Bitcoin's Unit of Account: The Watt-Hour
"Our view is that if it is viewed scientifically and rationally that money should have the function of a standard of measurement and thus that it should become comparable to the watt or the hour or a degree of temperature.”
Introduction
Bitcoin has had a short, but incredible history since its inception in 2009. There has been much debate about both the technology and the economics of Bitcoin. Many have made compelling arguments about the technological innovations that enabled Bitcoin to be successful. There has been somewhat less discussion on the economics of Bitcoin. I’d like to share a few economic thoughts in this post.
Bitcoin as Money
Bitcoin has many great qualities as a money. As a digital money it’s durable, easily divisible and easy to transport. The core functions of money is that it is used as a store of value, medium of exchange and unit of account. The primary function for Bitcoin currently is as a store of value and it’s especially attractive for that when compared to weak government currencies such as the Bolivar in Venezuela. Bitcoin may be preferable to major currencies like the dollar/Euro/Yen for people that prefer not to have any form of quantitative easing, currency management or manipulation. Bitcoin currently is only used sparingly as a medium of exchange. That may not be a reason for alarm because Gresham’s law essentially dictates that bad money circulates while good money gets hoarded. The last function of money is as a unit of account. This is where at first glance Bitcoin, like fiat currencies, may seem to have a problem.
Money’s Unit of Account
Ludwig von Mises spoke about the unit of account problem when discussing fiat currency in his book “Theory of Money and Credit”. How can anyone distinguish between 1 fiat paper dollar and 1,000 fiat paper dollars if there is no intrinsic value in it? If the world had amnesia one day and had to determine the fiat paper dollar price of a good, how can anyone achieve that with no reference to some base reference value of money. Based on the Austrian economic school and subjective value theory people each should compare any one good they own with all the other goods they own. Hence an individual would first consider the use-value of gold as jewelry, a collectible or an industrial metal as a reference point before he/she could compare it to other goods and before that person can assign some additional value to gold as a money. A money does however need to have some original base reference value, otherwise how does any individual even begin to assign a fiat paper dollar amount to it? Hence with the gold standard there was a precise measurement of gold that fiat money referred to. The US dollar was based on a certain weight/measure of silver based on the Spanish silver dollar that commonly circulated in the eighteenth century. Hence because there was a historical link of paper dollars to silver and people could reference past prices, they are able to use fiat paper dollars as a unit of account. This idea is called Mise’s regression theorem and the main idea is that there needs to be some originating intrinsic value of a commodity before it can become money. If people measure and compare all goods with each other, they can only initially compare the commodity value of a good to others. Hence people compare a certain weight/measure of gold to other items subjectively before adding an additional ‘objective’ value component to the value when that commodity is also used as a medium of exchange. So what does one Bitcoin represent? How can anyone distinguish between 1,000 Bitcoins, one Bitcoin or a tiny fraction thereof?
Intrinsic Value of Bitcoin
The primary value of Bitcoin is based on its utility as a money. Some describe it as being an immutable digital ledger. There is an underlying tangible software & hardware network underlying Bitcoin that makes it sustainable, secure, reliable and resilient. Bitcoin is as difficult to shut down as the Internet. As long as the Bitcoin network is useful to some people and bitcoins are scarce they will have some nontrivial value. The more users that use the Bitcoin network, the more valuable it becomes. Whether one views Bitcoin as an immutable digital ledger or a resilient software network with hardware infrastructure, Bitcoin can be described to have a ‘commodity’ component of value.
von Mises describes in “Theory of Money and Credit” that there is an ‘objective’ value component of money that is added to the value of any commodity when it becomes used as money. In other words a commodity becomes more valuable the more it’s used as a money. Bitcoin just so happens to inherently have the qualities that make it a good money and its primary role is to serve as a money. Hence it is even more valuable with this additional ‘objective’ value component of money when it’s used for that purpose.
Furthermore the earliest forms of money had characteristics of value that differed from typical commodity money. Nick Szabo, the godfather of Bitcoin, writes extensively about the origins of money. One of his theories is that the earliest forms of money had certain qualities as ‘collectibles’ as opposed to commodities that arose from barter. According to Szabo, early money such as beads & necklaces and jewelry had certain characteristics such as being secure from accidental loss/theft (eg. worn as necklace and secured closely to the body), having unforgeable costliness (eg. required unique human labor) and also having easily observable measurements of value (eg. jewelry that had rings or chains). Bitcoin also has these characteristics as a ‘collectible’ form of money.
Bitcoin’s Cost of Production
The intrinsic value of bitcoin rewards incentivizes Bitcoin miners to buy hardware and consume electricity similar to how gold mining companies set up operations to produce gold. The increased utility of bitcoins drives its value up and subsequently attracts Bitcoin miners to invest more capital. The utility value drives the price of Bitcoin first and foremost.
