Building a bridge is costly: It takes labor and machinery and raw materials that have alternative uses. Does it follow that building it is a waste? No. Waste occurs when the cost incurred exceeds the benefit attained. Cost greater than zero does not imply cost greater than benefit. Does it follow that the bridge is worth building? No again. A bridge to nowhere might be built even though it is wasteful, if the few beneficiaries don’t bear the costs themselves. To know whether a particular bridge is worth building we need to compare benefit to cost.
To count benefits and costs, we observe market prices and transaction quantities. None of us has access to a god-like perspective. Consequently, for normal private goods where costs and benefits fall on producers and consumers, economists normally defer to the judgments of the market participants who actually bear the costs about whether the benefits of an activity exceed its costs. Buyers presumably value a good more than the price they pay, or they wouldn’t buy, and producers incur average costs that are less than that price, or they would exit the industry. In the case of Bitcoin, the electricity bills for proof of work are ultimately paid by Bitcoin users, just as costs of production for bread and milk are borne by buyers of bread and milk. Bitcoin users pay directly when they pay blockchain fees, and indirectly when new Bitcoin is awarded to miners, enlarging the stock of Bitcoin and diluting the purchasing power per unit compared to what it would have been with a constant stock.
These are the opening paragraphs of Lawrence H. White, “How to Think Straight about Bitcoin’s Social Costs and Benefits,” Alt-M, March 1, 2022.
Larry does a beautiful job of applying basic tools of Cost/Benefit Analysis to Bitcoin. Almost everything we talk about in teaching Cost/Benefit Analysis is present in his succinct post: the role of market prices, the importance of benefits exceeding costs, irrelevant externalities (pecuniary externalities) versus relevant externalities, and deferring to consumers of goods rather than to government agencies.
I recommend this article as a reading on any syllabus that does Cost/Benefit Analysis because it’s such a beautiful application of the basic tools.
READER COMMENTS
Alan Goldhammer
Mar 2 2022 at 8:12am
This is not a very useful analogy. Production costs for bread and milk are stable compared to Bitcoin mining which, because of the design of the algorithm, are constantly increasing. Arguably, bread and milk are necessary for life (along with other foodstuffs) while the case for Bitcoin other than a method of saving has yet to be made. Even the savings case is fraught with some peril given the price volatility.
Jon Murphy
Mar 2 2022 at 8:28am
Volatility does not have to do with who bears the costs (and benefits).
Knut P. Heen
Mar 2 2022 at 9:01am
Who decides what is necessary? I would argue the buyer by revealed preferences. You show that you prefer Bitcoin over bread when you buy the Bitcoin.
Suppose the exchange-ratio between dollars and euros changes a lot. Do we say that the dollar is volatile or do we say that the euro is volatile?
Jon Murphy
Mar 2 2022 at 9:19am
You’re right, but I want to tighten up your language a little bit to avoid confusion.
When one buys Bitcoin over bread, it does that one prefers Bitcoin over bread on that margin and point in time. In total, one may prefer bread over Bitcoin. But on the margin, one prefers Bitcoin over bread.
Matthias
Mar 14 2022 at 8:10am
How does the design of bitcoin make mining costs ever increasing?
(And even if it did, wouldn’t that mean that either mining will stop, or the benefits of bitcoin to users also have to be increasing?)
Thomas Lee Hutcheson
Mar 2 2022 at 10:06am
Of course the electricity costs probably do not include the costs of the CO2 emissions they entail.
Jon Murphy
Mar 2 2022 at 5:54pm
It’s not the case empirically that electric generation does not internalize CO2 costs. They may not internalize all the costs, but they certainly do internalize some.
Thomas Lee Hutcheson
Mar 3 2022 at 6:07am
Agree. Each mining site would be different. I think some are in Iceland with the electricity coming from geothermal. Bitcoin folks should get behind nuclear power. 🙂
Jon Murphy
Mar 3 2022 at 7:50am
Even if we just look at “dirty” energy, which still accounts for the majority of electricity emissions if my memory serves, it’s not the case they do not internalize CO2 costs. They may not optimally do so, but there are already numerous Pigouvian taxes and other abatement measures dirty producers face.
Henri Hein
Mar 2 2022 at 12:21pm
Electricity is often subsidized, though. I remember reading about some enterprising young people in Venezuela who took advantage of the free power – the one thing they had in abundance – to mine bitcoins on cheap old PCs.
Phil H
Mar 2 2022 at 6:39pm
This is probably right – the world probably needs more financial innovation, not less.
The counterargument would be that bitcoin is a leech on existing social systems and a net negative for the world. The idea is that it would be profitable for any individual to produce and/or buy bitcoin; but the ultimate impact of bitcoin is negative, because the consumers of its value are those who now have a currency that they can use for illegal ends, which impacts negatively on the world. That’s been very graphically demonstrated in the last week: Russia is big on crypto, and with all that cash floating around, Putin felt like he was ready to go on an adventure.
I lean more toward the first camp: I suspect that more innovation is a good thing. And I’m not really convinced that bitcoin is to blame for Putin (fossil fuels are much bigger). But it’s a sobering thought to wonder if Ukraine is paying the cost of those bitcoin millionaires.
Ken P
Mar 2 2022 at 9:04pm
What about the costs of fiat? It’s often said that money is backed by men with guns. The petrodollar lens certainly seems to provide a picture of history that is consistent with many military actions that have taken place over the past 50 years. I think it’s safe to say that increased military spending is a cost of fiat. Unlike our fiat systems from money printing through banking, BTC doesn’t have any office buildings to heat, or employees to drive back and forth to work.
Matthias
Mar 14 2022 at 8:16am
That’s not true.
Bitcoin is developed by humans. Development is still ongoing.
Those humans also work in offices (or home offices) and commute etc.
Comments are closed.