Hi Matt,

First of all, I'm a big fan, I love your column and your writing style. Yes, I'm a bitcoiner, so strap in for some bad economics. You're one of the few critics that actually bothers to engage with the substance and ideology behind Bitcoin, so I really appreciate that.

I'm writing about the critique frequently leveled at Bitcoin about its energy consumption and the supposedly dirty source of that energy. Your colleagues wrote a fairly inflammatory article about this recently, which I believe you referred to in a recent Money Stuff. Something to the tune of 'most bitcoin is mined with coal'.

I don't think that's entirely wrong, but I have lot a bit of time trying to determine where Chinese miners get their electricity from, and I have spent a regrettable amount of time mapping China's energy landscape. I like Bitcoin, and I think it's generally very good for the world, but I'm an environmentalist as well, and I'm fairly concerned about the energy use.

If you're bored and just want a tl;dr the main point is that Bitcoin performs global 'energy arbitrage', and right now a lot of Bitcoin is mined with otherwise-wasted hydro power, especially in Szechuan province.

You may know this already, but I'll briefly explain. Bitcoin essentially auctions off $237k worth of new coins every 10 minutes, or $3.2m daily. Bidding is a function of energy committed to the system through hashes. So whoever generates hashes most cheaply wins.

First of all, energy used basically scales linearly with price, assuming miner margins don't shrink (they will) and the fixed cost/ variable cost ratio of miner expense doesn't change. So that's an initial point. We can project how much energy bitcoin will use more intelligently than simply extrapolating current growth like some commentators have done.

Secondly, Bitcoin rewards whoever is able to generate hashes most efficiently. ASICs, economies of scale, and vertical integration come into this. But so does electricity cost, and that's really why China predominates today - because miners were able to exploit cheap electricity. In Szechuan, in particular, where a huge amount of mining is situated, mining is done almost exclusively with hydroelectric that is considered excess capacity. (Dams need to let out water occasionally, but if the grid doesn't demand it, it's wasted). Miners cut sweetheart deals with local energy administrators, and they both win – miners get below-market electricity, and the local energy authorities get paid for hydro that is otherwise wasted.

Obviously, there's only so much spare capacity hydro laying around, so that doesn't account for all bitcoin mining. But that's definitely the case in Szechuan. For mining operations in inner mongolia (Chinese province), coal is mostly used, although about 10% of that is wind.

The point is, the premises i) 70% of bitcoin mining is situated in China and ii) 60% of Chinese energy is coal do not yield  iii) most bitcoin mining is done with coal. That may be the case, but we know hydro is influential, and we also know things like rigs in iceland mine with geothermal.

The broader point is that bitcoin optimizes for the cheapest possible electricity. Renewables are following a Moore's law-style distribution whereby they continually get more efficient and cheaper. Today utility scale PV and wind are cheaper, on a LCOE basis (Lazard study) than coal. The problem is storing that energy (at night, or on non-windy days), which generally makes them less economical. But what if there was a sponge which could 'mop up' that energy and store its value?

Bitcoin is an energy sponge, and it monetizes inefficiencies like excess wind when the grid doesnt want it, or stored water in dams when it has to be let out, or solar super far away from population centers. This is why I consider bitcoin synthetic energy. It not only monetizes those inefficiencies, but it also incentivizes the construction of cheaper energy generation. Its time and space-indifferent properties make formerly impractical stuff like solar or wind more viable. And it's a $12.4b dollar annual subsidy for cheap energy installation.

Obviously, some things need to change for this to become a legitimate line of argument. Right now the arb is being performed by miners benefiting from political things like electricity subsidies in inner mongolia. But you get the broader point. Bitcoin is a colossal battery that absorbs energy and then releases it anywhere, whenever. Far from being a waste of energy, it's a tremendous opportunity for society to build a better, more efficient energy grid.

If you're still with me, thank you for reading! Keep up the good work with the column.

All the best,
Nic