Topic: If PMCs are so bad for the investor, WHAT IS THE ANSWER? (Read 2376 times)

These last few posts are really saying that PMCs can be good if you pick them up cheap. To me, that means someone else already took a bath.

Next DI is slated to be about 30-35%

I have considered perpetual 25% growth in difficulty as steep, maybe I was wrong. Next difficulty grow will be probably bigger...

Thats not steep, thats pretty much where its heading right now http://mining.thegenesisblock.com

What is "steep"? With 0.004, growth has to be < 25% per jump to break even. And < 20% to make some profit worth mentioning.

It all depends on the price - e.g. last night somebody bought hundreds of DMS.MINING for 0.004 (that's 0.0008 per 1 MH/s) - that could be profitable even with steep difficulty growth.

You could always invest in a managed fund and let people who do a lot of research make the decisions for you.

Just make sure they aren't morons who have no business running a fund, such as Sandstorm, or you will lose 24.3% of your investment in the first week.

Awesome funds include BTCInvest, BTC-EQTY. *self-promotion*

Exactly, I dont see why people are paying such a huge premium for exactly the same thing, look at Tatvm currently trading at 0.0022 (2.2btc per g/h) or you could wait a little while and buy a KNC miner or join a group buy!
It all depends on when or if they deliver, but looking at price per g/h you will only pay 0.175BTC per g/h. Or buy ASICMiner USB's currently priced at 1.8BTC per gh/s but these will probably never return 100% ROI or keep their value.

So, short of having your own ASIC, this PMC model is a loser for the investor.

I'm more of a tech geek, rather than an investor type, but I'm no stranger to investing, but I tend to keep things simple in that area.

If you don't want to do the mining, don't pay for the privilege of someone else profiting from your investment in mining. That is all PMCs are, them taking a nice % cut of the rather small profits and slowly paying your less due the pretty normal nature of bitcoin mining returns lowering over time, ensuring what little profits there was, you won't make back enough to cover your initial investment, but the owner sure would of (though many argue they don't).
That is also why their contracts are so complex, so when they get a lot of complaining investors near the end of their life expectancy who haven't made as much as they hoped, they are off the hook. They care more about that aspect, rather than reinvestment to keep a PMC going for the long term.
The only investment that looked like a mining contract to me that actually turned a good profit for me was ASICMiner, but that was quiet different, that as an investment in a new technology for Bitcoin, rather than someone just buying someone elses tech, something you could of done yourself.

Currency trading is far better for those who don't prefer the aspects of dealing with the mining and only deal with the buy low, sell high principles of turning a profit. Find an few exchanges you can trust, with low fees and give it a try, start low and sensible and it's easy to turn a profit.
Not every exchange will have buy and sells at the same price so you can sometime find a nice gap to make a profit between them.

Just do your research on an exchange first, some have a bad reputation for a reason and for a currency trader you are best staying away from them. Don't let greed get the better of you just because their have good prices.
For example; the Mtgox price is higher than most other exchanges at the moment, but a lot of people have trouble getting Fiat money and Btc out of mtgox, so it's a terrible choice if you want to move your assets around to make the most of prices elsewhere.

Anything is bad if priced incorrectly. The reality is most people are bad at math (and the kind of realistic assumptions necessary to price these kind of contracts), that combined with the opaqueness of "future difficulty" means most "investors" were simply doomed as soon as they opened their wallet.dat

Let me give you a simplified scenario.  Imagine I wanted to sell you a contract.  This contract would pay 1 BTC the first month (30 days after issuance) and then it would halve the payment every month until it reached 1 satoshi at which point it would no longer pay the following month.  The only recovery for the investor would be the monthly payments.  There would be no "principal" or repayment of prinicipal.  The payments would also be independent of any offering price.  Make sense?  Pretty simple 1 BTC, 0.5 BTC, 0.25 BTC, ..... 2 satoshi, 1 satoshi, 0 satoshi.  I will do the math for you; the contract will make 28 payments and pay out a total of 2 BTC.  The first thing to note is the first payment is 1 BTC but it only pays out 2 BTC over 28 months, this makes the initial payment deceptive at first glance.  The other thing to note is that while it is structurally similar to a PMC, it has the important distinction that the payments are fixed (not based on any variable like future difficulty). 

