Bitcoin Mining Meets the Dizzying Reality of Electricity Markets

Something strange is afoot. We see eye-popping statistics about the electricity consumption of mining Bitcoin and other cryptocurrencies. We read about Bitcoin boomtowns where “mining farms” take advantage of cheap local electricity rates, and countries that subsidize electricity to encourage crypto mining within their borders.

When Markets Collide

How is it possible in a free market to use “too much” electricity to mine Bitcoin? There are many good introductions to Bitcoin mining, but for our purposes, suffice it to say that the system is programmed to require more computing power (and thus electricity) as more mining operations come online, and more mining operations have indeed come online as Bitcoin’s price has increased. That’s pretty basic supply and demand.

The problem lies in the pricing in our electricity markets, and it isn’t going away anytime soon. Ideally, as demand for electricity increases, the price is bid up, leading to an equilibrium level of consumption consistent with Bitcoin’s value. But to even approach rational electricity pricing, economics must navigate a nearly impossible labyrinth of physics, geography, history, and politics.

An article in Politico this spring on the cryptocurrency mining boom along Washington State’s Columbia River shows what happens when a largely unregulated, global market for Bitcoin and its cousins comes crashing into electricity markets constrained by factors both natural and human. And the collision is fascinating.

Pesky Institutional Details

As a graduate student in economics, I was told that electricity was an extremely fruitful industry to study, but only if one fully specialized in it, because of the near lifetime required to master its unique institutional details. I didn’t specialize, but I’ll do my best to explain how each of the four factors I note above contributes to our story (and I welcome suggestions from more-expert readers).

Physics

Electricity cannot be stored in meaningful amounts. It also can’t be transported over long distances without significant losses. That means electricity, to some extent, must always be a local good. Rates in Nebraska can’t effectively discipline rates in New York City.

Geography

These physical laws mean geographic areas with certain features will have access to significantly cheaper electricity — areas just like Washington’s Columbia River and surrounding valleys, ideal for the construction of hydroelectric dams.

History

Eight of Washington’s 10 largest power plants are dams, all of which were built by, and have been run by, federal government entities. The largest, including the famous Grand Coulee Dam, were New Deal infrastructure projects meant to put as many people to work as possible. This enormous local capacity has left Washington with among the lowest electricity rates in the country.

Politics

Some areas along the Columbia River have access to up to six times the amount of power they use. Local utilities sell a large portion of that excess supply to other areas of the country (even with that pesky transmission loss), using proceeds to further subsidize local rates. This leads to towns like East Wenatchee, Washington, having some of the lowest electricity rates in the world. And even if locals don’t like a poorly understood new industry like cryptocurrency flooding the area, what incumbent politician in his right mind is going to let the utilities raise rates for everyone?

Reaching Consensus

Electricity rates are basically the sole determinant of short-run variable cost for Bitcoin mining: once a hardware rig is set up, only electricity stands between being a profitable operation and selling one’s hardware and moving on. Combine that fact with what we’ve learned about electricity markets, and Bitcoin boomtowns become an easy phenomenon to explain.

Reporting on the mid-Columbia basin, Politico refers to abandoned fruit warehouses filled with computer servers, jet-setting international entrepreneurs arriving to get the lay of the land, and previously surplus electricity drying up.

All of this poses a challenge for local governments and federal utility operators. Raising rates only on the miners isn’t feasible or desirable, and some change to these communities is inevitable. Residents and authorities need to have real conversations about the tradeoff between low electricity rates that do not reflect skyrocketing demand, and preventing major lasting changes to communities brought on by an influx of miners.

Cryptocurrency miners also face a challenge: show these communities why they’ll benefit from being a hub for this activity, and deliver. Find ways to create jobs and economic activity benefiting current residents, rather than being a group of transplants having minimal interaction with the community itself.

There’s also a looming international problem of some countries, seemingly after a mercantilist treasure grab, subsidizing electricity just for Bitcoin miners. Here at home, it looks like small towns and big technology will be having to come  to terms with each other for quite some time. If they communicate and work together, it can be to the great benefit of both. If they do not, it can constitute yet another complication in today’s cryptocurrency landscape.

This article is based in part on research by Pedro Alvarenga and Jackson Brex, 2018 graduates of the Berkshire School, as part of the school’s Advanced Math/Science Research program, supervised by Dr. April Burch.

 

 

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Max Gulker

Max Gulker is an economist and writer who joined AIER in 2015. His research often focuses on free markets and technology, including blockchain and cryptocurrencies, the sharing economy, and internet commerce. He is a frequent speaker at industry conferences, especially on blockchain technology. Max’s research and writing also touch on other economic topics, including governance, competition, and small businesses.
 
Max holds a PhD in economics from Stanford University and a BA in economics from the University of Michigan. Prior to AIER, Max spent time in the private sector, consulting with large technology and financial firms on antitrust and other litigation. Follow @maxgAIER.