grows more slowly than anticipated or falls, the contract would lose value or the call option premium would expire as worthless, but a miner would make more money than expected on mining operations.“
“While the disclosed embodiments will be discussed with respect to the Bitcoin virtual currency, it will be appreciated that the disclosed embodiments may be applicable to any virtual currency now available or later developed that incorporates a proof of work methodology.”
- CME Group
Derivative contracts described in the patent application can be created to estimate the income that a miner can expect to produce based on the operations and configuration of a selected computer system. The value of these contracts at settlement can be tied to an index value that is determined based on the estimated or actual number of virtual currency rewards granted over a designated time period.
The estimated or actual transaction fees associated with all virtual currency blocks generated during a designated time period can also be accounted for. An expected yield can be calculated based on a hash rate, in order to estimate the amount of virtual currency that a virtual currency miner can expect to produce using a given mining configuration. The expected yield can then be converted to a real currency value using a known conversion factor, and this real currency value can be used to generate a settlement value for the associated contract.
The conversion factor can be included in the definition of the contract to be cleared and can be used to determine how much the contract will pay on settlement. For example, the conversion factor may describe a conversion rate from the received difficulty factor to a predetermined real currency (e.g., USD).
A separate example contract can also be used by mining hardware manufacturers to hedge their product inventory. As the difficulty factor rises, mining computers may become less marketable, so taking a long position in the generated contract, or being long a call option on the generated contract, would allow manufacturers to lock in a projected growth rate of the difficulty factor and hedge against the risk of falling hardware prices.
“In certain embodiments, the contract can also be used in strategies involving other virtual currencies or with other related contracts. For example, the Peercoin virtual currency has the same mining hardware requirements as Bitcoin, so virtual currency miners can easily switch from mining for one currency to mining for the other currency. Because of this, there is a known relationship between the difficulty factors of the two currencies and the relative values or exchange rate of the two currencies. Based on this relationship, in certain embodiments, the contract may be used in arbitrage strategies involving the two currencies.”
- CME Group
The patent includes far more than derivatives contracts. The filing describes a financial computer system that also lists the contract, receives, and matches orders, prior to settlement by a clearing computer. The contract may take the form of a futures contract, an option contract, an OTC swap contract, or another financial instrument.
The system may also include an electronic trade engine, while a user database may include information identifying traders and other users of financial computer system. A match engine module may match bid and offer prices for contracts configured in accordance with aspects of the disclosure. Moreover, a trade database may be included to store historical information identifying trades and descriptions of trades. Furthermore, an order book module may be included to compute or otherwise determine current bid and offer prices.
“The computer network system is only one example of a suitable system and is not intended to suggest any limitation as to the scope of use or functionality of the various embodiments of the disclosure,” the patent application states. “Aspects of the present disclosure can be implemented with computing devices and networks for exchanging, transmitting communicating, administering, managing and facilitating trading information including, but not limited to virtual currency spot rates, network hash rates, and virtual currency difficulty factors.”
“The financial computer system can be configured to generate or receive market data, list contracts, analyze data, and calculate various values (e.g., contract parameters), and perform other operations in accordance with aspects of the disclosure.“
- CME Group
CME Group launched a pair of price indexes in November, for Bitcoin reference rate, while the company’s digital securities trading platform, CME Direct, was recently chosen to become the home of trading for RMG digital gold, a blockchain-based security product offered by the UK’s Royal Mint. Sandra Ro, CME Group’s Head of Digitization headed both the RMB and index projects, and is listed as one of three inventors on the derivative’s patent.
Despite Satoshi Nakamoto giving Bitcoin and blockchain technology freely to the world through an MIT Open Source license, Bank of America, R3 CEV, BitGo, and Coinbase are just a few of the many companies filing patents on intellectual property in the Bitcoin and blockchain space.