I am honoured and privileged to present another guest post from our good friend, The Male Brain, who has kindly translated an article from the original Hebrew by an Israeli blogger named Erez Raviv about the coming collapse of the Bitcoin mining economy. It is a lengthy and very interesting article for those of us with any sort of view about cryptocurrency in general, and Bitcoin in particular. I add my own thoughts at the end, as I have considerable knowledge in specific sub-sectors of cryptocurrencies, about the current state of the industry and what might happen in the future. As always, I am most grateful to our friend for taking the time and effort to translate all of this.
The “Mining Economy” is Going to Eat Away the Bitcoin Exchange Rate
By Erez Raviv
The past few months have seen unprecedented and aggressive marketing efforts to get people into crypto in general and Bitcoin specifically. Crypto markets are buying the most expensive commercial time, such as the Superbowl.
That FTX commercial, starring Larry David, doesn’t mention even one fact about crypto, and aims at creating gigantic FOMO (Fear Of Missing Out) for those not betting on that. More Hollywood celebrities become front and partners of various crypto initiatives. The (partial) list includes Kim Kardashian, Paris Hilton, Matt Damon, Jimmy Fallon and more. [Pro-Tip: if you want to know how to succeed in life, just look at what these clowns are doing, and then do the exact opposite – and add Didact’s name to the list while you’re at it. — Didact]
Melania Trump was caught buying her own NFT tokens to boost their price and generate demand. Trump denied the allegations, without contradicting the report.
Another type of aggressive marketing is the offer to get your salary, up to 100%, in crypto and not in national currency. CASH APP, owned by Jack Dorsey‘s crypto company, Block [formerly known as Square — Didact], has offered that lately. Reporter Amy Castor analyzed it as reprehensible move to encourage gambling, and note that Paypal and VENMO were there first.
The large marketing budgets of the major crypto player are showing us that they understand that deep s#!t is coming, unless they get “a river of new fools” to buy Bitcoin and other crypto in an increasing rate. That may work for a while, but not forever. The internal crypto dynamic may postpone the crash, but not avoid it.
Specific players may earn a lot from Bitcoin, but most will lose. Bitcoin is worse than a “zero sum game”, because the cumulative market cap is negative. Negative? In 2021 the public was drained ~US$7.4B that was invested in Bitcoin, never to return. That amount is the estimated global electric bill of Bitcoin mining.
Unlike a stock, which may yield dividends, Bitcoin is pure speculation. The only way to turn a profit is if someone else pours their money to the crypto market, and in higher speed. That money will also go down the drain, and the only way to escape the crash is if new investors come along with even more money than before.
The Growth of the Electric Bill
Bitcoin is more than a speculative asset, it also depends on a vast computer network, which needs more and more energy for “mining” new coins. The Bitcoin software weaves the “mining” of new coins into the payment clearance inseparably.
Since Bitcoin miners pay their electric bills in state currency, the crypto markets need to “devour” huge sums of the investors just to keep things running. This is a cumulative net loss for all investors, just to keep from crashing.
Bitcoin holders tend to say that in the long run their value will rise. That analysis has multiple explanations, yet they all seem to ignore what higher value means in the future. If one looks into it, it is evident that the higher the exchange rate is, the harder it will be to get it to rise in the mid and long term.
It looks like a simple supply and demand calculation. Higher demand increases price and higher supply reduces it. In the short term, those trends along with market manipulations explain the exchange rate. In the longer run, one factor is crucial to determine the exchange rate – the mining economy. Bitcoin has zero income, but requires enormous expenditures.
Bitcoin miners hold tens of thousands of dedicated machines, which supply their owners with as much Bitcoin as they can calculate, as a sum of the total offered Bitcoin. In 2021, that amounted to 40 Bitcoins/hr. That is arbitrary and is determined by the software, and about every 4 years it is cut by half.
If one has for example, 10% of the cumulative mining capacity, one gains 4 Bitcoins every hour. But what about capital expenses, operational expenses including the electricity bill? The theoretical mining economy hangs by two threads – the relative calculation power and the exchange rate. The actual mining economy depends on one thing – someone willing to pay new money for the new mined Bitcoins.
The exchange rate jumping over the past 18 months has made the average crypto profitability phenomenal. It is hard to have an accurate estimation, since some miners use old equipment, with marginal profitability. Having the newest equipment means a profit margin of up to 90%.
Alex de Vries, an economist tracking the crypto electrical consumption, estimates that this comes to 45% of the expenditure on net dollar value of the mining. However, some miners can get their hands on cheap and dirty electricity, thus extracting more profit.
