Because electricity is not priced optimally, we all pay for excessive Bitcoin mining.
(This post is coauthored with Catherine Wolfram)
You may be reading this blog post in your dorm room, while your GPU is mining for Bitcoin using that zero marginal cost (nerd-speak for “free”) electricity coming out of the wall. If you did not understand that sentence, let’s back up. Bitcoin is one of a number of virtual currencies, which can be used to pay for lots of things you can buy on the internet. Bitcoin use cannot be traced back to you, which makes it super popular for shady transactions.
While neither of us is a monetary economist, we learned in graduate school that currencies are usually issued by governments. In some places, these currencies are backed up by valuable physical resources like gold. Traditionally every currency has a physical manifestation, which we refer to as money, but that actually makes up a tiny share of the money supply. The rest is electronic and tracked by commercial banks and the federal reserve. The key is that the small pieces of paper currency have value because the government prints a limited number of them, can validate that they are real, and promises to honor non-fake currency. This makes the whole system work.
Bitcoin’s scarcity, validation, and hence value, comes from solving complex math problems. And, complex math problems require lots of computing power. Turns out that computing power is exactly what’s found in that nice computer (= gaming rack) your parents bought for your term papers. On a larger scale, it’s in dedicated servers.
There have been a number of articles recently about just how much energy all these complex math problems use. This site claims that cryptocurrency mining (i.e., solving the complex math problems) today accounts for more annual energy than the country of Bulgaria. This site helps you figure out how much money you can make mining Bitcoins. The basic calculation seems to suggest that the less you pay for electricity, the more money you will make.
The fundamental problem is that worldwide electricity prices are not designed to sustain this onslaught of new Bitcoin miners.
- The most obvious problem is that prices do not (for the most part) reflect the local or global environmental damages from electricity generation. Specifically, those electrons powering your computer, and generating “coin”, more than likely come from a fossil-fuel power plant that’s contributing to global warming and local air pollution. This has been a long-running theme on this blog, but the explosive growth of Bitcoin mining promises to really make us cringe.
- Another problem is that, unlike most goods and services, the prices for electricity are set by regulators (read politicians) and not by markets. This point is made ultra-clear in the developing world, where power theft can be a problem. For example, this paper, shows that power theft in India increases around election time. Politicians are not very motivated to cut down on theft, even though it’s bankrupting the local utilities. This is problematic even if you have millions of rural households using free electricity to power a single lightbulb. It is a real problem if someone with a Bitcoin server farm moves in to access the free electricity.
Politicians usually have at least 23 goals they’re trying to achieve with electricity prices — including fairness and gradual changes, if there are any at all — all while guaranteeing that elderly customers can run life-support systems and that we can pay for pet programs.
The mish-mash of electricity prices that arises doesn’t lend itself well to something like Bitcoin mining.
- In addition to power theft, there are instances where the price of the electricity is zero for more benign reasons. For example, college students living in dorms often get electricity as part of their housing package, which means that students don’t pay more if they use more. On the margin, then, their electricity is free. The same for many apartment renters, as in many older, large buildings you don’t have individually metered apartments.
These problems are not unique to Bitcoin mining. If electricity prices do not reflect marginal costs for environmental, political or other reasons, it’s bad for the overall economy. But, most humungous electricity consumers – think aluminum smelters – are much more centralized and aren’t growing at the same astronomical pace as cryptocurrency mining, so it’s easier to track their use.
While it is impossible for us to track the physical locations where Bitcoin is generated, we hypothesize that it is most likely generated in American dorm rooms and regions with cheap electricity (e.g., India and China and Mexico) and less likely in places with expensive electricity like Denmark, Germany and Hawaii. If you can find prime numbers, you are smart enough to figure out that you should run computers in the places where electricity is cheapest. While China and India are working hard on improving environmental regulations (which might make up for some of Scott Pruitt’s war on the environment), there is a long way to go to get to electricity pricing that reflects its full cost to society, including pollution.
Put differently, the Winkelvoss twins, who seem to have redeemed their Facebook losses with big Bitcoin wins, are indirectly helping to drown polar bears, kill trees and guarantee that utilities in the developing world move towards bankruptcy.
But, you say, what is the alternative? We had a lively discussion at the EI lunch table about this. Max likes his currency traceable and issued by a government. This allows for things like taxation and easier monitoring of illegal transactions. Some graduate students called him an old grouch (which is correct). But, after all, we are a bunch of energy economists and eventually got to thinking about the energy implications. The question we could not answer on the spot was whether maybe the energy penalty for Bitcoin is not so much bigger than that for cash or credit cards.
So, we did some blogmath. The calculations can be found here. Turns out that a banknote uses about 0.8 watt-hours per transaction. To put this in perspective, a 60 watt lightbulb (which is your average incandescent – now illegal in many places) uses, well, 60 watt-hours if left on for an hour. A credit card transaction uses about 7 watt hours per transaction. So, about eight times more energy than the cash transaction. Now, get ready for it. A Bitcoin transaction uses 100,000 watt-hours per transaction. That is 100kWh, so about the equivalent of 115,000 cash transaction. This is why the annual electricity consumption is surpassing Bulgaria, and by some estimates, on track to exceed the US by mid 2019. If we use a number of external costs from electricity consumption of 6 cents per kWh which assumes the US fuel mix, which is much cleaner than e.g. China’s, we are talking about almost $2.5 billion worth of free riding. This is a conservative number, with the true number potentially much higher.
So, what on earth are we doing? We are destroying the environment in order to subsidize an untraceable currency which enables and encourages tax evasion and other illicit behaviors. We thought that refrigerated pet food was going to take the cake for dumbest and most frivolous new use of electricity. Move aside kitty, here comes the itty-bitty coin to take the prize!