Energy Use by Bitcoin Is Significant, But That's Okay

This summer, investors are still upset about the recent crash of cryptocurrencies, but there is a threat that is even worse: bad environmental policy. According to Bloomberg Law, the Biden administration is "gearing up policy recommendations to lower cryptocurrency mining's energy use and emissions footprint." This is in line with the president's executive order about digital assets from March 2022. The early drafts of the executive order suggest that the government will pay most attention to Bitcoin and its unique "proof-of-work" system.

But this shows that the administration doesn't really understand how cryptocurrencies work or how important energy is to the U.S. economy. Before you can figure out why Biden's plan doesn't make sense, you need to know how Bitcoin works and why it uses so much energy.

Proof-of-Work and Energy Consumption

Bitcoin takes up a lot of power. According to the Cambridge Bitcoin Electricity Consumption Index, it uses about 120 terrawatt-hours (TWh) of power each year, which is more than 0.5 percent of the world's total. Even though that may not seem like a big number, consider that Argentina uses 122 TWh per year (with a population of 45 million) and Pakistan uses 104 TWh per year (population: 220 million). To make the comparison more personal, Bitcoin uses more electricity every year than all the refrigerators in the United States combined.

Even though the idea of a digitally traded asset is easy for the average American with a smartphone to understand, it can be hard to understand how the numbers on a screen relate to the large amounts of energy used that were mentioned above. But the whole Bitcoin system is held together by the link between these two numbers.

Bitcoin is a peer-to-peer network that runs on open software. Its main benefit is that it will make possible an electronic payment system based on cryptographic proof. This will allow, in the words of Bitcoin's founding white paper, "any two willing parties to transact directly with each other without the need for a trusted third party."

People use special computers called application-specific integrated circuits (ASICs) that can solve cryptographic puzzles to earn bitcoin. This is called "mining." When the first operation solves the puzzle, it confirms new network transactions, adds a new block to the Bitcoin blockchain, and gets the newest coin. To win the race to figure out the puzzle and get the new coin, you need a lot of computing power, which uses a lot of electricity.

Proof-of-work is the name for the way Bitcoin is mined (PoW). This is Bitcoin's most important security feature, and its supporters say it gives Bitcoin an edge over the thousands of other cryptocurrencies that are sold online. PoW is a way for everyone to agree on which transactions are legitimate and can be added to the blockchain. In a way, the energy needed to run mining operations keeps bad things from happening. Because of this system, people who own bitcoin think they can trust the accounting on the network more than on other systems, like traditional digital financial systems or other blockchains.

Most competing blockchains use a method called "proof-of-stake" to reach a consensus (PoS). Ethereum, the most popular alternative cryptocurrency, will soon switch to PoS completely. With Bitcoin's Proof of Work (PoW), real-world computers use energy to verify transactions. With Proof of Stake (PoS), buyers "stake" their existing cryptocurrency holdings to be able to buy new coins. Even though this method reduces the amount of energy needed to verify blocks and gives some additional scaling benefits, it breaks the blockchain's connection to the real world by making computers use energy. In other words, it doesn't have what Bitcoin supporters think is the most important thing about cryptocurrencies.

The energy need that is built into the Bitcoin system is one thing that has gotten the Biden administration very angry. The administration has said that it wants to force decentralized finance away from PoW and toward PoS. Even though cryptocurrencies use a shocking amount of energy, the administration's focus on energy use and its crusade against Bitcoin because of it are both wrong. The Biden plan falls into the trap of depletionism, uses whack-a-mole thinking about the environment, and, most importantly, doesn't take into account the important idea of subjective value.

Depletionist Trap

The depletionist trap is a school of thought that says we are going to run out of natural resources. This school of thought is widely discredited. Thomas Robert Malthus, a British economist from the 18th century, was a forerunner of depletionism. He famously said that the Industrial Revolution would cause a population boom that would grow faster than food production. Instead, industrialization brought food security to a level that had never been thought of before.

Half a century later, William Stanley Jevons took Malthus's flawed reasoning and applied it to energy. He said that coal would become even harder to find as time went on. In "The Coal Question," which he wrote in 1865, Jevons said that as factories, trains, and ships continued to use up the coal supply, the price of coal and the energy taken from it would rise steadily.

Malthus and Jevons couldn't see that, while raw materials are important, the most important resource is human creativity, as Julian Simon famously said. We have shown over and over that we can find new ways to use resources faster than they can be used up.

