Unit 5 Lecture Notes

1. Global liquid energy market

The most significant impact that bitcoin can have on the market for energy is that it is a technological solution that makes energy production far more fungible and liquid. Bitcoin mining is unique in being an energy-extensive and highly profitable use of energy that does not need to be located near human settlement to operate. As discussed above, the problem of energy is not in its scarcity, but in the ability to channel it to where it is most needed, and that is usually where humans live. Bitcoin mining does not have that problem. The implications of this are tremendous, and only just beginning to be understood.

First, areas blessed with cheap energy can now monetize this capacity by using it to mine bitcoin. Second, it makes monetizable isolated energy sources which are left untapped because they would require significant costs to be connected to electric grids near residential or industrial areas. Simple satellite internet connections are sufficient to connect a bitcoin miner in a very isolated location to the bitcoin network and allow it to monetize the energy source it is near. A relatively small investment can allow an investor to monetize the energy source and cover their capital costs, before then using the energy to built more residential, commercial, or industrial facilities that benefit from the low cost of energy.

Third, only the energy with low opportunity costs leading to very low electricity rates will be consistently profitable for mining, and will attract long-term capital investment and infrastructure. Wherever energy is in high demand by residential, commercial, or industrial facilities, using that energy to produce bitcoin will carry a significant opportunity cost, as there are people who would pay dearly for using that energy. Energy sources that are isolated, however, can be used for bitcoin mining but cannot be used for residential, commercial, or industrial uses, and so carries a very low, zero, or even negative opportunity cost. The first kind of energy will be profitable for mining during spikes in the price, such as what we saw in 2017, but this profitability will be quickly eliminated through rising difficulty, as we saw in 2018.

This is why Bitcoin mining will only be profitable at prices lower than the average global electricity rates. These rates would be expected to converge more and more over the coming future thanks to Bitcoin putting a bid under their prices, and thanks to Bitcoin investment in cheap energy allowing the accumulation of capital and the reduction in the cost of energy production.

2. Increased energy production

The essential property of capital goods is that they increase the marginal productivity of the producer who uses them. The fisherman who catches fish with a modern trawler has a much higher hourly productivity than the fisherman using a little boat and net, whose productivity is in turn higher than that of the fisherman on the coast holding a fishing rod, whose productivity is higher than anyone trying to catch fish with their own hands. As the stock of capital increases, the marginal productivity of the worker increases, and that is why countries that have higher capital stocks have higher income than poorer countries. The march of human progress and civilization is the march of capital being accumulated to produce more output per unit of effort expended by a human being, and the more capital is accumulated, the more productive humans are, and the lower the marginal cost of the good produced.

As mentioned above, energy on this globe is not a fixed stock which we slowly deplete, but rather an ever-renewing flow from which we only need to utilize a tiny fraction to thrive. As such, more capital investment in energy production will only lead to more capital dedicated to the utilization of these vast resources of energy, more energy production, and lower energy cost.

Applying this analysis to the question of bitcoin power consumption has startling implications. Contrary to your local news anchor bimbo's hysteria, bitcoin isn't "consuming" the world's energy, bitcoin is providing a powerful market incentive to energy producers worldwide to increase their energy production. By giving a large financial incentive to anyone able to mine at an electricity cost below that of the market, Bitcoin makes the development of cheap sources of electricity, anywhere in the world, very rewarding. This financial reward in turn leads to growing investment in capital infrastructure for cheap energy sources, which leads to increased energy production, and decreased cost.

This might sound too good to be true for some readers, as it seems that bitcoin will magically created resources to go toward investment in energy infrastructure. The mark of a good economist is to stop whenever someone is trying to sell you a feel-good story and ask "Where's the catch? What's the opportunity cost?" The resources do indeed have to come from somewhere, and that is government seniorage.

