Bitcoin and Energy: Everything is Actually OK

I found many arguments that Bitcoin wastes energy to be lacking, so I decided to write up this post. However, it’s gotten pretty technical, so be warned.

TL;DR:

  • Bitcoin is an economic activity like any other, and thus it has associated input costs that are paid for by its users. Its costs just happen to be very clear and singular (electricity)
  • I go over several technical ways we could change the Bitcoin protocol to achieve Pareto improvements and why I don’t think they would work, or work only marginally.
  • I discuss how Bitcoin counterintuitively may help renewable energy rather than just rack up carbon emissions.

Economically Efficient

I’m defining “wasteful” as economically inefficient.

First, why I think referring to Bitcoin’s energy consumption in terms of economic efficiency makes sense.

Bitcoin mining is economic activity. It provides the service of securing and running the Bitcoin network. Like all economic services, there are costs associated with providing it. Reddit is a website that provides the service of an online forum and discussion, and it has associated costs. Some people don’t use Reddit or find that Reddit is a time sink, they might say that Reddit is “wasteful”, after all, they don’t use it, and they could think of better things to do with the resources. In another example, some people might be uninterested in baseball and thus believe that the New York Yankees are a waste of resources. They use space for their stadium, training facilities, and offices, they use energy to run those facilities, and they use advertising space to promote their organization where more useful things could be advertised, like charity. I think this usage of “wasteful” is fine for both Bitcoin and the New York Yankees, but this seems to be more an argument about preferences or about Bitcoin being a bad thing that exists in the world regardless of its resource use.  There’s nothing really economically inefficient with Reddit’s existence or the existence of the Yankees; people want the services those organizations provide, they provide them, and they fund it through ads on a website or ticket sales to baseball games.

Bitcoin mining provides something that literally didn’t exist before 2009; the ability to send digital value across the internet with no third parties, or at least no specific third parties. This is technically impressive and apparently highly valuable. To do this, the Bitcoin network had to solve all the problems normally solved by the banking and payment system, including how to prove authentication when sending money, how to check you actually have the money you are sending, how to avoid double spending, how to achieve consensus on the current state of the network and transactions, and how to survive malicious attacks on the network, all without state support, or in fact any third party of any kind. This is remarkable, and to provide this difficult service securely, the network relies on Proof-of-work by miners. Just like the New York Yankees, Bitcoin’s services aren’t used by everyone, yet they still have costs associated with with providing their services, used by many around the world. This work done by miners isn’t wasted any more than the Yankees’ investment in staff, facilities, or their brand.

So how do Bitcoin “consumers” pay for their service? Each transaction has a fee associated with it, which is given as a reward to miners for including the transaction into the next “block” or batch of transactions. Additionally, the protocol slowly adds new Bitcoin into the system by including a block reward for the miner who finds that block. Thus each block has a reward for the miner, which is what Bitcoin users are “paying” to miners to keep the network safe.

In fact, this is where articles that discuss how much energy Bitcoin is using come from: they are taking the current market value of the block reward (12.5 Bitcoin @ $5000/Bitcoin today) and multiplying that out for a year. One block every 10 minutes and 525,960 minutes in a year means 52,596 blocks worth a total block reward of $3.3 billion a year and probably more with transaction fees. Bitcoin mining is competitive; you only get the block reward if you solve the hashing problem first. Consequently, margins are tight. That means there are big incentives to only use the most efficient hardware (efficient in terms of hashes/kilowatt hour) and the cheapest electricity. Depending on your estimate of what miners are paying for electricity, you can divide 8 cents a kilowatt hour or whatever into the ~$3.5 billion to get a these massive energy estimates. Of course, we should note we don’t really know what percent of earnings goes into R&D for ASIC design and manufacturing costs, rent, etc.

