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Bitcoin is not a Battery — it is a Sink

In a recent blogpost, Nick Grossman argues that Bitcoin acts as a battery — moving electricity across time and space, from where it can be cheaply produced to where it can provide the most utility. In this blogpost, I argue that Grossman’s economic analysis fails to consider the particularities of Bitcoin’s mining mechanism. Bitcoin is not a battery; it is a bottomless sink for marginal-cost electricity. It doesn’t store energy to be deployed later; instead, it sucks marginal cheap energy and produces no marginal asset in return. The reason is simple: if Bitcoin was a battery, then the more electricity you’d put into it, the more “charge” you’d get. But that’s not the case: in Bitcoin, more electricity does not buy “more Bitcoin”, it rather buys “more security”, a common good for the entire Bitcoin system. And security is not an asset, and cannot be later traded. As a result, Bitcoin likely does not have the social utility that Grossman ascribes to it, of promoting the production of cheap power.

A few days ago, Nick Grossman published the blogpost Bitcoin as Battery. I love this blogpost. It’s clear, it’s appealing, and it has an optimistic conclusion about the great social benefits of Bitcoin.¹ Sadly, I’m pretty sure it’s also wrong. In this blogpost I will explain why. To be clear: this is not an attack on Bitcoin, on its power consumption, or its social utility;² this blogpost is purely a critique of Grossman’s argument and an invitation for a more careful economic analysis of Bitcoin’s power usage and its implications.

Grossman writes:

Crypto mining converts electricity into value, in the form of crypto assets (BTC, ETH, etc). Those assets […] can then be moved, transferred and transformed […] instantly via an internet connection.

This seems to suggest that Bitcoin is a battery: storing energy at one place and time, and releasing it at another place and time. In this blogpost, I explain why Bitcoin is not a battery, but rather a sink. This is a simple corollary of the following two facts:

Fact 1: the price of Bitcoin is dictated by the cryptocurrency market, i.e. by the supply and demand for Bitcoin. Most importantly, the price of Bitcoin is barely affected by the availability of electricity, or by the price of electricity.

Fact 2: Bitcoin is produced at a fixed rate: 6.25 new Bitcoin are generated approximately every 10 minutes. The newly-created Bitcoins are distributed among all miners, proportionally to the amount of electricity that they burned. (This is not technically accurate: I’m making some big simplifications here and in the rest of the post.³)

From these two facts, we already see that Bitcoin cannot be a battery: no matter how much electricity is poured into Bitcoin, the output is always the same — 6.25 Bitcoin per 10 minutes. And while the value of 6.25 Bitcoin is not fixed but fluctuating, the fluctuations have nothing to do with the price of electricity. In a battery, the more electricity you put in, the more you’ll get out. In Bitcoin, the output is constant regardless of the amount of electricity you put in.

In fact, taking Fact 1 and Fact 2 together teaches us a lot about Bitcoin’s electricity usage economics: the Bitcoin mining system is something between an arbitrage and an auction. Miners who can generate electricity cheaper than some threshold can profitably mine Bitcoin. Miners whose electricity is more expensive than this threshold, cannot mine Bitcoin profitably. The value of this threshold fluctuates with time: it depends on the amount of current mining power deployed to the network, and is determined every two weeks in a process called “Bitcoin Difficulty Adjustment” that’s sort of like an auction (we won’t discuss that here). There is a lot more to say about these economic behaviors, but the bottom line is this:

Corollary: the Bitcoin network incentivizes miners to invest into it all electricity that’s substantially cheaper than the threshold. In return for all this electricity, it produces a fixed economic outcome — 6.25 Bitcoin every 10 minutes. And the value of this economic outcome has nothing to do with the amount of power fed into it — it only depends on crypto market forces that are unrelated to mining. The economic equilibrium of the Bitcoin economic model is as follows: the total cost of all electricity invested into the network over a 10-minute period strives to be equal to the present financial value of 6.25 Bitcoins.³ If electricity becomes cheaper, then more electricity gets poured into the system, producing the exact same output. That is why Bitcoin is not a battery but rather a sink: its economic output is pre-fixed, and does not depend on the amount of resources poured into it. When miners pour more electricity into Bitcoin, they don’t get more Bitcoin; instead, the entirety of the Bitcoin network becomes more secure.⁴ Security is not a commodity, and can’t be usefully traded-away later: we’ll get to this later in this post.

Now, what happens if the price of bitcoin increases? As the price of Bitcoin increases, more and more sources of energy become marginally-profitable to spend on mining Bitcoin, so more expensive electricity will be poured into the network. This is true regardless of the availability of any kind of clean or cheap energy: as Bitcoin’s price increase, more expensive and wasteful sources of power become attracted into the sink as well.