Now some people (all PMC are scams regardless of price) would have to logically say this contract is also a scam.  That an investor would ALWAYS lose money no matter the purchase price but that obviously isn't correct.  The bond will pay out 2 BTC over it's life so any price <2 BTC will have a nominal gain.  What would you buy this bond for?  To get an accurate fair market value you need to calculate the NPV as that takes into account the time value of money (1BTC paid tomorrow is worth more than 1 BTC paid 20 years from now).  Anytime you have a future revenue stream you can (use a computer) to calculate the NPV.  The NPV is the "fair market value" of the contract.  If it is selling for more than FMV the transaction favors the seller, if it is selling for less than FMV the transaction favors the buyer.  NPV does require one to assume a cost of capital.  Since there is significant counter-party risk and it locks up your Bitcoins for two years so lets assume a high cost of capital of 20% annually.  Cost of Capital is simply a way of measuring the time value of money, simple version is that a 20% CoC reflects that you value 1 BTC paid a year from now as equal to 0.8 BTC paid today).    That would put the "fair" value of the perpetual fixed contract at 1.94 BTC.

 Lets step back a second, before you could determine if a selling price is good you need to know the NPV of the future cashflow and before you can calculate the NPV you need to determine the lifetime cashflow.   The major difference between this simplified bond and a PMC is that in a PMC to accurately project future cashflow you need to accurately predict future difficulty.  That is very tough to do.

Lets compare this to a second bond with a lower decay rate.  If instead of payments starting at being reduced by 1/2 every month lets instead assume they are reduced by 1/4th rounded down to nearest satoshi.  (1.0 BTC, 0.75 BTC, 0.563 BTC .... 3 satoshi, 2 satoshi, 1 satoshi). The NPV value is now 3.75 BTC for this offering vs 1.94 BTC for the first bond.  Both have the same assumption on cost of capital, and the same terms except the rate at which payments decays yet have widly different fair market valuations.  Starting to see where I am going with this.

Imagine I offered the first bond for 2.5 BTC.  You have no hope of every making a profit (beyond speculation, selling to a "greater fool").  I have priced all profit out of the bond; Me=all profit, you= all risk.  Now given the simplicity of the bond do you think I would be successful selling a bond for 2.5 BTC that is mathematically impossible to return more than 2.0 BTC.  I don't think so.  The transparency of the contract makes that impossible.  You would have to be REALLY bad at math to buy the bond at 2.5 BTC. If you did buy it however you would suffer a 72% annualized loss over the life of the contract.  The second contract priced at 2.5 BTC (3.75 BTC NPV) has an IRR of 435% annualized over the life of the contract.  Same price, similar contract the factor which determines the loss or gain is the rate that payments decay. 

Now these are two different fixed contracts but imagine instead they were the same contract just different estimates of future cashflow.  Remember in a PMC to calculate cashflow (and thus NPV, and thus potential return) you need to project future change in difficulty.   PMC are very explicit but for them to be transparent requires a sophisticated buyer who can make accurate projections of future difficulty.  Since difficulty is so hard to estimate it would be wiser to make multiple projections weight them by likelihood and form a combined risk profile.  I guarantee you PMC buyers were not doing that.  They were using the "bitcoin calculators" punching in 1 MH/s and seeing they would get X BTC this month. If the bond sells for 1 BTC and I get 0.2 BTC a month I break in 5 months and more than double my money this year.  This is more like assuming you have the terms of the second bond thus paying 2.5 BTC IPO price and not realizing until after the fact that you have the first bond.

Simple version PMC buyers were assuming the contract would perform like the second hypotheticla contract above but in reality they performed like the first one.  After the first IPO it became obvious to anyone who could do simple math that buyers were widly unrealistic above the decay in payments.  It would be little risk to offer a PMC even if not backed by hashing power.  Most buyers were more concerned about getting "scammed" (person doesn't have rigs, will stop paying, won't be able to afford payments, etc) they never considered the seller didn't even NEED any hashing power.  The selling price was so high compared to any realistic payments that the payment would never exceed the selling price.  If these PMCs were trading on a regulated market they likely would be limited to professionals with the skill to accurately determine their risk.  The general public is just woefully ill equipped to make the kind of accurate projections necessary to properly price the contracts.  