But in my view, it doesn’t really matter; all of these costs are paid for by Bitcoin users in order to use the network. The energy input into the Bitcoin network is determined by the block reward and price of Bitcoin; if Bitcoin and Bitcoin transactions are in demand, the block reward is higher, and miners spend more resources on energy and chip manufacturing. If the demand is lower, they spend less. It’s analogous to people who pay to go to Yankees games; if the demand is higher and fans are willing to pay more for tickets, the Yankees can spend that on advertising, improving the stadium, or getting better players, etc.

Technical Improvement Proposals

Next, technical counterarguments would demonstrate that this ability to send value across the internet with no third party can be done for cheaper than is currently available with Bitcoin. I will now go over the best arguments I know of.

No Block Reward

Currently, miners complete work through hashing to solve a difficult problem. The problem can only be completed with brute force, meaning you just need to run as many hashes as possible to solve the problem. The way this is done today is with specialized hardware and electricity as noted above. However, it is a protocol design that Bitcoins are added to the network with each block that is mined (and this is a pretty useful idea for bootstrapping a digital currency when none existed). We can quickly imagine a cryptocurrency that is identical to Bitcoin except no new coins are added, the ~17 million that currently exist are the grand total. Each block only gets transaction fees rewarded to the miners.

It seems in this case that we have recreated all the value of the Bitcoin network for users, but have reduced the input of electricity on the cost side. Ignoring the usefulness of the block reward for bootstrapping Bitcoin, isn’t this an efficiency gain?

It depends on how liquid and efficient the Bitcoin/dollar exchange market is. If Bitcoin was unexpectedly changed so that no more coins were created, the market cap of Bitcoin (total units of account * exchange rate per unit) would soar, by the net present value of all future coins that are no longer going to be produced. It’s hard to say exactly what that is, but it’s about 3.6 million coins, with the majority produced in the next 10 years. The value would be at least a few billion dollars, maybe as high as $10 billion depending on the discount rate. The current market cap is about $87 billion so that’s not a huge percent increase in price, but it’d be notable. That means if transaction fees in Bitcoin remained constant, in dollars they’d increase by a similar amount forever, unlike the fixed block reward which decreases over time.

In an efficient market, we’d expect this increase in transaction costs due to the higher market price of Bitcoin to exactly offset the reduction in block reward. In other words, current Bitcoin holders are “paying” for the block reward though a reduction in net present value of Bitcoins they hold today. Simply removing the block reward doesn’t change that, it just moves value around.

However, markets may not be that efficient. Dollar/Bitcoin exchanges seem relatively liquid, but they are certainly less liquid than traditional stocks. Additionally, I’m not sure you can borrow money from an exchange to invest in Bitcoin, which is also a sign of an underdeveloped market. So we can imagine a hypothetical world where the Bitcoin protocol originally had much smaller block rewards or had reduced its block reward more quickly. In this world, it’s possible we could achieve a net decrease in total energy expended even with a likely higher price. However, I’m not sure we could know which direction the market inefficiencies would go; perhaps the price of Bitcoin would “stick” higher, meaning higher priced transactions outweigh the reduced block reward.

A final point to be made for this counterargument; transaction costs don’t have to remain constant in Bitcoin terms in this hypothetical. If Bitcoin prices go up, transaction costs might remain the same in constant dollars since users will probably continue to demand transaction space on the blockchain at the same level as before. We do however, have empirical evidence that transaction fees in dollars have correlated with the dollar/Bitcoin exchange rate, and even perhaps in pure Bitcoin terms.

If this argument is true (and so far I don’t believe it is), it should also be noted that it would imply Bitcoin will get more efficient over time as it moves towards smaller block rewards.

Inefficiencies Due to Fixed Bitcoin Protocol Constants (Block Size)

In a theoretical free and efficient market, consumers demand goods with downsloping demand curves, producers supply the good with upward sloping supply curves. Where the curves meet, there is a market clearing price and quantity. In Bitcoin, consumers demand transactions (or transaction space) on the blockchain, but producers don’t produce blockchain space; they produce hashrate, or perhaps “security”. The transaction space is fixed by protocol.

