Over the course of last week, bitcoin reached an all-time high value of just under US$17,000, and currently hovers close to that record high. The increase has generated many media articles and much commentary from financial experts. Before we look at the reasons behind the increase, let’s consider the infrastructure.
Society sorts its garbage for recycling and attempts to save energy in many different ways: some speculators in bitcoin may be shocked by the statistics on power consumption of the bitcoin network published by Digiconomist.
To understand the power consumption issue it’s important to have a conceptual overview of how bitcoin works. The system comprises a blockchain, a ledger of records that contain all the transactions and timestamps. A new block is created approximately every 10 minutes by so-called miners. These are a distributed network calculating complex algorithms to create blocks to extend the blockchain. Every miner attempts to calculate the next block, the first to calculate a valid block distributes it to the other miners.
The miners are paid for their services to the network with additionally created bitcoins, diluting the value of existing bitcoins. This is not an issue today, as the increasing value means the dilution has no negative effect. Current revenues paid to Miners are $9.9bn and their estimated mining costs are $1.58bn, making mining a lucrative business and the reason people are keen to create miners.
Bitcoin’s estimated annual power consumption is 31.6 TW⋅h, that’s more power than Ireland uses on an annual basis. The electricity consumed for a single transaction is 251 kW⋅h, which is sufficient to power 8.49 typical households in the US for a day.
If you grab lunch from one of the many restaurants that accept bitcoin, and lunch costs under $15, it will cost more to process the payment than you paid for lunch. Using The average cost of a kW⋅h in California, which according to Electric Choice, is $0.1816, so the cost of a single bitcoin transaction would be approximately $45.
The energy costs are not the only charges in a transaction: the bitcoin network itself levies a charge which, according to a blog from Valve, the gaming provider behind the Steam network, has skyrocketed from $0.20 in 2016 to $20 per transaction today. Based on this and the current volatility in value Valve has decided to discontinue accepting payment using bitcoin.
Logic indicates there is a serious flaw in this business model when you look at the energy costs and the transaction fees. However, as long as the price of bitcoin continues to rise then the flaw may be acceptable to those spending their newly-found wealth.
“If you grab lunch from one of the many restaurants that accept bitcoin, and lunch costs under $15, it will cost more to process the payment than you paid for lunch”
With the heightened interest around bitcoin, I have been actively asking people I meet if they hold any of the digital currency. Not surprisingly I have found a few… none of whom use the currency for daily transactions, but who are investors or speculators looking for capital gain. And here lies the problem: the currency’s value appears to be inflated by the demand from organizations and individuals looking to make a quick buck.
Sir John Cunliffe, the Deputy Governor of the Bank of England, was quoted in a BBC article as saying “investors should do their homework and think carefully”. He points out that there is no government or central bank behind bitcoin, that it is not an official currency, and that it should be viewed more as a commodity.
Speculation on the recent surge in value is varied: Derek Thompson, a journalist for The Atlantic describes the recent rise as an ‘unsustainable paroxysm’ and compares it to the 17th-century tulip bulb bubble. No one actually knows what is causing the surge, other than demand, and an important factor in this could be that so far 16.5 million bitcoins have been issued, and since in its current format there is a theoretical limit of 21 million, maybe people are just scared of missing out?
One other important element to this is that bitcoin is popular with criminals due to its lack of regulation and pseudo-anonymous character. The UK Treasury recently stated that it believes anti-money-laundering regulations should be updated to include bitcoin and other virtual currencies. Detective Superintendent Nick Stevens from the Serious and Organised Crime Command of the Metropolitan Police stated that “Organised criminal groups have been early adopters of crypto-currencies to evade traditional money laundering checks and statutory regulations”.
I am curious whether the speculators investing in bitcoin have considered that as they push the price up, they are increasing the value for criminals too?
What is apparent is that we are in unchartered territory, a new era of digital currency. While there are problems, for example with currency exchanges being knocked offline by DDoS attacks, and potentially greed playing its part in todays inflated valuation at present, there are likely to be real uses for a digital currency in the future. When the bitcoin bubble inevitably bursts, as all bubbles do, then it will only be a matter of time before another currency appears and those behind, we hope, will have learned from the mistakes of the first.
Author Tony Anscombe, ESET