This issue of poor due diligence however goes beyond PMCs.  If you invested in Google when it was a startup but were such a bad investor that you paid the equivalent of $2,000 per present day share you would have lost money.  It didn't matter how successful Google was, the wrong price made the deal a failure.  This is why generally speaking investing in startups is done by venture capitalists and angel investors.  They on average have a little more skill and expertise, they also tend to be a little more critical and more cautious in their valuations of an asset.  No VC would accept the kind of terms that are offering in the IPO of any of the "companies" sold on Bitcoin "exchanges".

Yeah - there are exceptions where someone has a specific competitive edge.  Manufacturing your own ASICs being the obvious one - but even that will cease to be profitable for new entrants at some point: when the returns cease to repay NRE costs in a timely manner.  And even then they still face the risk of making a BTC-denominated loss if BTC rises strongly vs USD at an unfortunate time.

"Reinvestment in more advanced hardware can make an operation more profitable." is only true if the operation is already profitable.

To an extent we're already at the point where small-scale miners (and companies) can't make a profit - in part because there's only one manufacturer with a monopoly on shipping actual hardware (everything other than ASICMINER is either pre-orders or vaporware).  So ASICMINER are in the lucky situation of being able to sell hardware at a price where the recipients would be lucky to ever break even if their power was free and they had zero other costs.  But when other manufacturers finally get their act together it won't change anything - as cheaper prices will just increase demand and hash-rate will rapidly rise to make those new cheaper prices unprofitable as well.

All the time issuers can sell over-priced shares to the ignorant they'll do so.  And in the process they suck any chance of profit away from the few investments that may otherwise have had a chance to be profitable for investors - and also ensure there's no urgency for manufacturers to lower prices.  Mining will only be profitable for those who either gamble (first preorders from a new manufacturer who are selling preorders cheap to gain capital without giving away equity rights) or have a significant edge.

(not quoting the entire post to save on screen real estate)

I don't think reinvestment is necessarily a red herring if done properly. Reinvestment in more advanced hardware can make an operation more profitable. What is required is that the percentage of the network hashrate remains constant or increases. That means outperforming your competitors and this is something only few companies will be able to do. Companies that have a technological edge (like ASICminer), but not "i'm going to buy a few ASICs and mine with them"-style operations.

I also don't think that mining is always only marginally profitable. That involves a completely free and liquid market. If there are barriers to entry, be they financial or technological, then there is room for profitability. It is already no longer the case that anyone can buy a stack of GPUs and compete on equal footing. Right now, buying an entry-level unit such as a USB Erupter or BFL Jalapeno (assuming you could get one soon) will already give you significantly worse returns per $/BTC invested than the large machines that big miners can get. I wouldn't be surprised if in the future, mining will turn into oligopoly of those companies that design and produce their own hardware, with small-scale miners unable to make a profit simply due to scale-disadvantages.

In such a scenario, mining could be more than just marginally profitable.

Right now, I'm staying at a safe distance from mining-assets (other than AM) except for short-term speculation.

Right, unless the company in question is aggressively pursuing the next technology.

The ideology of sticking with something until it is time to upgrade won't work here.

Reinvestment is a huge red herring - if something is making a loss in the first place then all reinvestment does is compound that loss.

The fundamental error OP is making is working on the assumption that there IS a way to profitably invest in mining.  In general mining is, at best, marginally profitable (exceptions being those that get in EARLY on new technology - early has now passed for ASICs) - that leaves very little scope for a manager to take a fee and investors to still make a profit.

The basic theory is simple : all the time mining is profitable more people will mine until it ceases to be profitable.   That then gets compounded because when BTC rises vs USD mining becomes profitable (in USD terms) again - so mining capacity again increases.  That not only removes the profit from new miners but guarantees a loss (in BTC terms) for existing miners/investors - whilst they end up making a USD profit (sometimes) they're inevitably going to be worse off than if they'd just held BTC throughout.

