Cryptocurrency Design – Green or Gold?

OWNx Team Global Finance and Economics, News & Commentary

Within the FinTech world, there is a great deal of activity in the cryptocurrency space and there will be for the foreseeable future. Incubator labs around the world are designing new types of currencies. The last thing any of them want is to discover that they missed a variable that could kill the viability of their currency.

It turns out that the leader of the cryptocurrency world – Bitcoin – may have a significant problem in this regard. It is one that could have easily been overlooked. That is – energy consumption.

According to a recent article, in June 2015 the Bitcoin network was consuming enough electricity to power over 170,000 American homes. Less than two years later, that number has grown to over 1 million homes. The Bitcoin system is designed in such a way, that it takes ever increasing amounts of computing power to mine a new coin.

That means, unless there is a significant reduction in the cost of energy, new coins are going to be very expensive to mine.

The author of the article makes the following observation:

“ …if no changes are made to the system, the viability of the currency itself might be challenged because the seigniorage (defined as the difference between the face value of money and what it cost to make it) could be minimal or negative. In other words, the marginal electricity costs could outstrip the value of the newly minted Bitcoin.”

This places Bitcoin in a very interesting position by introducing several free market variables that may or may not be appropriate for a currency.

  • Adoption of Bitcoin in the currency market must increase such that the value of the coin increases enough to support the energy required to create new coins.
  • Alternatively, mining may decrease due to costs that are higher than the cost of production. This creates scarcity of the coins themselves, which would drive up the value (assuming it has enough market acceptance) and draw miners back into production. This is similar to gold and silver production.
  • Will the pace of energy efficiency in computing power overcome the demands of the mining network and make this all a moot point?

These factors introduce questions that must be answered in order to determine whether Bitcoin can emerge as a stable medium of exchange or a long-term store of value.

  • Will excessive energy consumption cause Bitcoin to become just another speculative investment and not a viable currency?
  • Are energy related and other non-monetary free market components appropriate inputs to determine the value of a currency?

Some of these questions can also be applied to gold and silver. They too require energy consumption. The value of energy inputs has a direct impact on the willingness of companies to mine them.

However, there are significant differences as well.

  • Gold and silver are tangible, physical assets.
  • The infrastructure and energy costs to mine gold and silver are well established.
  • They have a 5000 year history as being a central component to most monetary systems.
  • The energy required to purchase, trade, and sell gold and silver is minimal due to their using an already existing financial infrastructure.

One thing is certain. What money is and what it should be is being reconsidered around the world. While these important questions get sorted out, we can be confident that the enduring track record of gold and silver will ensure that they will maintain a place in whatever new monetary paradigm emerges.

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