More On: Bitcoin
Senators and regulators explain why the $60 billion collapse of a major cryptocurrency is not the industry's Bear Stearns moment
Bitcoin supporters have been known to downplay the expenses, while opponents have been known to discount the benefits—however, it is critical to examine both the costs and the benefits.
Building a bridge is expensive because it necessitates the use of labor, machinery, and raw materials with multiple applications. Does this imply that building it is a waste of time? No. When the expense incurred exceeds the benefit obtained, waste occurs. A cost larger than zero does not mean that the cost is greater than the benefit. Does this imply that the bridge is worthwhile to construct? No, not again. If the few beneficiaries do not meet the costs, a bridge to nowhere may be built despite the fact that it is inefficient. To determine if a particular bridge is worthwhile, we must weigh the benefits against the costs.
We observe market pricing and transaction amounts to calculate benefits and costs. We don't have access to a godlike perspective. As a result, for ordinary private products where costs and benefits are borne by producers and consumers, economists typically defer to the judgements of market players who incur the costs on whether the benefits of an activity outweigh its costs. Buyers presumably value a good more than the price they pay, otherwise they would not buy, and manufacturers incur typical costs less than that price, or they would leave the industry. In the case of Bitcoin, the electricity bills for proof of work are eventually paid by Bitcoin users, just as the costs of manufacturing for bread and milk are carried by bread and milk customers. Bitcoin consumers pay directly when they pay blockchain fees, and indirectly when new Bitcoin is given to miners, increasing the stock of Bitcoin and diluting purchasing power per unit relative to what it would have been if the stock remained constant.
A useful accounting for Bitcoin, like for other things, must reflect both costs and benefits. Bitcoin supporters have been known to minimize or even count the costs as benefits, whilst opponents have been known to downplay or even count the expenses as benefits.
Bitcoin proponents sometimes emphasize the ability of Bitcoin mining companies to locate wherever electricity can be produced at the lowest cost, such as natural gas fields where excess gas would otherwise be burned off, or isolated hydroelectric plants with few other clients (Goyal 2021). And Bitcoin miners hooked into a standard electrical grid will shut down promptly to free up electricity for other users during high demand periods when the price per kilowatt hour exceeds the miners' breakeven point. When compared to the alternative of using solely high-priced electricity, these capabilities lower the opportunity cost of Bitcoin's electricity use. However, it does not eliminate the cost or change it into a benefit.
Proponents commend the fact that the Bitcoin mining sector uses a higher proportion of green, sustainable, or nonpolluting energy than other industries. However, using electricity from those sources is still an expense, not a benefit of Bitcoin. Green energy is still expensive to produce.
When Bitcoin mining helps to finance expenditures on materials and labor to build new electricity generating facilities, or on repairs and maintenance crews to bring old facilities back into operation (Murillo 2022), this is not a benefit provided by Bitcoin in comparison to cryptoassets that use less energy. It comes at a price. Even if the new facilities use no fossil fuels and release no carbon, building or renovating power plants is an expensive use of labor and material resources.
According to European Central Bank economists Ulrich Bindseil, Patrick Papsdorf, and Jürgen Schaaf (hereinafter BPS) (2022, p. 4), Bitcoin is a "encrypted threat" since "the Bitcoin network comes with a huge energy appetite due to its dependency on proof of work," and so "wastes power." However, jumping to that conclusion without considering the benefits is a non sequitur. Even when expressed in a comparable manner, such as when they claim that Bitcoin is inefficient because the proof of work way of processing transactions uses more energy per transaction than alternative techniques such as proof of stake or the status quo banking system, it does not follow. To prevent making hasty decisions like these, we must analyze the benefits that can be attributed to the proof of work methodology. To suggest that the proof of labor approach is wasteful because it consumes more energy is to assume that it delivers no benefits (no greater privacy, no higher security, no greater credibility of the release schedule) over a payment system based on proof of stake or a single central ledger. However, the assumption of zero benefits contradicts the reality that some users prefer proof of work systems.
The default assumption of current Paretian welfare economics is that the market for a private product like Bitcoin (or any other cryptoasset) runs efficiently under the force of free competition. Mutual benefits from trade are discovered and realized. A benign would-be increaser of net social benefits must meet a burden of proof to disprove that presumption. To justify limitations on mutually beneficial exchanges, proof must be provided that Bitcoin production is harming other parties in ways that violate their property rights, or, as stated by BPS (p. 2), that Bitcoin imposes large negative externalities.