If you believe BTC will rise vs USD there's NO long-term profitable way to invest in mining (by which I mean ending up with more than if you'd just held BTC).  All the companies doing reinvestment achieve is compounding their losses (in BTC terms) whilst at the same time giving the illusion of making more profit by paying out more dividends whilst their book value falls far faster.  And, of course, if BTC doesn't rise vs USD then that means it's stagnating and dieing anyway - as it HAS to rise if demand/use increases (due to supply definitely not increasing much and quite possibly falling in terms of BTC available for circulation/use).

The reason PMBs/PMCs perform worse than mining shares is two-fold:

1.  A real reason : the massive markups often placed on their price.
2.  An illusory reason : The visibility of it.  Even when they aren't performing worse than other mining investments they give the impression of doing so as their value (the dividends they pay) are visibly dropping.  In comparison mining companies don't depreciate their hardware or even give book values in BTC - so the (often as bad or worse) losses occurring there are hidden and so don't get reflected in market price.  That's until someone notices what the emperor's new clothes actually are - and the share price crashes.

Any mining share valued at above its Book Value is unlikely to ever make a profit if you invest and hold - as the manager's fees will inevitably outweigh any marginal profit made and reinvestment will turn out to be throwing good money after bad.  And if BTC rises at all significantly a loss (in BTC terms) is assured.

There's a few simple questions to ask when looking at a mining investment:

1.  Will the manager take fees/shares even if investors don't make a profit?
2.  Where's the manager's projection of future difficulty - and how has it compared so far to what actually happened?

If they can't answer 2 then they don't even claim to know it'll make a profit - not many businesses get away with raising capital without even a token effort to establish that there'll be a profit.  Which explains why the answer to 1. is nearly always "Yes - they get a cut of revenue not profit : turning a small loss for investors into a large one".

There's only a small set of securities that should be allowed to operate without some reasonable effort to determine that investors will make a profit - investments which are by their very nature speculative.  Things like:

Precious metals funds - which are explicitly speculation on something outside the control of the issuer (the price of PMs).
Options, Futures and similar - where investors effectively bet with one another on things (DMS is this type of operation - those holding SELLING and MINING are basically betting against one another on what the future dividends from 1 MH/s will be.  It's explicit that some of them will win at the expense of others who lose).

Anything which actually plans to operate a business should determine whether it'll make a profit before asking for cash.  Mining investments don't do this - with the general excuse being that it's hard to work out how difficulty will change.  That's true - so look back rather than forward - and see how horribly mining investments did in the past.  Now try to explain why the same won't happen again - why hashing power will stop being added before it becomes unprofitable.

You DON'T need to predict future difficulty to work out that mining investments in general won't make a profit.  Common-sense and history tell you that they'll make a loss in BTC terms unless BTC falls vs USD.

This thread puts it in perspective pretty well.
https://bitcointalksearch.org/topic/hashrates-of-mining-securities-229564

Basically, yes.

Most PMCs don't have any reinvestment plan, which means that as the difficulty increases, the asset decreases in price alongside its dividends. I think that many people who buy PMCs don't realize how rapidly the asset-price can decrease. I guess that everyone realizes that dividends will go down with difficulty, but there are people who expect that they're able to resell the asset for a similar price to what they paid for it after some time (as evidenced by a discussion from the TAT.VIRTUALMINE thread a while back, where someone was upset that the asset-price had gone down and demanded a refund).

On a different note, anyone interested in PMCs and their price-development, should look at the DMS set of assets and its price/dividend developments.

So your answer is that people are bad at math or that issuers are pricing their value add too high?

PMCs are not necessarily a bad investment. Almost nothing is a automatically a bad investment. It all depends on the price they're being sold for.

If you look at the currently marketed PMCs, then most/all of them will not give you back your investment at their current price unless the difficulty rise slows down soon. IPO prices for these assets were even higher.

Why are current prices so high? People still "believe" in PMCs because they haven't done the math or think that difficulty growth will slow down very soon. So there is buying pressure to slow down the price decrease.
Why were IPO prices so high? Ask the people issuing these assets.

Consensus responses go here.