This means that total transaction fees could theoretically be lower if the fixed transaction space (i.e. block size) was changed. This would be determined by the slope of the demand curve for Bitcoin transactions. A shallower slope would mean shifting the supply curve to the right will increase the value of total transaction fees, even if each individual fee drops. A steeper one would mean total transaction fees could drop. It’s been pretty common for Bitcoin blocks to be less than the maximum for the past year, so I’m skeptical that a larger block size would lead to a drop in total transaction fees, and I suspect even if it there was a drop, I don’t think it would be massive in magnitude. Nonetheless, I think this is an argument that Bitcoin could achieve the same ends and be slightly less wasteful, but it needs more empirical evidence.

Proof-of-Stake

This section is a reiteration of Paul Sztorc’s “Nothing is Cheaper Than Proof of Work”.

Suppose instead of hashing and Proof of Work, new transaction fees went to current holders of Bitcoin. This “Proof-of-Stake” would demonstrate commitment to the blockchain’s success not through investment of mining hardware but rather direct demonstration of stake in the blockchain through ownership of the currency.

Firstly, I still have some doubts that this allocation of new currency can actually be done without any actual work. Casper (Ethereum’s proposed Proof of Stake system) requires some calculation as to which random number to pick, which determines which staked coins get the transaction fees. It would be highly valuable to affect that calculation, and it seems optimistic to suggest there will be no way to influence it. But Ethereum isn’t my specialty, so I’ll concede it’s actually possible despite it not existing today.

In Bitcoin, miners spend the equivalent of the block reward and transaction fees every 10 minutes in order to compete and be in the best position to obtain that reward. In Proof-of-Stake, Validators still have to deposit coins to be staked. They risk these coins, because if they misbehave and disagree with other Validators, they can lose them. The amount deposited determines likelihood of receiving the transaction fees, and so these are just a form of “bonds”. Returns to bonds are analogous to returns to mining resources. Value locked up in bonds could have been used in other more productive parts of the economy. The opportunity cost isn’t as externally obvious as the electricity used in Bitcoin mining, but it is nonetheless there and it is identical. Locking up value in validation bonds isn’t a permanent thing, whereas investing time, money, ASICs, R&D, and electricity in Bitcoin mining cements that value into silicon and heat which can only be used for one thing. Thus the returns to mining are going to be higher on a per percentage basis to account for the increased risk.

We already pointed out that the cost of Bitcoin mining is a consequence of the block reward. The block reward if Bitcoin switched to a Proof-of-Stake system would still be the same. But because buying validation bonds isn’t as risky as tying up resources permanently into silicon and electricity, there will be significantly more resources tied up in Proof-of-Stake for any given level of block reward/transaction fees (because the market will keep putting more until the rate of return reaches the market rate for the given risk level). There is thus no free lunch with Proof-of-Stake; users of Bitcoin are auctioning off a block reward/block transaction fees worth of value every 10 minutes, and so a competitive market will form to always provide that value at that opportunity cost, whether that cost is through validation bonds or mining.

My view here is agnostic on whether PoS is a “better” system than PoW, just that PoS doesn’t eliminate the mining cost from the system.

“Useful Work”

What if you used Bitcoin mining to do “useful work”? One counterpoint is that mining is already useful work, since Bitcoin users are paying billions of dollars for it a year. Another is that using Bitcoin for some useful work wouldn’t change anything if miners can capture the benefit of the useful work. For example, using mining rigs for heating in the winter allows you to profit more. But this is equivalent to an increase in mining ASIC efficiency which happens all the time. The network uses this extra efficiency to increase the hashrate, the difficulty level adjusts (the network aims to always have a new block average every 10 minutes) and we are back to where we were, same energy used, but now with a higher hashrate.

However, what about useful work that was a positive externality? For example, finding prime numbers? Assuming away all the difficulties with this specific example, like how hashes are much easier to check than prime numbers, if the work resulted in a true positive externality public good, like information becoming public, then that has to be an efficiency gain.

