Though the recent crypto crash has left investors smarting this summer, an even graver threat looms: misguided environmental policy. As Bloomberg Law reports, the Biden administration is “teeing up policy recommendations to lower cryptocurrency mining’s energy consumption and emissions footprint” in accordance with the president’s March 2022 executive order regarding digital assets. The emerging sketches of the executive order suggest that the administration will primarily focus on Bitcoin and its distinct proof-of-work mechanism.
But this betrays the administration’s fundamental misunderstanding of both cryptocurrencies and energy’s role in the U.S. economy. To properly analyze and evaluate the faulty logic of Biden’s plan, it is important to understand how Bitcoin works and why it consumes so much energy.
Proof-of-Work and Energy Consumption
Bitcoin uses a lot of electricity. According to the Cambridge Bitcoin Electricity Consumption Index, it consumes about 120 terrawatt-hours (TWh) of power on an annualized basis—more than 0.5% of the world’s total. While that number may not seem extraordinary, compare it to country-based consumption figures: Argentina uses 122 TWh per year (population: 45 million) and Pakistan uses 104 TWh per year (population: 220 million). To bring the comparison closer to home, Bitcoin’s annual power consumption exceeds that of all the refrigerators in the United States put together.
Although the notion of a digitally traded asset is easy to grasp for average smartphone-wielding Americans, the relationship between the numbers on a screen and the significant energy consumption figures cited above can be hard to comprehend. But it is the link between these two numbers that girds the entire Bitcoin system.
Bitcoin is an open software protocol and peer-to-peer network. Its value proposition is that it will enable an electronic-payment system based on cryptographic proof, allowing, 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.
To earn the cryptocurrency bitcoin, people use specialized computers called application-specific integrated circuits (ASICs) that can solve cryptographic puzzles—this process is called mining. When the first operation solves the puzzle, it confirms new network transactions, adds a new block to the Bitcoin blockchain, and earns the newest coin. Winning the race to solve the puzzle—and the new coin—requires significant computing power, and this demands significant electricity.
Bitcoin’s mining process is known as proof-of-work (PoW). This is Bitcoin’s core security feature and what gives Bitcoin an advantage, according to its proponents, over the thousands of other cryptocurrencies peddled online. PoW is a consensus mechanism that determines what transactions are valid and can be added to the blockchain. The energy required to power mining operations acts, in effect, as a barrier to malfeasance. Because of this mechanism, holders of bitcoin believe they can trust the network’s accounting more than those of the alternatives, including both traditional digital financial systems and other blockchains.
Most competing blockchains use a consensus mechanism known as proof-of-stake (PoS). Ethereum, the leading crypto alternative, will soon move fully to PoS. Whereas Bitcoin’s PoW relies on the energy expenditure of real-world computers that validate transactions, with PoS, buyers “stake” existing cryptocurrency holdings for the privilege of acquiring new coins. This approach, while it reduces the energy consumption needed to verify blocks and brings some additional scaling advantages, severs the blockchain’s link to the physical world through the energy expenditure of computers. In other words, it fails to provide what Bitcoin backers consider a key feature to cryptocurrencies.
The energy requirement that is a built-in feature of the Bitcoin system has drawn the specific ire of the Biden administration. The administration has indicated that it wants to coerce decentralized finance away from PoW and toward PoS. However, despite cryptocurrencies’ startling energy use, the administration’s focus on energy consumption—and its crusade against Bitcoin specifically because of it—is misguided. The Biden plan slips into the depletionist trap, uses whack-a-mole environmental thinking, and, most fundamentally, fails to consider the important concept of subjective value.
The depletionist trap is the broad and widely discredited school of thought that says we are going to run out of natural resources. Eighteenth century British economist Thomas Robert Malthus was a forerunner of depletionism, notoriously predicting that the Industrial Revolution would prompt a population boom that would outpace food production. Instead, industrialization elevated food security to a previously unimaginable level.
Half a century later, William Stanley Jevons applied a version of Malthus’s flawed logic to energy, warning that coal would become ever scarcer. In his 1865 tract “The Coal Question,” Jevons predicted that cost of coal (and the energy extracted from it) would climb inexorably as factories, trains and ships continued to deplete the supply.
What Malthus and Jevons could not see is that while raw materials are indispensable, the ultimate resource, as Julian Simon famously identified, is human ingenuity. We have proven time and again that our ability to make creative use of resources will outpace any resource depletion.
Economists now understand that the mechanism that makes this favorable outcome all but certain is the price system. All else being equal, with rising demand for commodities—in Bitcoin’s case, electricity—comes an increased incentive to bring them to market. Higher prices increase profit, and profit incentivizes producers not only to cast a wider net over existing resources but to marshal new materials and deploy new technologies. The price mechanism, as Milton Friedman said, “successfully steered us over several centuries from wood to coal to whale oil to petroleum to natural gas.” Continued economic development through industrialization has had the same effect on energy production as it did on agricultural production—that is, energy from coal is cheaper today in relative terms than it was 150 years ago.