Remember here that Bitcoin only has any value because people choose to hold it. If bitcoin has a price, it is only because someone decided to go to bed tonight without selling their bitcoin at that price. Only demand for holding money gives money value. When demand for holding money declines, the value of the money declines too, while when the demand increases, the value increases. If bitcoin continues to grow, it would acquire more demand, which must come at the expense of something else people will be demanding less. In this case, the obvious alternative is government money. Bitcoin's growth will have to come at the expense of the demand that people have for government money worldwide, and thus, it would cause the value of government to decline, or to grow less than it otherwise would have. This will either lead to the destruction of the value of a highly inflationary national currency if people dump it for bitcoin, or at least limit governments' hands in inflating their currency, forcing them to be more careful with their monetary policy, as was discussed in the monetization scenarios of last month's research bulletin. Either way, in a world in which bitcoin is growing fast, government's ability to finance its operation through the stealth tax of inflation would be seriously compromised. Instead of inflation taking away from the wealth of the productive in order to finance needless wars, politicians, bureaucrats, their cronies and other unproductive parasites, bitcoin's seniorage would is being awarded in an open global competition to whoever can produce the cheapest electricity. Instead of seniorage rewarding parasitism, corruption, and warmongering, bitcoin's seniorage rewards smart engineering, creative technological solutions, and intelligent use of capital.

The problems of government control over money are discussed extensively in Chapter 8 of The Bitcoin Standard, and will not be repeated here. Suffice it to say that not only can Bitcoin potentially defund governments from the resources they need to grow more controlling and exploitative of their populations, it will also direct these resources toward developing energy production.

There's an old saying in economics that the cure for high prices is high prices. As the price of anything rises, the incentive for producing it increases, so its supply will increase as a response, thus bringing the price down. But the relationship is more complex than just an increase in supply as a response to an increase in demand. Once one understands the nature of capital production it becomes clearer how this relationship works. As the price of a good rises, producers earn increased returns on their sales, which allow them to invest in capital production, and as rising prices help cover the initial capital costs, the costs that remain are the marginal costs, bringing prices down and quantities up.

3. Hydroelectric power development

Bitcoin changes the economics of power sources by introducing an energy-extensive and highly profitable use of electricity that is largely location independent. Large numbers of miners can be installed near a water dam and they could operate without much need for human supervision. This could finance the building of infrastructure in areas that are not profitable for human settlement currently. But after a dam and power plant have been built and financed over 5 years of operating Bitcoin mining, the energy that is produced could finance further infrastructure development, bigger dams, and even residential and commercial areas. Bitcoin mining will provide the start-up capital needed to finance a large amount of hydroelectric power around the world.

Followers of mining over a long period of time will conclude that the only kind of mining that is profitable in the long-run is mining based on hydrolectric energy or excess flared methane.

Hydrocarbon energy is simply too expensive as a source of energy for bitcoin mining. It can surely be profitable during times in which Bitcoin's price rises very quickly, but it cannot compete with energy sources like hydroelectric power which have a far lower opportunity cost. And that, fundamentally, is what hydroelectric power's advantage comes from. Hydrocarbons are much cheaper to transport than hydroelectric energy. They are thus in high demand everywhere humans settle. They can be used for cars, homes, cities or all kinds of other uses. They will always have a high opportunity cost, relatively, because there is always someone who could use them for something highly productive. Hydroelectric energy, on the other hand, usually has a very low opportunity cost, or even a negative opportunity cost, when one considers the dangers posed by flooding.

Bitcoin is already having a discernible impact in the world of energy production by allowing for the monetization of hydroelectric power in an unprecedented manner. Large amounts of hydro electric power are generally located in areas of mass water movement, and thus are not ideal for human habitation. Societies likely develop in areas away from this, and thus most cities and urban areas rely on hydrocarbon energy, or nuclear for their energy supply. Hydroelectric power, while plentiful, requires very large infrastructure and capital investment to make available reliably for urban areas. Enormous amounts of excess energy are disposed in the seasons with extensive run-off, when there is no conceivable way of storing it.

