At the outset of our contemplation regarding the relationship between bitcoin and energy, it became clear to me that the worth of bitcoin is essentially supported by the energy invested in its creation. Like any unregulated market framework, the value of an item (in this case, bitcoin) is influenced by the production cost of the item plus the varying profit margins necessary to transition from manufacturing to the end consumer. If an individual possesses a creative knack for providing something unique and there is considerable demand for this offering, they can leverage this scarcity to extract greater profits. Conversely, if the innovation isn’t sufficiently exclusive, others will identify this price discrepancy and strive to meet some or all of the demand. Over a certain duration, we anticipate that the ecosystem of producers will vie with one another for demand until a stage is reached where the product’s price mirrors the minimally acceptable profit margin level for all participants in the production, supply, and sales chain. Further advancements in production methods, sourcing materials, or labor expenses may temporarily benefit one producer over others, allowing them to enjoy a period of heightened profitability – until competitors introduce similar advantages, causing the overall product price to decline.
This phenomenon is what Adam Smith termed the invisible hand, or what contemporary economists refer to as the principle of economic equilibrium. If participants in a genuinely free market system (which is rarely achieved) act in their self-interest by pursuing profits, these actions will eventually yield a societal advantage through satisfying demand at the optimum economic value point. While we may never attain a truly ideal point of economic value exchange, we certainly observe the advantages of declining prices and rising quality (particularly in technological terms) across industries ranging from transportation to computing. My father acquired an IBM PS/2 Model 25 with a 16-color screen and 10MB storage in the late 1980s for approximately $7,000. Now, forty years later, a $70 smartphone from Asia surpasses that IBM’s capabilities by numerous magnitudes for merely 1% of the initial cost. This exemplifies the deflationary impact of technology that Jeff Booth elaborates on in his book, The Price of Tomorrow.
While a computing device can increase its features by 100,000% while diminishing in price by 99% over four decades, why can’t we state the same regarding automobiles?
I own a 1977 Range Rover that was priced near $14,000 when it was new. Nearly five decades later, the current version of the Range Rover is roughly ten times that price yet provides only slight improvements in capabilities. Why didn’t automobiles undergo the same technological deflationary effect as computers? Largely because the costs of raw materials to create a car, such as steel, aluminum, and copper, have risen significantly during this timeframe. Additionally, the expenses associated with operating a factory to manufacture cars and the cost of transporting a 2-ton vehicle from production to the point of sale have also escalated considerably over the years.
While you can’t acquire a comparable Asian SUV brand new for $14,000 today, you can obtain a highly capable SUV at about double that price with noticeably greater comfort and technological features compared to my basic 70’s off-roader. In 1977, the most basic VW Beetle had a price around $3,000. Modern low-end vehicles from Asian manufacturers with similarly minimal specifications typically hover around the $6,000 range. What is difficult to recognize with these figures is the inflationary impact of currency devaluation – in this instance, the US dollar. A dollar in 1977 had the purchasing power equivalent to approximately $5.19 today, or conversely, a dollar in 2024 possesses similar spending capacity to only $0.19 in 1977. This represents an 80% decrease in purchasing power. Therefore, a $6,000 basic vehicle in 2024 would equate to roughly $1,140 in 1977 dollars. Incidentally, the $7,000 IBM would be over $35,000 in 2024 dollars, rendering the $70 smartphone an outstanding bargain!
What is it about computers that allowed their technical deflationary effect to vastly outpace inflation while automobiles have not achieved a parallel result? In summary, the reason is twofold: energy and resource scarcity. It requires approximately 278 kWh of energy and 120g of raw materials to manufacture one smartphone. A car necessitates about 17,000 kWh of energy and 5,000,000g of raw materials for production (as per MDPI). Both products generally yield a similar profit margin for manufacturers of around 10%. While technology can resolve numerous efficiency or miniaturization challenges, it cannot fundamentally diminish the quantity of physical and energy resources required to produce an item the size of a vehicle.
Similarly, bitcoin possesses an inherent production cost that is dictated by the amount of energy necessary for its creation. Although we continually enhance the efficiency of the machines employed to convert energy into bitcoin (with efficiency improvements of about 83% noted from 2019-2024), the increase in network hashrate has nevertheless escalated the energy required to produce 1 bitcoin to roughly 800,000 kWh. This establishes the intrinsic value of a bitcoin generated in late 2024 at approximately $66,000, including a profit margin of roughly 10% for the typical producer.
Does this imply that the present value of bitcoin is solely dictated by its production cost?
Certainly not; but it does play an essential role in establishing the value of bitcoin. The production cost and current market price have converged to a point of equilibrium where the producer can secure enough margin to continue operations in their self-interest while the market can benefit from a reasonably priced product. The remarkable aspect of the bitcoin network is that it stands as one of the few genuine free markets in existence. Absent the capacity for an actor to monopolize or governments to exercise control over the market, the invisible hand will persist in guiding these two forces toward this state of equilibrium. This suggests that we can discern the true value of bitcoin by understanding the energy costs associated with its production. Thus, energy fundamentally assigns value to bitcoin.
