Bitcoin: The opportunity costs of mining for money

Everything we do and every choice we make has an opportunity cost. In a world of scarce time and resources each choice necessarily means rejecting many other possible opportunities. One of the best illustrations of this concept was made by President Eisenhower in a 1953 speech. Eisenhower criticized the use of scarce resources for military purposes because of the opportunity cost:

These kinds of choices are just as difficult as they were for Eisenhower in 1953. How much time, resources, and effort should be dedicated to military activities? It's still a contentious argument, and opinions greatly differ.

Businesses face similar dilemmas. Every dollar spent on marketing is a dollar not spent on product development and testing. Every dollar spent on purchasing new equipment to expand the business is a dollar not given back to shareholders as profit. These are difficult choices.

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In the 18th century, the economist Adam Smith criticized hard money like gold and silver because of its opportunity cost:

The idea of substituting hard money for paper money is a powerful one, because paper money takes very little resources or effort to create. The time, effort, and resources sacrificed to digging gold and silver out of holes in the ground, forging them into bars and coins, and then burying them in a different set of holes in the ground called bank vaults can instead be used for more productive purposes like building homes, roads, and schools.

Supporters of hard money argue that the fact that paper money takes much less effort to create is actually a disadvantage because it makes paper money vulnerable to inflation. Certainly, one historical reason that gold and silver became money is that they are rare and hard to counterfeit. This made people in the market willing to devote resources to mining them. And there are many historical examples of paper money systems that have failed due to high inflation. But as Barry Ritholtz at Bloomberg View recently argued, paper money has actually held its purchasing power well in the last century as economists have gotten better at managing the monetary system. Every country in the world has moved from metal money into paper and digital monetary systems, and as Matt O'Brien at The Atlantic recently argued, prices were actually much more volatile during the years of metal money.

But even with the rise of paper and digital money, hard money that takes effort to mine has not completely gone away. Cryptographic currencies like Bitcoin are mined in a very resource-intensive way, using huge amounts of computing power to solve complex cryptographic puzzles. Earlier this year, Bitcoin became the world's largest distributed computing project, eight times more powerful than the world's top 500 supercomputers combined. That is a huge amount of computing power that could be used for other projects like research into genetics, or searching for extraterrestrial life, or modeling weather and the climate, or a huge number of other endeavors. Mining digital currency entails a huge opportunity cost, just as mining gold and silver for money did.

But on the other hand, that's a choice that the market is making. Individuals and businesses in the market find Bitcoin interesting enough to put resources into mining it. And that's understandable — Bitcoin already allows users to securely send money around the world at a much lower cost than its competitors. And the price has been going higher and higher and higher, meaning lots of people are getting rich speculating.

In the future, governments or central banks or corporations like VISA could build peer-to-peer digital payments systems based on state currencies that don't require huge amounts of computing power to mine. Imagine the Bitdollar — issued at near-zero cost by the Federal Reserve, available to anyone in exchange for a regular dollar, stored on a computer or smartphone in a digital wallet, and, like Bitcoin, capable of secure peer-to-peer transfers and transactions around the world. Advantages of this could include less price volatility by tying the price to a real-world currency like the dollar, less risk for users as state-backed currencies run no risk of being outlawed, and mass acceptance as legal tender laws would require that it be accepted for payments.

Until then, it seems likely that lots and lots of computing power will be dedicated to mining for money.