Lots of people have opinions on Bitcoin and whether it is or isn’t a good investment, whether it is a tail-risk hedge asset or not, or whether it is just a massive speculative frenzy. However, in this newsletter we try to share insights, not just opinions. That is, opinions on things we actually think we know something about. Thus, while I have an opinion on Bitcoin, I won’t bother sharing it.
Investment merits to one side, Bitcoin is interesting from an electricity perspective. As electricity prices have collapsed over the last year or two, under the torrent of new zero marginal cost renewables entering the market, a key thing that many electricity investors are hoping for is increased electricity demand. While electric vehicles may deliver this in time – this is 5-10 years away and not much help for a struggling generator today.
What if Bitcoin was the answer! Then at last this craze would be good for something (sorry that was just an opinion leaking out).
Let’s dig into this in a bit more detail.
Bitcoin, as with all proof of work block chain cryptocurrencies, works through the efforts of a distributed network of “miners”. These miners are networked banks of computers that work to verify transactions occurring in bitcoin and, in this context, validate who owns each bitcoin at any point in time (and the transactions that give rise to that). In exchange for this service, miners are paid in bitcoin. That is, each time a miner solves a “Hash” (the complicated mathematical problem that acts as the encryption) it gets issued a quantity of free bitcoin. This free bitcoin is payment for the services of keeping transactions secure.
The rub with this process is that the price of bitcoin has become so high, that the 6.25 bitcoins you currently get issued to solve a hash is currently worth around $450,000. This is a big reward, and incentivises a large number of parties with thousands of server banks around the world to compete to earn this revenue.
The University of Cambridge has tried to estimate the current amount of electricity used by miners (see below). It is a staggering 130 TWh per annum. To put that in perspective, total usage in the National Electricity Market (all of Australia other than WA and the NT) is approximately 200 TWh. That is, bitcoin is currently consuming around two thirds of the power of the entire NEM.
Tragically for Australian generators – not much of the mining happens in Australia. The folks at University of Cambridge also analyse the location of mining activity (see below). You can see that mining disproportionately occurs in China as well as few other places.
One of the team at Infradebt’s father is a metallurgist who used to work in the Aluminium industry. Aluminium is sometimes referred to as solidified electricity – reflecting the vast amounts of electricity used to turn bauxite into aluminium. Well perhaps bitcoin should be thought of the same way. Bitcoin is a way of turning electricity (and a bit of spending on servers) into money (assuming you sell the mined bitcoin for real money).
At today’s prices, bitcoin perhaps consumes something like 0.5% of global electricity production. If prices rise further, let’s assume it goes up by another factor of 10 from here (simply repeating the experience of the past year), this will incentivise a 10 fold increase in electricity consumption by miners. That is, in this state of the world, bitcoin (and the other cryptocurrencies) would be consuming as much electricity as the world spends on lighting (lighting is around 6% of total electricity consumption in the US in 2020). Whether this seems like a good idea or sustainable, I will leave to you.
But what about Australia. We are an energy superpower – with our exports of coal and LNG – and we can be an electricity superpower given Australia’s abundant wind and solar resources (and in the interests of disclosure I should note that I am a director on Suncable). Should Australia think it could dominate the Bitcoin mining industry?
While the economics of Bitcoin mining turn on access to cheap electricity. I would say from the list of countries in the top 10 Bitcoin mining locations (see chart above) that there is more to it than that. While some of these countries have cheap electricity – who knows what electricity prices are in Venezuela (I am sure they are cheap in USD but are probably crushingly expensive in Bolivar). The mix of countries suggests that capital controls, risk of expropriation, currency debasement and exposure to international financial market sanctions are important drivers of the decision to establish a bitcoin industry (with apologies to Norway, Germany and Canada who also appear on the list). Thus, even if Australia dominated the rest of the world in electricity costs – which is something I think we can do – it doesn’t mean that the Bitcoin miners will flock to setup shop here.
In summary – Bitcoin is an impressive piece of modern alchemy. It is a way of turning electricity into money (or something that might be like money – depending on your opinion). However, it is important to remember it is a one-way trip – you can’t turn it back.