2021 saw a theoretical Bitcoin value of 16/US$58B mined. Luxor’s end of the year report, estimated earnings of US$16.7B. That makes the electricity consumption at about US$7.4B (45%), which was “burned” (TMB-pun intended) out of the investors’ money.
Running Faster to Stay in Place
The average Bitcoin price of 2021 was US$47,436. Luxor’s report suggested it was a year of record mining profitability. If Bitcoin price remains steady at 2022 [which it hasn’t, it’s gone DOWN quite a long way — Didact], the electrical waste of the Bitcoin network can dramatically increase with no net loss. This is known (based on Carroll Lewis’s Alice in Wonderland) as “Red Queen Race”. One must run faster and faster just to stay in place.
Indeed, the large mining corporations in the US plan to intensify their activity, while being aware that the competition is relative. If one company’s calculation power increases, all of the other’s increments are vanished.
E.g. Marathon Digital Holdings, announced last month that it had installed 5600 new S19 mining machines, out of a total planned 36,830. By the end of 2022 its computing power will increase 6-fold (600%).
The company has not sold a single Bitcoin since October 21, 2020. Bitcoin exchange rate was US$12,000. Since then, that company has only acquired more and more Bitcoin. So it is either deeply optimistic, or heavily pessimistic about the exchange rate. They are not alone. An estimated 45% of the market is using the same strategy: holding on to Bitcoins while going public to raise money paying for electricity and new mining machines.
However, if one looks at the blockchain registry of 2021, as published by Zack Voell on Bitcoin Magazine, the attributed Bitcoin of miners has dropped 7.4%.
Holding Bitcoin: Bottomless Pit
Financing a mining company via capital raising is a hefty bet. It is based on two assumptions: Bitcoin will continue to go up (or at least not crash) and that eventually it will be possible to convert it to regular money for profit. Both assumptions may be wrong, thus hurting the mining companies – badly.
Balance-wise, Marathon publishes the aggregated cash and Bitcoin worth together, yet practically there is a big difference.
The company can use the cash anyway it wants to, but if it tries to sell all 9,733 Bitcoins it owns, worth US$444M, it will utterly fail. Crypto markets are not “deep”. They lack liquidity, so trying to sell a lot of Bitcoin for dollars will crash the exchange rate, and with it – the company’s market value.
For “Bitcoin whales” (holders of large amount of Bitcoin), the exchange rate is theoretical value on the spreadsheet, and cannot be liquidated in reality.
While mining companies are acquiring mining machines, in a mad race to waste more power, sales pressure on the markets is accumulating.
Someday soon, those holders of crypto currencies will need to exchange it to national/sovereign money, when raising capital won’t be an option. That day will show how phenomenal profits, on paper, can become heavy losses in a blink of an eye. As miners acquire more Bitcoin, the “weight” of future sale becomes way bigger. The only way to avoid this scenario is to have a steady increase of cash flow to the market.
(TMB – I call it “Ponzi scheme”)
The problem is that the model defeats itself. Every new mining machine means increase “money drain” wasted on electricity and capital expenses. This means that to keep the current Bitcoin exchange rate, more new money is required, constantly. Even if other investors will stop buying or selling Bitcoin, mining requirements will crash the exchange rate.
The mining economy works in a way that raised exchange rate today means trouble keeping it up in the mid-term. E.g., let’s say one needs $1B to raise the exchange rate 5% (TMB – of electricity bill), then in 1 year that won’t be enough since everyone is “burning” more money.
Even if a crash is imminent, one cannot predict when and how fast it will happen. Bitcoin has crashed repeatedly, but was able to recover and climb back.
Payment for electricity in national/sovereign money makes the mining economy a frontier that mandates future crash. Crypto industry is going out of its way to convince not only individuals, but also regulators to allow institutional investors to invest in crypto. Success or failure can shift that day near or far in an unpredictable manor.
There are a few signs that the pressure to crash is increasing:
1. Market supply of Bitcoin, but no dollars
The mining companies’ tendency to hold Bitcoin without selling it can be interpreted not only as “vote of confidence” but also as deep despair, as they understand that their holding ratio is bigger than the dollars entering the market pace.
It is evident that other companies are selling their Bitcoins, pushing back on those publicly traded mining companies, which need a higher valuation of their cryptoassets than cash. This cannot go on forever, and sometime the process will flip back and we will see an increased sale of crypto currencies. Crypto holding represents a big risk.
2. Bitcoin backed loans are accelerating
More and more mining companies are borrowing dollars with Bitcoins as collateral, or bonds. It started in China in 2019, and picked up pace in the US in 2021. Silvergate Bank, based in California, is a major player for Bitcoin-backed loans. It recently loaned US$205M to Microstrategy, which was used to purchased 4,167 BTC.