What happens when more sources of cheap energy become available? They will be poured into the bitcoin network, and then the auction (i.e. the Bitcoin Difficulty Adjustment) will lower the threshold for mining efficiency, which means that more-expensive sources of power will no longer be profitable for mining Bitcoin. But the Bitcoin system as a whole will end up consuming the sources of cheap power, so they will not be available for other uses. Bitcoin is indeed incentivizing the creation of cheap power sources, but then it promptly monopolizes those power sources: those sources are not going to be used for anything besides feeding the Bitcoin network itself. There is a subtle argument possible here: maybe there are secondary effects: the high price of Bitcoin might incentivize actors, over the long term, to develop technology for more abundant cheap energy, and such technology might allow us to create cheaper energy for non-Bitcoin uses! But this is a pretty tough argument to make credibly: such secondary effects usually turn out to be smaller than anticipated. And Bitcoin’s $50M-a-day bounty is likely not enough to incentivize true moonshot sustainable cheap-energy technology: it is more likely to incentivize unsustainable sources of cheap energy. And importantly, cheap energy is not the same as clean energy. Bitcoin incentivizes the development of cold fusion and more efficient solar panels in exactly the same way that it incentivizes more aggressive fracking in the global south.

Comparison to Aluminum Smelters: Smelters produce Aluminum, but the Bitcoin Network produces Network Security

Let’s go back to Grossman’s argument. Grossman compares Bitcoin to Icelandic Aluminum smelters. He explains that Aluminum smelters are a battery: smelters convert cheap electricity into a commodity, which can then be moved across space and time. (This claim about Aluminum smelters might be dubious as well, because it once again includes uninternalized externalities; but from a theoretical economics viewpoint, we can take “smelters == batteries” as a reasonable economic model of smelters.)

Grossman claims that Bitcoin acts in the same way: taking cheap electricity and converting it into a commodity — Bitcoin. But the analogy does not hold. The product of Aluminum smelters is indeed a commodity — Aluminum. The more electricity you put in, the more Aluminum you get out. But the product of Bitcoin mining is not Bitcoin, at least not in the same sense as the product of Aluminum smelters is Aluminum. Whether you put in more electricity or less electricity, exactly 6.25 Bitcoin will be generated every 10 minutes, no matter what. No, the product of Bitcoin miners is security. If you spend more electricity, you get better security.⁴ And sadly, security is not a commodity. It can’t be re-sold, and it doesn’t maintain its value over time. If you convert twice as much electricity into Bitcoin, you don’t get twice as much value (remember that the value of Bitcoin is determined by unrelated market forces!); instead, you just get the same amount of value, and simultaneously you provide the bitcoin network with twice as much security. Bitcoin Miners are service providers. The service they provide is security, and the amount they provide is “whatever security you can sell me at 6.25 Bitcoin per 10 minutes”.

Satoshi Nakamoto explicitly designed the Bitcoin network to NOT work like a smelter, but rather as an auction to provide the most security for the lowest price. So it shouldn’t surprise us that Bitcoin does not work like a smelter, and that what is produced is not a commodity. Satoshi designed the Bitcoin network with one key objective in mind: security. They designed Bitcoin to be as secure as possible, not to incentivize society to find new sources of cheap energy — that’s just a side effect, and one that creates perverse incentives.

Wrapping it up.

To summarize: Bitcoin is not a battery. Bitcoin is a sink for low-cost power. As such, its environmental impact is quite negative (in a vacuum), and will get more negative as the price of Bitcoin climbs. Still, Bitcoin has many useful social properties as digital money, and is still likely much cheaper than the banking system (depending on how you measure it). Bitcoin also provides the substrate for the development of useful protocols and primitives, which will build Web 3.0, a global network efficiently transacting in data and value, with immeasurable social utility. Bitcoin’s contribution to the world is (in NPV terms) more than worth its energy cost. But we shouldn’t ignore Bitcoin’s energy cost; this is a nuanced topic, which shouldn’t be swept under the rug by wishful thinking.

Acknowledgments. After posting this, I saw that Shayle Kann has used the “Bitcoin as Sink” metaphor before I did.

ℹ️ About me

🎆 I’m a computer scientist, investing in startups changing the world using computer science.
Are you building a pre-seed startup based on cryptography, machine learning, optimization, or any other kind of algorithms? Are you bringing cutting-edge science to market in a way that can change the world? I’d love to talk to you! Please drop me a line at elad@lunarventures.eu !
Do you know someone building such a startup? Send them this blog post or just tell them to email me!

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Elad Verbin is a Berlin-based Computer Scientist. He is a founding partner of Lunar Ventures.
Lunar Ventures is a European pre-seed/seed VC fund investing at the overlap of deep-tech and software. Lunar was founded solely by R&D people, to serve the needs of R&D founders building horizontal moonshots across Europe.