It should be noted that the work can’t be too useful because if it’s profitable enough where any single individual could benefit given the cost to mine, then lots of people would start mining for the benefit of the work itself.  In which case, this would be treated again like an increase in efficiency with the difficulty level increasing significantly until the marginal cost of mining again equaled the total marginal revenue of both block reward/transaction costs and the public good. But assuming it’s not usually profitable, the benefits could be so spread out across society that there is no way for an individual to benefit, yet there benefit at the societal level. I just don’t see “finding prime numbers” as fulfilling that value, but I’m open to other suggestions. Given the current value of mining is over $3.5 billion a year, I think the useful work would have to have a value that’s a significant fraction of that to matter in terms of efficiency gain.

Carbon Emissions, Regulatory Arbitrage, and Renewal Energy

Bitcoin mining is location independent. That means it will only be undertaken in locations where the input values are cheapest in the world. We don’t actually know where Bitcoin mining is done, but we have some guesses based on information in blocks mined by companies and where the coins are deposited (see this article). The majority is certainly in China due to proximity of the world’s computer manufacturing base there. Miners in other countries would have to wait for mining material to be shipped to them, which could be out of date by the time it gets there. Eventually, we would expect diminishing returns to slow the rate of improvements in ASICs, which would allow non-Chinese miners to utilize mining equipment before it becomes antiquated. That means they could use their locally low price of electricity to their advantage.

That also means that the Bitcoin network could be optimizing for polluting energy, like fossil fuels that are incorrectly priced (i.e. lack of carbon tax). A country that creates a carbon tax would make fossil fuel energy more expensive, and Bitcoin miners there unprofitable, so they might switch to a country without a carbon tax, thus polluting more. This is a regulatory arbitrage and is an efficiency loss.

However, there are caveats to this argument. One is that many countries, including the ones with the most Bitcoin miners, China and the U.S., never had carbon taxes. Bitcoin blew up there because of their technical advancement and network effects of their tech economies (hardware and software respectively). If they were to implement carbon taxes, and miners then left, that would be an inefficiency brought about by Bitcoin.

Another caveat is that Bitcoin is highly efficient in finding the cheapest energy sources. Many renewable sources of energy are very cheap on a per kilowatt hour basis, and so Bitcoin has actually acted as an incentive for expanding renewable energy (see Morocco).

Bitcoin’s monetary existence, unstable though it is, provides a floor underneath which states can no longer mismanage their currency, or else those states risk their population turning to Bitcoin instead. Similarly, Bitcoin mining’s existence means that there is a floor under which local energy prices won’t be able to drop. This is good, as locally cheap (not globally cheap!) energy means that demand is lower relative to supply in a given area, but it’s too expensive to build transmission lines to other areas where energy is more in need. Compared to a world without Bitcoin mining, mining creates value from cheap local energy which can then be transported digitally. The beneficiaries are the users of Bitcoin who get a payment network that literally didn’t exist before. It is paid for with locally cheap energy around the world that had excess supply. There are also secondary effects as users and miners are better off and the wealth effect on their behavior will be to increase some spending, some of which should enrich people who live in already energy expensive areas. This means some people in expensive energy areas will see a cheaper relative cost of energy.

Final Notes

A couple other arguments that I hear a lot but I don’t consider to be challenges to this view.

  • Bitcoin mining leads to centralization. This is true empirically, but not an argument that it’s wasteful, just that it’s bad for Bitcoin.
  • Bitcoin uses a lot of energy. This is basically the argument I’m opposing and it is very common. I’m not saying Bitcoin doesn’t use a lot of energy, I’m saying it provides a service and has associated costs and expenses.
  • Bitcoin has no use cases. The empirical evidence seems to contradict this, as billions of dollars of Bitcoin transactions happen every day. If you need some more discussion on what Bitcoin is used for, check out my previous post on the subject, or check out this useful page from the EFF on how payment service providers can be used to censor free speech.