The fact that the Bitcoin network runs on electricity is insufficient evidence. Hospitals, school buses, and airplanes all utilize power. Almost every industry relies on electricity to generate its output. Bitcoin is not an outlier in this regard. It is true that, on the margin, Bitcoin's demand for electricity contributes to total demand and, as a result, to the determination of electricity prices. The bigger Bitcoin's electricity consumption, the higher the electricity price. However, this is also true for every other industry that uses electricity. In technical economic terms, the spillover impact of increased electricity demand on electricity prices is only a financial externality, not a technology externality. As such, it is not an inefficient source. Price changes are required for any market to regain efficiency in the face of variations in supply or demand. Price fluctuations have no effect on anyone's usage and enjoyment of his or her property. They are not the type of Pareto relevant externality that we should be concerned about.
An obvious concern regarding energy use in any industry is that increased electricity generation generates considerable negative externalities in the form of greater carbon dioxide and other emissions. The BPS questions if the negative externalities of energy consumption are "really priced in through suitable levies." The authors propose a fee on carbon emissions as a solution to carbon pollution. If the economic costs of marginal carbon emissions were known, an adequately sized carbon tax would internalize the externality by shifting the costs to energy producers. However, it should be noted that the proposed levy would be a charge on electricity producers based on their carbon emissions. It would not be a tax on any particular energyusing activity, and it would surely not be a reason for prohibiting or restricting any particular energyusing activity. Because the right level of a carbon tax is orthogonal to the mix of energy consumption, it has nothing to do with Bitcoin in the traditional sense.
To allow the economy to produce the most valuable mix of outputs, we must allow producers with the most valuable uses for electricity resources (that is, those who can convert a marginal dollar's worth of electricity into the outputs for which consumers are willing to pay the most) to bid them away from others.
Critics who declare Bitcoin to be "worthless" despite users' willingness to pay for it demonstrate that they disregard consumers' valuations and arbitrarily invoke their own personal valuations, just as they would if they deemed hospitals, school buses, or airplanes to be worthless. Sometimes the critic's personal preferences are obvious, like in the claim that there are no social benefits to offset Bitcoin's costs, only transfers, because Bitcoin is merely a "gambling game." People who freely choose to gamble at casinos or participate in lotteries benefit in their own view since they selected gambling over other sources of amusement, assuming there is no fraud. Similarly, Bitcoin gamblers.
Of fact, many Bitcoin investors believe that the odds of winning are not stacked against them in the same way that they are in casino games and lotteries, but rather in their advantage. Their risktaking attitude is similar to that of an optimistic investor who believes that a specific stock will exceed the market. They believe that the purchasing power of Bitcoin will continue to climb as the (hoped for) medium of exchange use of Bitcoin spreads, maybe to the point where Bitcoin becomes the world's dominant currency. They may be overestimating the possibility of that conclusion (in my opinion, the volatility of Bitcoin's purchasing power makes broad usage as a medium of exchange extremely unlikely), but in a free economy, such risk taking is left to the investors who bear the gains and losses.
At the pessimistic end of the spectrum, BPS (p. 2) predicts that Bitcoin's use and price would plummet, resulting in "substantially negative net welfare impacts of Bitcoin during its life cycle." Their estimate obviously contradicts the forecasts of Bitcoin holders, as well as venture capitalists and entrepreneurs who are investing enormous sums in supplementary items to enable Bitcoin use. We have no idea what the future transaction use and pricing will be. Meanwhile, the Efficient Markets Hypothesis argues that the current price of Bitcoin is the best point estimate of the discounted future price.
BPS (pp. 9–10) is concerned not just about the "risks and costs for invested people," but also on the "risks and costs for society at large." They write, noting that the Bitcoin project may fail:
If it were true that Bitcoin is eventually unsustainable and will not persist, and will not have generated value for society apart from temporary hopes of speculative gains which eventually are disappointed, then these private costs will however have represented a net loss for society.
If Bitcoin's value falls to zero, investors will lose the gains they made during Bitcoin's rise from zero to its peak. The episode would result in a net loss for society because the costs of labor, machines, and electricity used would not be offset by any advantage to third parties. However, this is true of every investment initiative on the planet. The failure of a specific corporation, or even an industry, which wipes out shareholders' equity and the value of certain specific physical and human capital, does not abridge property rights or impoverish those who avoided investing in or working for it. As a result, in a free economy, we allow entrepreneurs to take risks. In circumstances where they succeed, the profits are net social gains, according to the same rationale. The higher economic growth of an economic system in which entrepreneurs are allowed to innovate and fail benefits society as a whole.
To suggest that Bitcoin "will not have provided value for society aside from temporary aspirations of speculative gains" ignores the fact that Bitcoin is more than just a gambling game. It adds value in a second sense by serving as an alternative payment rail for transactions or donations that must bypass a censorious central bank in order to reach government-favored beneficiaries. Viewing such transactions as troublesome, as a cost rather than a gain, would be viewing things through the eyes of a state advocate rather than a consumer advocate.
** Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. You should do your own thorough research before making any investment decisions. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of USA GAG nor its advertisers. The author will not be held responsible for information that is found at the end of links posted on this page.