When considering the relationship between bitcoin and energy, it’s clear that the value of bitcoin is essentially linked to the amount of energy used in its creation. This is similar to any free market system where the value of a product, in this case, bitcoin, is determined by its production cost and the various profit margins required to get it from the producer to the consumer. Profit margins are largely determined by supply and demand dynamics; innovative products with high demand and low supply can command higher prices. However, if the product or service is not proprietary, competitors can capitalize on the arbitrage opportunity to cater to the demand. Over time, we expect a competition among producers to meet demand until a price equilibrium is reached that is acceptable for all parties involved. Any further innovation in production technique or cost reduction can temporarily give a producer an upper hand, but this advantage is typically short-lived as other producers soon catch up.
This economic principle, often referred to as Adam Smith’s invisible hand or the economic equilibrium principle, suggests that individuals acting in their own interests eventually leads to societal benefits through demand satisfaction at optimal economic value. While perfect economic exchange value may not be achievable, the benefit of price reduction and quality increase is evident in many industries, from transportation to computing. A prime example is the computer industry where capabilities have increased exponentially while costs have decreased significantly over the past 40 years.
However, the same cannot be said for the automobile industry. While a computing device can increase its capabilities by 100,000% while decreasing its cost by 99% over 40 years, the same cannot be said for a car. This is primarily due to the increasing cost of raw materials and operational costs involved in car production and distribution. This illustrates the inflationary effect of currency devaluation, with a dollar in 1977 having significantly more purchasing power than a dollar in 2024.
The reason behind this disparity is twofold: energy and resource scarcity. While technology can solve many efficiency or miniaturization challenges, it cannot fundamentally reduce the required physical and energy commodities for producing large items like cars. Similarly, the cost of producing bitcoin is fundamentally linked to the energy required to create it. The energy required to produce one bitcoin is continually increasing due to the network’s growth, setting an intrinsic value for a late 2024 Bitcoin at around $66,000, including a profit margin of about 10% for the average producer.
While the cost of producing a bitcoin does not solely determine its current price, it does play a crucial role in establishing its value. The cost of production and the current market price have found an equilibrium point that benefits both producers and the market. Bitcoin, being one of the few true free markets, is continually pushed towards this state of equilibrium by the invisible hand of the market. This suggests that the true value of a bitcoin can be understood by understanding the energy cost of producing a bitcoin, implying that energy effectively values bitcoin.
Similarly, the value of energy can be determined by bitcoin, completing the energy-bitcoin paradox. The value of a unit of electricity is set by bitcoin, but the seller decides whether to accept that price or sell to someone else for more. Therefore, energy is the fundamental commodity upon which all valuable things are produced, and bitcoin is the purest representation of energy in a monetary form. Without energy, bitcoin would be no better than any other fiat money system. Therefore, energy is the true source of value, and no other monetary system is built on energy.
This article is a guest post by Philip Walton. The views expressed are entirely his own and do not necessarily represent those of BTC Inc or Bitcoin Magazine.
