January 21, 2018

BENITEZ | The Real Cost of Bitcoin

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Bitcoin mining consumed nearly one percent of the United States’ electricity last year. Globally, Bitcoin’s estimated yearly power usage is greater than that of Ireland, or 30 times more than that of Tesla vehicles. Considering this, one wonders whether the societal benefits of the world’s foremost cryptocurrency offsets its significant energy consumption, which expedites greater, existential risks like irreversible climate change. Does Bitcoin justify its power bill?

First, while Bitcoin is often described as an emerging currency, its illiquidity — you can’t just buy groceries with it — makes it as an asset best-likened to gold. Throughout his annual shareholder letters, Warren Buffett repeatedly disavows acquiring gold, arguing that it isn’t something he can evaluate as a non-income-generating asset. Indeed, as a value investor, Buffett has always been wary of evaluating an asset based on market expectations, which are impossible to predict. Despite attempts to calculate Bitcoin’s intrinsic value, the extent to which ambiguous probability governs its future enthusiasm therefore shows Bitcoin has two purposes: being a store of value, and being another volatile asset on which speculators can bet.

Nobel economics laureate Robert Shiller recently explained in a New York Times article how few people use Bitcoin as a store of value. But even then, it still doesn’t offer a unique comparative advantage over other assets. Gold’s price offers a similar freedom from monetary policy — and, unlike Bitcoin, isn’t susceptible to a cyberattack. (If anything, Bitcoin’s value is always compared against fiat currencies, and so demand for it cannot totally escape the impact of monetary policy decisions.) At least the dollar retains value so long as there is public trust in the state. And even the currency of prisons, cigarettes, is supported by material utility.

On the other hand, as a speculative instrument, neither does Bitcoin offer a unique advantage. If it is Bitcoin’s volatility you love, there are other highly-volatile assets and derivatives on which to speculate, and it is always possible to adjust your portfolio’s volatility by adopting varying degrees of leverage.

As in gold, those who dabble in Bitcoin must therefore decide their trades using the questionable methods of technical analysis, or the spectral intuition of market momentum. The former is hamstrung by the problem of induction, which holds that what has been observed in the past will give us clues to the future, while the latter isn’t logical in the slightest. At least the value investing method of discounting future cash flows to the present, while also similarly inductive, depends more strictly on the rigor of arithmetic. (To those unfamiliar with technical analysis, imagine making trading decisions based on literal geometry: retroactively superimposing “trend lines” on price movements.)

Considering the technology behind Bitcoin, some argue the blockchain could transform the way we log transactions in the 21st century. However, as argued in a recent long-form piece by Kai Stinchcombe, after years of research and investment, we haven’t yet found an advantage to blockchain over existing technologies besides increasing the ease of  illegal transactions. Not only is it less safe, but it’s also less efficient.  The blockchain is cool for being a public log, but as argued, “the hard part is [not] getting money from A to B or keeping a record of what happened. In each case, moving money and recording the transaction is actually the cheap, easy, highly-automated part of a much more complex system.”

The shared public log stored across multiple “wallets” supposedly safeguards against widespread digital deletion, but the susceptibility of digital infrastructure, including how a Minecraft botnet disrupted the East Coast’s internet service, betrays troubling possibilities. In another recent New York Times article, a cryptocurrency enthusiast described investing in them as “the ultimate short trade,” for “the worse regular civilization does … the better crypto does.” The grand irony of Bitcoin as fodder for libertarian distrust is that its existence depends on digital infrastructure as we know it, which, like all infrastructure, is maintained by government regulation or spending. At least with gold, you’ll be able to retrieve the bars under your mattress once the apocalypse strikes.

It is  fascinating to note who of our fellow classmates have excitedly adopted Bitcoin — and its younger sibling Ethereum — trading as their next hobby. Not too long ago, a Snapchat contact — undeleted from freshman orientation — posted to his story a large monitor displaying a candlestick chart, with a caption that read “Balling with Bitcoin.” Seeing literal college students proudly trading one of the most volatile and unpredictable assets as among their first forays into the financial markets is deeply worrying. Not only do the eagerness and relative inexperience of traders our age (who’ve known nothing but roaring bull markets of the past decade) resemble the shoeshine boys of lore giving stock tips in the lead-up to the 1929 crash, but also reveal the tulip-like mania surrounding Bitcoin’s popularity. It’s a fundamentally unpriceable asset, for its value entirely depends on guessing what the next schmuck will pay for it.

Currently, knowledge of Bitcoin’s eventual finitude hastens attempts to mine it. But while the amount of Bitcoin that can be supplied is ultimately limited, it isn’t unlikely that there could come a more imminent point at which the pace of its mining outpaces growth in demand for it. There are only so many people in the world with an interest in Nakamoto’s brainchild — soon enough, Bitcoin will exhaust the demand of retail traders with enough disposable time and income. As liquidity for institutional funds eager to short Bitcoin increases, likely too will downward pressure on the cryptocurrency. And one shouldn’t count on high-frequency trading, for who knows where equilibrium price might fall if momentum in either direction is exacerbated by algorithms, in aggregate, going long or short.

At least gold is material, pleasing to behold, and has some use-value in the creation of both electronics and medicine. Other than falsely stimulating libertarian fantasies of a currency free from governmental interference, Bitcoin, as an immaterial experiment, offers little warranting its material cost.
Lorenzo Benitez is a junior in the College of Arts and Sciences. He can be reached at lbenitez@cornellsun.com. Not a Cop appears alternate Mondays this semester.