cover image: How to Think Straight about Bitcoin’s Social Costs and Benefits

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How to Think Straight about Bitcoin’s Social Costs and Benefits

1 Mar 2022

Building a bridge is costly: It takes labor and machinery and raw materials that have alternative uses. Does it follow that building it is a waste? No. Waste occurs when the cost incurred exceeds the benefit attained. Cost greater than zero does not imply cost greater than benefit. Does it follow that the bridge is worth building? No again. A bridge to nowhere might be built even though it is wasteful, if the few beneficiaries don’t bear the costs themselves. To know whether a particular bridge is worth building we need to compare benefit to cost.To count benefits and costs, we observe market prices and transaction quantities. None of us has access to a god‐​like perspective. Consequently, for normal private goods where costs and benefits fall on producers and consumers, economists normally defer to the judgments of the market participants who actually bear the costs about whether the benefits of an activity exceed its costs. Buyers presumably value a good more than the price they pay, or they wouldn’t buy, and producers incur average costs that are less than that price, or they would exit the industry. In the case of Bitcoin, the electricity bills for proof of work are ultimately paid by Bitcoin users, just as costs of production for bread and milk are borne by buyers of bread and milk. Bitcoin users pay directly when they pay blockchain fees, and indirectly when new Bitcoin is awarded to miners, enlarging the stock of Bitcoin and diluting the purchasing power per unit compared to what it would have been with a constant stock.For Bitcoin, as for other goods, a useful accounting needs to consider both costs and benefits. Proponents of Bitcoin have been known to downplay the costs, or even count them as benefits, while opponents have been known to downplay the benefits and even count them as costs.Downplaying costsBitcoin proponents sometimes emphasize that Bitcoin mining operations are able to locate wherever electricity can be produced at least cost, such as natural gas fields where excess gas would otherwise be burned off, or remote hydroelectric plants with few alternative consumers (Goyal 2021). And Bitcoin miners plugged into a regular electricity grid will shut down quickly to free electricity for other users during times of peak load that push the price per kilowatt‐​hour above the miners’ break‐​even point. These abilities reduce the opportunity cost of Bitcoin’s electricity use compared to the counterfactual of using only high‐​cost electricity. But it does not make the cost zero or turn it into a benefit.Proponents applaud the fact that the Bitcoin mining industry draws a higher proportion of its electricity from renewable or sustainable or non‐​polluting sources than other industries. But using electricity from those sources of electricity is still a cost and not a benefit of Bitcoin. Green energy is still costly‐​to‐​generate energy.When Bitcoin mining helps to finance expenditure 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), that is not a benefit that Bitcoin provides by comparison to cryptoassets that use less energy. It is a cost. Building or refitting power plants is a costly use of labor and material resources, even if the new facilities burn no fossil fuel and emit no carbon.Downplaying benefitsEuropean Central Bank economists Ulrich Bindseil, Patrick Papsdorf, and Jürgen Schaaf (hereafter BPS) (2022, p. 4), labeling Bitcoin an “encrypted threat,” have written that because “the Bitcoin network comes with a large energy hunger due to its reliance on proof‐​of‐​work” it therefore “wastes power.” But it is a non sequitur to leap to that conclusion without considering its benefits. It doesn’t follow even when stated in a comparative fashion, as when they suggest that Bitcoin is wasteful because the proof‐​of‐​work method of processing transactions uses more energy per transaction than alternative methods like proof‐​of‐​stake or like the status quo banking system. To avoid rushing prematurely to judgments like these we need to consider the benefits that can be attributed to the proof‐​of‐​work protocol. To say that the proof‐​of‐​work method is wasteful simply because it uses more energy is to suppose that it provides zero benefits (no greater privacy, no greater security, no greater credibility of the release schedule) over a payment system run by proof‐​of‐​stake or on a single central ledger. But the assumption of zero benefits is inconsistent with the observation that some users prefer proof‐​of‐​work systems.The default presumption of modern Paretian welfare economics is that under the force of free competition the market for a private good like Bitcoin (or any other cryptoasset) operates efficiently. Mutual gains from trade are found and realized. To rebut that presumption, a benevolent would‐​be increaser of net social benefits needs to meet a burden of proof. To warrant restrictions on mutually beneficial trades, evidence is necessary to show that Bitcoin production is harming third parties in ways that violate their property rights or, as BPS (p. 2) have put it, that Bitcoin imposes significant negative externalities.The fact that the Bitcoin network uses electricity does not provide the requisite evidence. Hospitals use electricity, as do school buses and airplanes. Virtually every industry uses electricity to produce its output. Bitcoin is not exceptional in that regard. It is true that, at the margin, Bitcoin’s demand for electricity contributes to total demand and thereby to determining the price of electricity. The greater is Bitcoin’s electricity use, the higher is the price of electricity. But that, too, is equally true for every other electric‐​power‐​using industry. The spillover effect of additional electricity demand on the price of electricity is, in technical economic terms, merely a pecuniary externality, not a technological externality.
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Authors

Lawrence H. White

Published in
United States of America

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