That increases the risk to the entire market. If the exchange rate goes down, the bank will call the collateral and selling pressures will ensure. Lenders know that being pressed to sell means long-term damage, but not everybody can have deep pockets to wait it out, while holding on to the Bitcoins.
3. Michael Saylor is not immortal
Michael Saylor owns Microstrategy, which is the largest active Bitcoin holder, having ~130,000 Bitcoins, at an average rate of US$30,700. The company basically acquire US$4B of Bitcoin. Theoretically it is worth ~US$6B, but since there is no liquidity it cannot be materialized.
Saylor keeps announcing he wants more:
Saylor is the Bitcoin investors’ hero, but he won’t be there forever. He may be replaced, and his predecessor may show the same loyalty to the holding strategy, and may want to sell some or all.
4. Past swindle haunts present investors
Some 140,000 BTC are due to be released to the market soon, as part of the settlement of the MtGox case. The investors have lost their Bitcoins in 2014 and may now gain a theoretical value of US$6.7B. Even though the number of Bitcoins is fewer than those they had, the dollar value is way higher. However, it is about 24,000 different holders, so coordination is going to be tough, expect market flood shortly and exchange rate going down.
Another case in question is the trial of Heather Morgan and Ilya “Dutch” Lichtenstein. They were caught with 94000 stolen Bitcoins, with a theoretical value of US$4.4B. Even if the state sells them in small amounts, that pressure is still increasing.
5. Regulatory mines ahead
The crypto players – traders, markets and miners – all share the same mantra: “We welcome any regulation to stabilise the market”. However, they actively use lobbyists to cut, push back and postpone almost any regulation.
For now it is working, but will not for long. Europe is increasing the effort to limit mining and transactions of anti-environmental currencies such as Bitcoin and Ether. The US president has signed an executive order that closer the day major regulation will come into play in the US, thus jeopardising the current profitability.
It Ain’t Gonna Be Pretty
When the crash begins, it’s not only low rate losses, but also crashing some of the crypto market places. It will be a classic “bank run” when they won’t be able to satisfy the demand for crypto or asset swap for real money.
It’s no secret that crypto transactions are saturated with fraud (both market places and entrepreneurs), hacks and all of it does not come out in real time, but mostly during a crisis. A new Netflix film called Trust No One, shows in detail how a drastic drop in Bitcoin value launched the chain of events leading to the exposure of the scam behind QuadrigaCX – the Canadian crypto marketplace which crashed taking with it some US$250M of investors’ money.
Crash: Major Environmental Relief
The crypto market is not big enough to cause global financial damage, it is not like the sub-prime mortgages scam that caused the 2008 crisis. Yet, the internal dynamic and the massive marketing investments have made several critics view it a “smaller-scale sub-prime”. Meaning, an attempt to manufacture a crisis, lacking the depth of the US housing market, thus with limited damage.
Environmentally it’s a different story – a big one. Crypto crash will cause severe damage to investors but a major relief for the planet. Most commodities and services derive their power supply from actual usage. Crypto is different. The bitcoin electrical bill is based on its value, and not the amount of transactions.
The Bitcoin-related increased electrical consumption is estimated at 120 TW/hour in 2021, and it keeps on growing. That is about 0.5% of the global power, for Bitcoin alone. All the others are about the same combined – so it is ~1% of the global electrical consumption.
De Vries data indicates that one transaction (end to end) of Bitcoin creates 1200Kg (2640 lb) of CO2. That is the equivalent of 2.6 million visa charges.
Bitcoin major crash will most likely cut the power on most of the mining machines, since operation becomes non profitable. Once off the grid, all negative impacts of Bitcoin will drastically be reduced – Air pollution, Greenhouse gases, e-waste and destabilizing power grids globally.
(TMB – let’s skip gases, as we disagree. All the other issues seem logical.)
Environmentally, there is a significant public interest to crash the Bitcoin. From a global stability standpoint, every day that crypto gains more theoretical value only increases the systematic risk to the system. Sooner is better than later.