The fear that Bitcoin is using more energy resources than the global energy production system can keep up with is one that history has proven to be unwarranted. Bitcoin’s addition to the cumulative energy demand will only serve to spur more resource creativity and technological deployment.
It is critical, however, that the mechanism of the price system is respected as the key moderating device. In other words, let the price increase with the demand, so that profit will incentivize innovation. When the price system is interrupted, such as when electricity consumption is unduly subsidized, problems will inevitably arise. But those problems—as seen, for example, in Kazakhstan—stem from political miscalculation, not a depletion of resources. The Biden administration’s panic over Bitcoin’s energy consumption is a new manifestation of an age-old Malthusian fallacy.
Whack-a-Mole Environmental Thinking
As Bloomberg Law reports, the Biden administration’s concerns are not limited to energy use per se; they extend to the environmental effects of emissions. The emissions question is a separate—and more valid—issue, but the administration’s approach is likewise misguided.
To be clear, where Bitcoin mining operations are powered by fossil fuels, this energy use can entail significant emissions of both local air pollutants and greenhouse gases. But that does not mean the Bitcoin network is the source of the emissions any more than are a Netflix data center or a personal laptop. For the most part, mining operations are consumers of electricity not much different from other businesses drawing power from the grid. Bitcoin mining is just one of many power-consuming activities—and should be treated as such. The Biden administration’s plan to target Bitcoin is whack-a-mole environmental thinking.
Instead of focusing on end users, pollution policies should focus on emissions sources, such as coal-fired power plants. When plants emit harmful pollution, they should be compelled to internalize the cost and come up with ways to reduce it. When mining operations themselves emit pollutants, such as when ASIC mining units bypass the grid and are powered by natural gas at wellheads, they, too, should be subject to policies that keep pollution in check.
Moreover, Bitcoin companies have an incentive to set up their operations in countries where environmental standards are upheld because environmental policy enforcement correlates with good governance. While cryptocurrencies may exist in the world of bits, mining operations are firmly planted in the world of atoms—and are thus subject to real-world governance, both good and bad. Companies that seek short-term gain by locating operations in countries with the cheapest electricity (often coal-fired) make themselves vulnerable to arbitrary governmental actions, such as when China banned mining in 2021 and Kazakhstan cut off the industry’s power supply in early 2022. Respect for free enterprise and concern for environmental outcomes are both hallmarks of good governance, and countries that display those qualities will be the most attractive to Bitcoin companies over time.
In keeping with good governance practices, U.S. environmental policies should focus on limiting emissions in the broadest sense possible, not on narrowly targeting particular energy users. The U.S., as Bloomberg Law notes, typically does not regulate energy usage by consumer or industry, and since the emissions from Bitcoin are no better or worse than those from anything else, why treat it like a unique evil?
Failure To Consider Subjective Value
The Biden plan’s singling out of Bitcoin contains a third and most consequential problem: the administration’s disregard for the value markets place on Bitcoin. It is fine if Joe from Scranton thinks crypto is a load of hooey. He is within his rights to say so. But it is another issue entirely when the Biden administration implicitly passes judgment on the legitimacy of the Bitcoin network by deeming its energy use as wasteful.
Yes, Bitcoin uses energy. That energy use is an expression of people’s willingness to buy what Bitcoin provides. In other words, if people are willing to pay for it—and the plants that power mining operations internalize the cost of their emissions—Bitcoin’s energy use isn’t a waste at all.
By targeting Bitcoin’s energy use, the Biden administration is saying that it does not think people need the financial service it provides. But nobody needs on-demand Avengers movies either. We accept that when there are millions of people willing to pay good money to stream them, it means those movies have value. Another comparison is the global gold mining industry. According to the Cambridge index, gold mining uses the equivalent of 131 TWh of electricity per year, which is close to 10% more than Bitcoin (120 TWh). Gold’s value is driven primarily by people’s perception that it is worth something. The formal name that captures this concept is subjective value.
As 20th century Austrian economist Ludwig von Mises explained in his landmark tome “Human Action,” the value of a product is determined not by its inherent properties but by the importance individuals ascribe to that product in achieving their desired ends. If many people are willing to pay $20,000 for one bitcoin, it is obviously important to them—and thus has economic value.
At its root, the Biden plan is not really about energy; it’s about whether people should be free to pursue what they value, provided they cover the costs. The plan reveals a paternalistic impulse against people’s consumption choices.
The Biden administration may be right to doubt the usefulness of Bitcoin. It may be that the less energy-intensive PoS approach will ultimately prevail. But that is irrelevant to environmental policy. The administration’s skepticism does not justify stymying Bitcoin.