Economists now know that the price system is the thing that makes this good outcome almost certain. If everything else stays the same, when the demand for goods, like electricity in Bitcoin's case, goes up, there is more reason to bring them to market. Higher prices lead to more profit, and more profit encourages producers not only to use more of the resources they already have, but also to find new materials and use new technologies. Milton Friedman said that the price mechanism "successfully led us from wood to coal to whale oil to petroleum to natural gas over several centuries." Continued economic growth through industrialization has had the same effect on energy production as it did on agricultural production. That is, energy from coal is cheaper now than it was 150 years ago.

History has shown that the worry that Bitcoin is using more energy than the world's energy production system can keep up with is not true. Bitcoin's addition to the total amount of energy needed will only make people think of new ways to use resources and develop new technologies.

It is important, though, that the price system is respected as the most important way to keep things in check. In other words, let the price go up as demand goes up, so that making money will encourage new ideas. When the price system is broken, like when people are given too much money to use electricity, problems will happen. But these problems, like those in Kazakhstan, are caused by political mistakes, not by a lack of resources. The Biden administration's worry about how much energy Bitcoin uses is a new example of an old mistake called the Malthusian fallacy.

Whack-a-Mole Environmental Thinking

Bloomberg Law says that the Biden administration is worried about more than just energy use. They are also worried about how emissions affect the environment. The emissions question is a different and more important issue, but the way the administration is handling it is also wrong.

To be clear, when Bitcoin mining is powered by fossil fuels, this energy use can cause a lot of pollution in the air and greenhouse gases to be released. But that doesn't mean that the Bitcoin network is the source of the emissions any more than a Netflix data center or a personal laptop is. Most mining operations are just like any other business that draws power from the grid: they use a lot of electricity. Bitcoin mining is just one of many things that use power, and it should be treated like any other. The plan of the Biden administration to go after Bitcoin is like playing "whack-a-mole" with the environment.

Pollution policies should focus on the sources of pollution, such as coal-fired power plants, instead of the people who use the pollution. When plants make pollution that is bad for the environment, they should have to pay for it and find ways to cut it. When mining operations themselves cause pollution, like when ASIC mining units go around the grid and get their power from natural gas at wellheads, they should also be subject to rules that limit pollution.

Also, Bitcoin companies have a reason to set up shop in countries that follow environmental policies, because good governance is linked to environmental policy enforcement. Even though cryptocurrencies exist in the world of bits, mining operations are firmly rooted in the world of atoms. This means that mining operations are subject to the good and bad rules of the real world. Companies that try to make short-term profits by putting their operations in countries with the cheapest electricity (often coal-fired electricity) leave themselves open to arbitrary government actions, like when China banned mining in 2021 and Kazakhstan cut off the power supply to the industry in early 2022. Respect for free enterprise and care for the environment are both signs of good governance, and Bitcoin companies will be most interested in countries that show these traits over time.

In line with good government practices, U.S. environmental policies should focus on limiting emissions in the broadest way possible, not just on limiting the amount of energy used by certain companies. Bloomberg Law says that the U.S. usually doesn't regulate how consumers or businesses use energy. Since Bitcoin's emissions are no better or worse than those of anything else, why treat it like a unique evil?

Failure To Consider Subjective Value

The third and most important problem with the Biden plan is that it singles out Bitcoin. This shows that the administration doesn't care about how much the market values Bitcoin. It's fine if Joe from Scranton doesn't believe in crypto. He has every right to say that. But it's a whole different story when the Biden administration implicitly judges the Bitcoin network's legitimacy by saying that it wastes energy.

Bitcoin does use energy. That energy use shows how much people want to buy what Bitcoin has to offer. In other words, Bitcoin's use of energy isn't a waste at all if people are willing to pay for it and the plants that power mining operations cover the cost of their emissions.

By going after Bitcoin's energy use, the Biden administration is saying that it doesn't think people need the financial service it offers. But no one needs to watch Avengers movies whenever they want to. We agree that movies have value when millions of people are willing to pay good money to stream them. Another similarity is the gold mining industry around the world. The Cambridge index says that gold mining uses the same amount of electricity as 131 TWh per year, which is about 10% more than Bitcoin (120 TWh). Gold is mostly worth something because people think it is worth something. Subjective value is the name for this idea in a formal sense.

Ludwig von Mises, an Austrian economist from the 20th century, wrote in his seminal book "Human Action" that the value of a product isn't based on how it works, but on how important people think it is to achieving their goals. If a lot of people are willing to pay $20,000 for one bitcoin, it is clear that it is important to them and has value in the economy.

At its core, the Biden plan isn't about energy. Instead, it's about whether or not people should be free to do what they want as long as they pay for it. The plan shows that the government wants to control what people buy.

The Biden administration might be right to think that Bitcoin isn't very useful. It's possible that the PoS method, which uses less energy, will win out in the end. But that has nothing to do with policy about the environment. Even though the government isn't sure about Bitcoin, that's no reason to stop it.

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