Given that I have already introduced you to my perspective of viewing most matters through the lens of a Land Rover, I shall maintain that approach as we examine the contrasting aspect of this Joule Paradox. As previously stated, I drive a 1977 Range Rover (now referred to as a Range Rover Classic Suffix D). I purchased the vehicle here in Kenya about five years ago for roughly $5,000. It was entirely intact, unaltered, and 100% rust-free. It was the equivalent of what is often termed a barn find – a perfect candidate for a functional restoration. Within the Kenyan market, I paid slightly above the average price for a comparable vehicle due to its excellent condition. If I were to seek a similar vehicle in the UK market (assuming you can locate a rust-free unit), it would have cost me significantly more. Fully restored to original condition in Kenya, the truck might be valued at $15,000 on the best of days; however, a perfectly restored version in the UK would likely command tenfold that price. Why is there such a discrepancy in the value of two essentially identical items? In summary, it is due to the isolation of economies.
The economic environment I navigate within here in Kenya does not appraise this vehicle in the same manner as the economic environment in the UK. If I could simply transfer the truck via my Starlink connection to the UK, I could makea substantial amount of money from this arbitrage chance. Nevertheless, vehicle transport does not function in that manner. For me to relocate this truck from my Kenyan economic zone to the UK economic zone would necessitate an enormous amount of time (navigating governmental paperwork on both sides), transportation costs, and a plethora of unexpected costly issues to ensure that the standards of my Kenyan-executed work would satisfy the significantly more stringent regulations for operating a vehicle in the UK. Would it be financially rational? Possibly. Is it economically worthwhile for me? Absolutely not. Additionally, I have a deep affection for the truck, which makes me overvalue it emotionally.
Energy endures from this same seclusion of economies. If a natural gas supplier in West Texas is attempting to sell electricity into their regional market while the wind is gusting and the sun is shining across the state, the value of their energy unit can actually become negative. This signifies that they would have to compensate someone to accept their energy. Simultaneously, an individual recharging their electric vehicle in California might face a peak-demand surcharge for electricity that doubles their energy costs. The Californian Tesla owner would greatly appreciate having less expensive energy from Texas, and the Texan producer would greatly prefer to charge even a few cents for their power to anyone willing to acquire it. Regrettably, these two energy markets operate separately. You cannot transfer a joule of energy from the Texas market to the California market without a considerable amount of governmental paperwork and transportation expenses. The arbitrage opportunity cannot be actualized.
The same holds true for a small hydro energy producer in Northwestern Zambia; they are confined to a very limited economic sphere. They can generate more energy than they can sell to the local populace, but there is no one else besides the community to purchase their electricity. Even if they offered it for $0.01, no one would accept it. Meanwhile, 100km away, another community is being charged nearly $1.00 per kWh to obtain electricity from a solar mini-grid. Those villagers would be eager to have some inexpensive electricity. Unfortunately, you cannot transport a joule of energy across 100km of uneven, dusty African roads. The arbitrage opportunity is forfeited due to economic isolation.
Although I speculate that Satoshi did not view it this way, the bitcoin mining network serves effectively as an adapter to link any isolated energy pool into a global marketplace. By merely plugging in a mining device and connecting it to the internet, you can now market your electricity to an always receptive buyer. These two uncomplicated pieces of technology enable energy pools to be connected in a manner that has not truly existed before. Bitcoin represents a non-government-controlled, internet-enabled, real-time energy market that remains open 24/7, 365 days a year.
At any given moment, the market’s invisible hand will ascertain the prevailing hashprice. This refers to the amount of bitcoin awarded to a miner for providing 1TH/s of computational power for 1 day. This value signifies how much a miner can gain from operating their devices and – owing to mining pools – this amount is payable in very small units of work. If you operate a 100TH/s machine for 1 hour, you will earn 1/24th of the hashprice credited directly to your bitcoin wallet. This holds true anytime of day and from any location on the planet. Utilizing this hashprice and understanding the efficiency of your mining apparatus, you can know with absolute certainty how much the bitcoin network is ready to compensate you for any kWh of electricity that you want to offer for sale.
As an illustration, as of 7:34am East Africa Time on October 5th, 2024, the bitcoin network will compensate you $0.078 per kWh if you are utilizing a 24J/T Whatsminer M50s and $0.103 per kWh if you are using an 18J/T Antminer S21. Those figures will fluctuate with the movement in bitcoin value, but it is then your choice to ascertain if you can secure a better offer from your local economic environment. Willing buyer, willing seller, as the saying goes.
By serving as the real-time marketplace for internet-enabled energy, the bitcoin network permits us to fulfill the Joule Paradox: energy establishes the value of bitcoin and bitcoin establishes the value of energy.
Note that I mentioned value and not price. An old acquaintance of mine often stated that price is what you pay and value is what you receive. This holds true in this instance. The value of a bitcoin is determined by the energy inputs and production expenses, but the market dictates the price. Likewise, bitcoin determines the minimum value for a unit of electricity, yet the seller decides whether they will accept that price or market it to someone else for more.
In contemplating the correlation between bitcoin and energy within this paradox, we begin to understand why the proof-of-work model that Satoshi opted to implement, along with the automated market regulation system through the difficulty adjustment, is so brilliant. If either of these features were absent from bitcoin, we would not have the highly valuable asset we possess today. It all circles back to this straightforward realization, energy is the fundamental, base commodity upon which everything of value is created and bitcoin represents the most pure manifestation of energy in monetary form. If we eliminated the energy from bitcoin, then bitcoin would be no more advantageous than any other fiat money system. Keep that in mind when someone asserts that ethereum is the more environmentally conscious cryptocurrency. Energy is the genuine source of value, and no other monetary system is grounded in energy.
This is a guest post by Philip Walton. Opinions expressed are solely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.