Let me start off by stating openly that pretty much everything the author has written is correct. Bitcoin is not rooted in anything real – neither is any cryptocurrency except a fiat- or commodity-backed stablecoin, or a cryptocurrency that is actually redeemable for a physical asset. They are all digital assets, not currencies. Bitcoin does not meet the four key criteria of money:
- Medium of exchange – you cannot use Bitcoin to exchange one good or service for another, with very limited exceptions;
- Measurement of value – most goods and services used in the real economy are not indexed against Bitcoin, and cannot be;
- Standard of deferred payments – Bitcoin sort of comes somewhat close to this, because it can be used as collateral for loans, or for overcollateralised crypto-backed stablecoins like DAI, but in general, you cannot make loans denominated in BTC, not yet;
- Store of value – Bitcoin is a complete failure in this regard, its extreme volatility relative to other currencies makes it useless as a store of monetary value through time;
The natural counterargument to this is that most modern currencies do not meet all four criteria. That is also true. And, note, I am not anti-Bitcoin. I have personally bought mining space on Genesis Mining, for years, and even endorsed it here for quite some time. I believe that Bitcoin represents a fundamental power shift in practical monetary applications, away from governments and toward users.
However, even though I own and have mined and used Bitcoin in the past, and I will continue to endorse its use as a speculative asset, I am objective enough to state that just about everything that the author wrote above is true, correct, and concerning.
First, he is entirely correct to note that the electricity cost of Bitcoin is becoming prohibitive. In fact, at current prices, it is generally not economical to mine Bitcoin, unless you make the extremely strong assumption that the price of BTC will simply keep going up, AND you live in a country with extremely cheap electricity.
This assumption is unwarranted if Bitcoin does not become a reserve currency. Unlike the Russian ruble, it is not backed by anything whatsoever in terms of hard commodities. And unlike the US dollar, it is not a medium of exchange in global trade. So it has nothing real causing it to appreciate in value.
Unlike corporate share prices, Bitcoin does not have an underlying stream of cash flows, either real or projected, to provide a basis for its value. It is purely a speculative asset with very few real-world applications.
Even those nations that have adopted it as a national currency, like El Salvador and the Central African Republic, find that it comes with more problems than solutions. In fact, the El Salvador experiment actually ended up causing dollarisation of the country, because people simply took their BTC and exchanged it for USD, because it is such a volatile cryptocurrency.
Compounding these problems is the fact that Bitcoin IS NOT DECENTRALISED. Please do not try to lecture me about how cryptocurrencies are totally decentralised and nobody controls it. That is nonsense. In fact, ALL cryptocurrencies that have any real-world applications are subject to some form of centralisation.
The reality is that, with cryptocurrencies that rely on Proof-of-Work (PoW) algorithms to validate new transactions – such as Bitcoin and, for the moment, Ethereum – the power in the market lies entirely with the miners. They have BY FAR the most power and influence over the entire network. And global regulatory trends are moving decisively toward centralisation. In order to do anything useful with cryptocurrencies, you have to go to a centralised exchange – and to register with most of those, you have to provide some KYC documentation in the form of proof of ID and existence.
Given these trends toward centralisation, and the problems noted above with power consumption eating seriously into the profitability of Bitcoin mining, what, then, are we to do?
The first thing to note is that the power balance in cryptocurrencies is rapidly shifting. The crypto developer community knows full well that the mining-centric model of BTC, ETH, LTC, and others, is simply not workable. Ethereum, in particular, has major issues with “gas fees” – essentially, a variable toll that users have to pay in order to get their transactions processed on the blockchain – because the Ethereum blockchain involves a lot more than just ETH transactions. It actually involves a lot of smart contracts, the bulk of which are stablecoins.
That is why the ETH community is actively working on moving toward Proof-of-Stake validation for new information. This is hard to do and it has taken much longer than originally planned. But that is likely one of the ways to resolve this issue. That will shift power from miners to large holders of the currency, and that creates its own set of headaches, but it will also resolve the power consumption problem.
As for the question of whether BTC will ever become a true currency – I rather doubt it. We WILL eventually see realistic digital currencies come into widespread use, both in Central Bank Digital Currency (CBDC) form, and privately-issued form. (Beware of CBDCs, by the way – those things are fraught with serious dangers with respect to privacy and anonymity, even more so than regular digital currencies.)
There is a substantial market for stablecoin-based payments that I know of, particularly for cross-border remittances. It is not at the stage of full-blown consumer payments, not yet, and will not be for some time – you can’t pay for your cup of coffee in the morning with stablecoins, and will not be able to for quite some time. But there are definitely a number of very powerful use cases in the real world for stablecoins, and I believe we will see real, gold-backed stablecoins emerging and gaining prominence in the future. I also believe that we will see a digital ruble, backed by a large basket of commodities, gaining traction in the years to come.
Personally, I believe that the outlook for cryptoassets is bright. With respect to Bitcoin, specifically, I consider it to be a brilliant, but deeply flawed, idea that will spur a revolution in payments and monetary thinking over the coming years.