Secondarily, the cost of production can be a good proxy of value in general. Szabo discusses this idea in his post "Of wages and money: cost as a proxy measure of value" Time-rate wages (eg. $/hr) are still used today as a proxy for a measure of sacrifice. Likewise the unforgeable costliness of bitcoin may instill a similar measure of sacrifice that can strengthen its perceived value.
In the long run Bitcoin mining resembles a purely competitive market because there are very few barriers to entry and it is a globally accessible market. Hence profit margins for the mining industry should be expected to trend towards zero. In theory, the marginal costs to produce bitcoin should eventually equal marginal product in a purely competitive market. These economic details are described by Hayes in "A Cost of Production Model for Bitcoin". Hence the price of bitcoin should approximate the cost to produce it.
The Watt As A Unit of Account
Ultimately the marginal costs for bitcoin are primarily driven by electricity consumption. Hence electricity consumption in Watt-hrs can be used as a proxy to represent the cost of producing bitcoin as well as approximate its price & value. Energy consumption is estimated to be 60% of the total cost of Bitcoin mining. The remaining 40% is the cost for purchasing mining equipment. Bitcoin users can ascribe a real world resource value to each bitcoin by using the energy consumption measured in Watt-hrs used to produce it. Using the current energy consumption estimates at Digiconomist, we can calculate each bitcoin generated to use about 35 Megawatt-hrs of electricity (60% of cost) plus the cost of equipment (40%). If we simplify the total cost of bitcoin production to an equivalent amount of energy we can estimate each bitcoin to be worth about 58 Megawatts-hrs of electricity.
Relating to the Real World
Bitcoin’s relation to electricity can be useful for everyone. In the past, societies used ‘grains’ as a precise weight and measure of gold and silver to enable common folk to easily compare the commodity value of gold/silver money to a roughly equivalent size of agriculture grains they farmed or bought. Today, people can use Watt-hours as a measure of electricity and unit of account that allows them to easily compare bitcoin money with electricity needs. In the modern world, electricity is probably a better and more useful measure of utility than a grain of wheat or rice. People can subjectively compare the amount of electricity required to power their car, home, appliances or computing needs to decide if and when they want to spend or hold bitcoin.
Conclusion
Bitcoin has all the qualities of a good money. It can serve as a store of value, medium of exchange and as a unit of account based on a measure of electricity, namely the Watt-hour.
Updated:
I was informed Joules or Watt-Hour is the appropriate measure for electricity consumption, not the Watt.
Corrected title and some content to reflect that.
Interesting way to consider the value of a bitcoin.
Of course not all bitcoins are created Equal. Over time mining difficulty changes as well as differing cost of electricity around the world.
Which is also exactly why the argument of value-backing through resource input is invalid. Resources and cost per mined bitcoin may vary, 1 bitcoin is worth EXACTLY the same as 1 other bitcoin. Always.
But the value of 1 bitcoin changes immensely over time, the swings are huge both up and down. That element of value also has nothing to do with the amount of resources used to create it.
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The "sunken" production cost of "old" bitcoins is quite irrelevant in this aspect, and most of the mining will always happen where the electricity is cheapest - but for Bitcoins to be a useful "unit of account", the production cost should be fairly constant over time - and it is not.
Actually, I'd argue that the author has put the horse behind the cart in his article, electricity consumption is a function of the bitcoin value, not the other way around. The higher the value of the bitcoin, the more energy will be used on mining, and the higher difficulty level. The lower the value of the bitcoin, the less energy will be used on mining.
I'd also argue that it's a quite bad design choice both to retarget the difficulty after 2016 blocks as well as to halve the reward every 210000 blocks, the algorithms should have been more smooth - now both the difficulty retarget and reward halving can be like major events affecting the market price a lot. Ideally, things should have been done more frequent and in smaller steps, and only external factors should be affecting the market price.
agreed
Thanks @eroche. Yes agreed not all bitcoins are created equal, but the current bitcoin utility value drives the electricity consumption/cost of production and not the other way around.
So rather than use historical input costs for each bitcoin individually, people will use the current electricity consumption as a proxy to value all bitcoins at the same time.
The problem is that it's the bitcoin value that is driving the electricity consumption, not the other way around. If bitcoin value drops, the miners with the smallest margins (i.e. old equipment or high electricity costs) will simply switch off their equipment. If the bitcoin value rises, there will be more investments in mining rigs and more electricity consumption.
Consider what will happen if the bitcoin raises tenfold in value (once more) - I do worry a bit on the impact on global energy consumption, electricity may become more expensive when used for other purposes.
Could bitcoin work as proof of stake? Because PoW is pretty wasteful.
This is the million bitcoin question.
I would say that history has already proven that agreement on value is enough for something to hold value, it doesn't need to be backed by anything else than consensus. Without the waste of PoW and the capitalist risks of standard PoS, the most elegant and efficient solution to date seems to be Delegated Proof of Stake, the consensus protocol Steem runs on.