A recent report by Coinshares observes data on bitcoin mining operations leads to an ob servation which cannot simply be explained by coincidence: the bulk of Chinese Bitcoin mining is located in provinces with significant solar, wind, and hydroelectric capacity. Outside of China, most large-scale mining operation are located in the "Pacific NorthWest (Washington State, Oregon and British Columbia), Quebec, upstate New York, Northern Scandinavia (Norway and Sweden), Iceland and Georgia. The energy sectors of almost all of these regions except New York and Russia are dominated by renewables and there are publicly available figures showing the percentage of renewables penetration in each region [Figure 9]. Europe and North America also have the lowest hydropower utilisation factors in the world, with both regions using less than 40% of installed capacity".

The smartest mining operations are the ones that have figured this out. In particular, Bitfury's main product is the Block Box, a shipping container custom-fitted with bitcoin miners and an engine to run them. The Black Box can be located anywhere energy is plentiful and cheap, and just needs a simple internet connection to mine and produce bitcoin for its owner. Upstream Data, Inc. is a Canadian firm located in Alberta which relies on building a similar custom-fitted mining operation to be located at oil fields to benefit from the flaring of methane that is too cheap to be transported or used for anything else. While these operations have only been around for a few years, it will be one of the most interesting aspects of the development of bitcoin to observe what kind of developments these projects will lead to.

As Bitcoin mining continues to move to natural sources of hydroelectric power, investors in these sources will likely accumulate capital, and once the infrastructure for the generation of the energy has paid for itself, it can be used for alternative uses, and it can power the building of more facilities and infrastructure around the energy source. Bitcoin mining can thus finance the first step of exploitation of natural energy sources, and then finance the building of residential, commercial, or industrial developments that can benefit from that energy. The long run net result will be that more and more communities and cities will start locating around these natural energy sources. We will start seeing more and more of humanity clustered around natural energy sources.

Historically, cities and population centers have developed according to many considerations, primarily around seaports, trade routes, and natural resources. The cities of the twenty-first century were not built with the utilization of the energy sources of the twenty-first century in mind, and so cities generally exist far away from sources of energy that could power them. As Bitcoin finances the development of energy infrastructure, it will naturally lead to a world where more and more of the population lives near abundant energy sources with a low marginal cost for energy.

4. Ending energy subsidies

By creating a globally liquid and fungible energy market, bitcoin has created a unique situation in human history where energy sources can be utilized independently of their location. Bitcoin thus creates a profitable use of an energy source anywhere it exists in the world, and gives an incentive for anyone to use their energy to mine bitcoin if the cost of the energy is too low. This doesn't just apply for stranded energy sources, but also for subsidized and artificially-cheap electricity sources. Wherever anyone has access to subsidized energy, it would make sense for them to mine bitcoin, and thus monetize the subsidy given them. As this becomes more apparent, it will soon become untenable to have significant energy subsidies anywhere.

The amount of distortions that have happened in the energy market around the world over the past century cannot be overstated. As electricity's spread came along with the spread of the modern managerial state, there is barely a spot on earth in which the production and consumptioin of electricity is not treated as a matter of national importance on which public policy must pronounce. In most of the world this has translated into subsidies for specific industries, interest groups, or energy uses. Such a subsidy, like all government subsidies, is highly destructive economically. It distorts consumption decisions, thus giving the subsidized an incentive to consume more than they need. It distorts production decisions, in- centivizing producers to produce less. The most pronounced impact of such distortions are the power cuts that plague much of the world, a simple market shortage caused by the control of the price of energy. At the least, these subsidies will cause inefficient waste of resources.

Bitcoin is a black hole heading for anyone trying to keep electricity artificially cheap anywhere.

Anybody trying to make some uses of electricity come at a lower price, because of political or whatever silly reasons, will find that people who get that cheap electricity will use it to mine bitcoin, until they bankrupt the people providing them subsidized electricity. Anybody subsidizing electricity today has a sword hanging over their neck. They need to either stop subsidizing electricity, or go bankrupt.