Footnotes:

  1. Grossman is a bit too optimistic about the social utility of Bitcoin. He writes:

crypto mining is driving the energy transition from fossil fuels to renewables.

[…]

Just recently the energy giant Aker announced a major Bitcoin-related initiative, Seetee. The shareholder letter where they lay out the vision is worth a read

My analysis in this blogpost suggsts an alternative reason that energy producers want to argue that Bitcoin has positive social utility — because an economic sink that siphons all cheap electricity is AMAZING for energy producers’ bottom line. “An insatiable target market for my product? Tell me more!” I don’t think we can rely on their communications as sound economic analysis.

2. I personally believe that in a macro view, Bitcoin does have a positive social utility which dwarfs the downside of its power consumption, at least for now. I also believe that Proof-of-Stake systems such as the one being currently deployed by Ethereum will eliminate the power-consumption problem altogether. I hope Bitcoin will also move away from its pure-Proof-of-Work system, sooner rather than later.

I believe Bitcoin has a chance to become the world’s most important currency, and there are excellent arguments why Proof of Work is a much safer system for a world currency than any Proof of Stake based system. I respect these arguments. However, Bitcoin has all the characteristics of a runaway self-reinforcing autonomous system which exploits humanity’s worst failures to internalize externalities in the electricity market in order to strengthen itself. Bitcoin is almost an organism in this sense: it grows, and as it grows, it eats cheap power, incentivizing humans to exploit the worst policy failures in internalizing externalities and capitalizing on them. And we have seen nothing yet: this harmful behavior will grow as the value of Bitcoin increases. I love Bitcoin, but the arguments on the power debate must become more nuanced, rather than one side yelling “Bitcoin is the future of freedom” and the other side yelling “you are ruining the planet”.

3. Note that this is a much-simplified economic analysis. In reality, much of the price of mining Bitcoin actually comes from the cost of hardware and operations. But @nickgrossman’s simplified his analysis to only look at electricity cost, and it’s a decent simplification in order to examine Bitcoin’s power consumption. So I’ll make the same simplification as him throughout this blogpost: assuming that any power-producing entity in the world can sink as much electricity as they want into the Bitcoin network, and get benefits that are proportional to the amount of electricity it invested. Interestingly, if this was actually true, then the power characteristics of the Bitcoin network would be much more malignant than they actually are, and might constitute a problem even with the current-day Bitcoin price.

If you do want a more realistic analysis that also considers the cost of hardware and operations, you’ll find that the statement “the total cost of all electricity invested into the Bitcoin network over a 10-minute period strives to be equal to the present financial value of 6.25 Bitcoins” ceases to hold. In reality, the decision of whether to use cheap electricity to mine Bitcoin begins to depend on complex NPV calculations, like the cost of hardware, and how efficient this hardware is at converting electricity to hashrate compared to other miners’ hardware, and how expensive is cooling (mining in cold places is cheaper due to reduced cooling costs). Future considerations also come into effect: maybe electricity is cheap for me right now, but will stop being cheap in 6 months? In this case, I shouldn’t make the large up-front investment in hardware. The economics of Bitcoin mining are complex and fascinating but are besides the point here. It suffices to say that for the purpose of determining whether Bitcoin acts as a battery, one can simplify the economic decisions around the profitability of mining simply to those related to the electricity consumption, and to also simplistically assume that all miners convert kw/h to #hashes at exactly the same rate and efficiency.

4. I keep claiming that the more electricity gets used in the process of mining a single block, the more secure the Bitcoin network is, but I don’t explain why. It’s a pretty nuanced technical reason, but here is the hand-wavy version: a typical type of attack that the Bitcoin network strives to defend against, is a 51% attack: an attack where dishonest parties create a fraudulent block, and then spend large amounts of mining power in order to create the longest chain under that block. To pull off such an attack, the attackers will need to produce a hashrate that is larger than the hashrate of the honest miners. The hashrate of the honest miners is proportional to their energy consumption (under some simplifications). Thus, the larger the electricity usage of Bitcoin miners, the more secure the network. This relation is roughly linear — Bitcoin security is roughly proportional to its electricity usage.

For a brilliant and poetic take on this, see this comment by Levi Aul on Hacker News:

[…] any left-over electricity that isn’t going into “good” mining, could instead be going into Sybil attacks. It’s as if every potential fire-fighter who isn’t hired as a fire-fighter, instead has a chance of being recruited by “Big Fire” to one day work together to all set fires at once. (here)

Lunar Ventures is a pre-seed/seed VC fund investing in deep-tech software and computer science startups, run solely by R&D experts, investing into globally ambitious algorithmic startups across Europe.

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Elad Verbin

Elad Verbin

Berlin. Computer Scientist & Algorithms developer. Invests in pre-seed algo-tech: ML, blockchain, zero knowledge, ... Partner @ Lunar Ventures

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