A month ago I would have agreed with you ,,, but I just learned of a 3 year old company (programmers) that is using an older tech called HashGraph which is mathematically even more secure than blockchain and the proof algorithm is even easier with less size.
http://www.swirlds.com
Well, Dan Larimer is pretty firm in his vision on Hashgraph and the limits of that technology. I don't know what technology will ultimately dominate the decentralized economy, whether that's DPOS, Tangle or Hashgraph... Could be something entirely new could be brought in by a big company like Google, Amazon, Facebook or Apple.
Be careful out there. Cryptoland is high risk land.
Not exactly "green". Funny how Enviros never seem to mention that.
Not exactly "green". Funny how Enviros never seem to mention that.
It also is not very useful in an emergency situation (e.g. Puerto Rico) where there's no wi-fi or electricity.
Just sayin'.
Hello, thanks for your question. It is a really interesting one and something that cant be answered, for sure, in one post. We need to learn and understand how does Blockchain technology works.
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I guess this is the question everybody is waiting to be answered!
HashGraph is the future.
http://www.swirlds.com
Sure it can work, but would it be preferable if it no longer was as good as a unit of account?
I like proof-of-stake coins, but I liken them more to shares of a company. I see DPOS systems similarly and it has a great system of getting more distributed over time as more stakeholders get involved. Can these coins eventually be used as money? Perhaps. A lot of it might depend on how people feel about using these coins as a unit of account.
Also distribution is always a difficult issue with POS ecosystems compared to POW systems, but that's another topic to discuss.
We'll see what the free market thinks!
Thanks for your answer, it's really interesting to ponder these "what if" scenarios.
@steemrollin Really your are right. Bitcoin is a strong cryptocurrency that is working in a wonderful way with a consensus among all users.
PLEASE let me come to know the original status and price of bitcoin in future, what do you say?
Interesting perspective. I note in your post that you comment on value linked to network effect and number of users. Metcalfe's Law. Utility increases as the network size increases. Another way to measure value.
Excellent post. I don't agree a watt should be used because once we have mined all the bitcoin, then a watt will be useless. Then people will just transfer bitcoins and not mine it. However this can change if bitcoin level cap is changed but then the value of bitcoin will drop since more is issued. Just like fiat currency.
Yes, bitcoin is unsustainable. POW will finally destroy our Earth.
Bitcoin also derives it's value by the notion that there will only ever be 21M mined. But just like our "honest" Federal Reserve, that notion could change with just a couple of keystrokes.
It can and de facto serves as money.
The only problem imho is what happens at the limit as the last bitcoin will be mined?
Bitcoin is deflationary in nature and as a result there is an incentive to hold it, unlike fiat currencies, which are mildly inflationary.
If everybody holds there will be no exchange of value.
The beautiful solution that works for now is PoW - everybody has a chance to get a newly created Bitcoin for Watt-Hour.
This drives the network.
But ones we are at the limit, what will be the incentive to run such network?
Everyone has a price.
I don't envision many people holding onto their bitcoin when their initial $1,000 investment can comfortably pay for a 50 year retirement with a nice house or two, paid for "in cash", ta boot! But perhaps those that do will get the 2,000 year retirement plan and several islands paid for in cash...lol.
However, I do tend to agree with the camp that says bitcoin is not ideal as a currency. When I first got word of bitcoin back around early 2012, IIRC, it was sold by most of the sources that I researched it at as "gold 2.0", not "dollar 2.0", to which I agree.
It's everything that gold is (besides not being something physical), but, assuming the network stays at least at its current size, it's also the safer option as a store of value in terms of keeping it out of thieves hands and much cheaper, safer and quicker to send where you want it.
Gold has the advantage when it comes to guarantees as to whether it will exist at x date in the future, but bitcoin has both the aforementioned advantages on top of the fact that it requires literally no space to store, besides perhaps the area taken up by the number of neurons required to remember a favorite quote with a change to one or two of the words (in the case of a "brain wallet").
As the main bitcoin chain stands today, I believe it has a good chance of eating into 10's of percent of gold's market cap in the coming decade, as more and more people start to discover some of these advantages and the test of time on the network raises assurance levels among the once skeptical crowd.
Hi @jamesbrown,
Sorry for not being clear on the meaning I put in the definition.
i was just following @steemrollin economic assumption that Bitcoin can serve as a store of value, medium of exchange and as a unit of account. I absolutely agree with you that Bitcoin at the limit will likely be turned into gold, i.e become the store of value.
What I meant by exchange of value should be considered in the vein of medium of exchange.
At the limit (one the last coin will be mined) I think this function will disappear as there will be no apparent incentive to mine and therefore maintain the network to fascinate exchange (as in I send you 1 Bitcoin out of my wallet to yours, but there could be none to validate the transfer).
And the solution to this problem (of preserving the network) would be an interesting experiment in itself.
Yeah, I read somewhere that miners will be paid in transaction fees alone at that point, but that's a major problem if bitcoin isn't spent at a high velocity and no one is going to want to use it if the fees get too high to offset the lack of minting rewards.
This post is awesome and very useful to all. I like cryptocurrency