One question people ask us is, “But what about bitcoin?”
For much of the past decade, cryptocurrencies were the preserve of digital enthusiasts and people who believe the age of fiat currencies is coming to an end. This niche appeal is reflected in their market value. For example, at a market value of around NZ$ 85,600 per bitcoin, the total value of bitcoin in circulation is less than half of a per cent of the aggregate value of global stocks and bonds.
Holding cash does not provide an expected stream of future cash flow. One US dollar in your wallet today does not entitle you to more dollars in the future. The same logic applies to holding other fiat currencies — and holding bitcoins in a digital wallet. So we should not expect a positive return from holding cash in one or more currencies unless we can predict when one currency will appreciate or depreciate relative to others.
The academic literature overwhelmingly suggests that short-term currency movements are unpredictable, implying there is no reliable and systematic way to earn a positive return just by holding cash, regardless of its currency.
A lot of volatility has occurred in the exchange rates between bitcoins and traditional currencies. That volatility implies uncertainty, even in the near term, in the amount of future goods and services your bitcoins can purchase. This uncertainty, combined with possibly high transaction costs to convert bitcoins into usable currency, suggests that the cryptocurrency currently falls short as a store of value to manage near-term known expenses. Of course, that may change in the future if it becomes common practice to pay for all goods and services using bitcoins.
None of this is to deny the exciting potential of the underlying blockchain technology that enables the trading of bitcoins. It is an open, distributed ledger that can record transactions efficiently and in a verifiable and permanent way, which has significant implications for banking and other industries, although these effects may take some years to emerge.
Even putting the high risk aspect aside, there’s a facet of bitcoin (and other cryptocurrency) that most people might not think of – its insatiable thirst for more and more electricity.
Bitcoin is designed with a few unique features in mind. Firstly, there are only 21 million Bitcoin to be mined. There will not be any more than that in circulation at any time. Currently we know that over 18.5 million of this has been mined, and the entirety of the cache is estimated to be mined by 2140 (if that).
The second important thing to know about how Bitcoin has been built is that, by design, it gets harder to mine over time. The payoff also decreases while the amount of energy to get there increases. This is because ‘mining’ involves solving complex math problems, where the reward is bitcoin. Early in the crypto wave this could be done on your average computer. Now that so much of it is claimed, the algorithms are much harder and requires computer equipment with huge processing capabilities. And of course, these use more electricity than your average computer did – a LOT more.
In fact, bitcoin mining has grown over the past few years to consume more energy than the Netherlands, Argentina, or Switzerland. In 2018 one dollar’s worth of bitcoin took more than double the amount of energy needed to mine one dollar’s worth of copper, gold and platinum. This quadrupled by 2019. We can likely assume the trend continues due to the increased need for processing power to mine the coins.
So on one hand, we have a by now quite famous cryptocurrency. It’s even legal tender in El Salvador, with predictions for more developing countries to join the train in 2022 (which is a whole other conversation).
On the other, we have enormous energy usage that will only get larger until all bitcoin is mined – and the knowledge that it was built this way on purpose.
There’s something ironic in the idea that a digital currency, created and controlled online, has such an enormous footprint.
The sticking point for this is that, as with bitcoin itself, the amount of electricity available at any one time is finite. And oftentimes cheap electricity is not from clean, renewable sources.
Historically, miners based themselves in places like China, where data from previous years indicated up to 75% of the world’s bitcoin occured – until Beijing called for a severe crackdown in May, and many fled to Kazakhstan instead. The country became the world’s second biggest bitcoin miner and electricity usage went up 8% where they would usually only see a 2% increase year on year.
As recently as 2020, data from the BP Statistical Review of World Energy reported that almost all of Kazakhstan’s primary energy was generated by fossil fuels (coal, oil and gas). So we know this increased energy consumption is coming at a pretty significant environmental cost.
Then, of course, the massive jump in electricity usage caused an energy shortage to the point where Kazakhstan had to tap into Russia’s supply – who, according to the same report, also still use fossil fuels to generate over 50% of electricity produced.
Vitalik Buterin, the computer scientist who invented another cyropcurrency known as ethereum, has stated that mining crypto can be “a huge waste of resources, even if you don’t believe that pollution and carbon dioxide are an issue.”
“There are real consumers – real people – whose need for electricity is being displaced by this stuff.” Buterin said.
Now Kazakhstan is also implementing measures to ration and suspend their electricity supply to these massive cosumers, who can use more energy than the Netherlands, Argentina or Switzerland while mining.
Other countries are also rallying to take action, with Swedish authorities calling on the European Union to ban crypto mining so they can meet their obligations under the Paris Climate Agreement.
There’s also likely to be more regulations (or at least reporting requirements) on crypto going forward as we see things like the US infrastructure bill getting signed.
Looking back, I wrote an article on this same topic back in 2017, which still rings true:
The higher the price of bitcoin and the more people who pile into it, the greater the risk of a government crackdown. Bitcoin is something that undermines the power government has over money and taxation, something it won’t relinquish lightly.
So, what about bitcoin?
Crypto in general is notoriously volatile. Just this week we’ve seen the crypto market fall by more than $200 billion overnight following a record-breaking rally last week. While it’s still too early to tell if this marks the start of a reversal or is just a correction, it is a good reminder of how dramatically crypto can fluctuate.
Basically if you’re the kind of investor who is after low risk investments – or sustainable ones – you may need to look elsewhere.
•Nick Stewart is a Financial Adviser and CEO at Stewart Group, a Hawke’s Bay-based CEFEX certified financial planning and advisory firm.
•The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz