Bitcoin and the Circular Economy
Reusable Proof of Work is production of eternal value
This article was originally published in The Capital on Medium on September 26, 2022.
This is not investment advice. Bitcoin is highly volatile. Size your position according to your ability to manage the risk, and preferably, think of it as a long-term savings-oriented investment.
The Circular Economy is about the efficiency of energy and material input into economic sectors through recycling, refurbishing, long lifetime and intensifying utilization, and reuse.
The point of the circular economy is to get away from a linear economy that produces, uses, and then disposes into landfills and to build in its place a circular economy with maximal recycling and reuse of inputs and intermediate products. The tightest loop in the circular economy diagram above is the reuse loop. The next tightest is longer use of a product or use in more applications or circumstances (intensifying use).
According to the Wikipedia circular economy article that quotes the Circularity Gap Report, “out of all the minerals, biomass, fossil fuels and metals that enter the world’s economy, only 8.6 percent are reused”.
History of Reusable Proof-of-Work
Bitcoin creation is based on Reusable proof-of-work, usually just referred to as proof-of-work (POW). The POW concept was invented by Moni Naor and Cynthia Dwork in 1991 as a way to deter denial-of-service attacks and e-mail spam. The name POW was introduced later, in 1999, by Markus Jakobsson and Ari Juels. Prior to that, in 1997, Adam Back had already created hashcash in the context of protecting against DDOS attacks.
POW is based on solving a cryptographic puzzle, and Bitcoin uses a form based on the SHA-2 hashing algorithm originally invented at the NSA and placed into the public domain. The hashing method also allows the creation of a chain of blocks, each linked to a prior block of transactions. But the limitation with hashcash is that it is like a postage stamp, it can only be used once.
In the 1997 essay How to Make a Mint, NSA employees Law, Sabett, and Solinas discuss the state of the art at that time for electronic cash with single use through a bank intermediary. And they noted:
“Transferable systems have received little attention in academic literature. The schemes presented in Part III.C are not transferable because the payee cannot use a received coin in another payment..any transferable electronic cash system has the property that the con must ‘grow in size’ each time it is spent, because the coin must contain information about every person who has spent it”
(to prevent double or multiple spending within a given time window).
It was not until in the middle of the next decade that Hal Finney, in 2004, created Reusable POW. This means an enhanced proof of work algorithm can be utilized to create a reusable token. In Bitcoin, this is implemented with a block reward subsidy, with new tokens issued in each block via a winner take all lottery to the first computer to solve a cryptographic puzzle. Once this problem of reuse was solved, proof of work become highly useful as a monetary technology. POW solved the double spending problem, and each transaction was uniquely stored in a distributed ledger.
Hal Finney made this breakthrough four years before Bitcoin was introduced on Halloween day, 2008. Some say Hal was Satoshi.
Such a token can be reused in future transactions in subsequent blocks of the blockchain (time chain) repeatedly (but only once per block). Reuse typically involves sending from one wallet to another, changing ownership. Bitcoin advocates gloss over a key point when just using the term POW without an R in front. It is the R, the reusability, that makes Bitcoin an efficient and valuable monetary product to create with substantial energy input. And most of the energy goes into asset creation, not the transaction validation service, at this point.
Another key point that Satoshi Nakamoto implemented with Bitcoin in 2008 was the elimination of the banker intermediaries assumed in most electronic cash models. Instead the ledger is open and globally distributed across many full nodes. It is privately created and available for both retail and wholesale (financial intermediaries) use.
Bitcoin has immediate, eternal reuse
Bitcoin is produced and immediately globally distributed and available for use by the owner within 10 minutes to an hour after creation, depending on the desired security assurance level. Miners sell some or all Bitcoin that they mine into the marketplace to pay for their operating and capital acquisition costs. They may pledge Bitcoin as collateral as well.
Bitcoin can be reused potentially with any new block in the blockchain, and over and over again. No refurbishing or remanufacturing is required. No recycling is required, apart from paying a minimal transaction fee, currently less than 1/2 of 1% on average of the value of newly created Bitcoin.
Since Bitcoin is both a product and a service, ESG critics mischaracterize it when they critique it as only a transaction service. They get away with this because most people are biased toward the consumption mindset, rather than a production mindset. Comparisons to the Visa network are vapid and irrelevant, since Visa creates no new wealth, it only extracts value for the Visa corporation and, for the banks that are members of the network, in return for the transaction service it offers.
Currently Bitcoin miners around the world are producing about $6 billion of new Bitcoin annually.
Each Bitcoin block at present produces 6.25 Bitcoin with value in excess of $100,000, and the transaction fees for a typical block are about $100 per Bitcoin produced. So 99% plus of the reward issued to miners is for the new Bitcoin created, not for the transaction fees. Less than 1% goes to transaction fees.
Bitcoin mining or minting is first and foremost about production of new, highly secure, quasi-eternal value. The thousand or so transactions executed for pre-existing Bitcoin in a given block are a benefit of this process, an ancillary service. Actually a block with zero transactions is technically possible.
Over decades, as the block reward subsidy drops with each halving, the network economics will gradually transition to be centered around the transaction service fees rather than the Bitcoin product creation. Bitcoin’s energy usage may peak later in this decade or in the 2030s for that reason. But note that Reusable POW continues until 2140, when the last (exceptionally) tiny fraction of Bitcoin’s 21 million supply will be issued. After that date it will be a POW network for putting transactions onto the distributed ledger, and the reusability will continue for all Bitcoin tokens and fractions thereof.
Bitcoin also possesses the circular economy attribute of longer use since it can be used quasi-eternally. It is dematerialized money, encapsulating energy as cryptographically secure information and as a form of stored value.
And Bitcoin possesses the attribute of intensifying use since the number of Bitcoin addresses is growing as more people join the network and because the value of each Bitcoin trends higher in the longer term. Bitcoin itself also is fully dematerialized, it all resides in information in a distributed ledger. Keys to access and move Bitcoin may be stored in hardware or software wallets.
The only real risk to self-custodied Bitcoin reuse is risk of loss, but while unfortunate for one person, this makes other Bitcoin in the network more valuable.
Table 1. Bitcoin compared to gold and fiat for the circular economy attributes of reuse and longer and intensifying use. Gold is highly durable and has been used industrially in a wide variety of ways, but as money its use peaked in the past century. Fiat is used everywhere, but has fully captured all market share for money at this point and any intensifying use happens at higher layers of debt-based finance. Bitcoin has better reuse in principle than the first two, since it can move quickly and in all denominations, and it has quasi-eternal reuse. Bitcoin’s use is intensifying as it is adopted by more individuals, businesses, and financial institutions, and even governments in a few cases. Bitcoin itself is dematerialized, as is fiat for the most part, but it requires physical mining rigs (computers) for its creation, thus the asterisk. This requirement to expend significant physical energy grounds it to the real world and real economy, unlike proof of stake cryptocurrencies that are entirely ethereal.
Lightning second layer lower fees to pennies
The fiat system has multiple layers, bank reserves held at the Fed, cash (in M2, second layer), checking account money (include in M2, but third layer). Bitcoin is also developing layers above the main blockchain.
WIth upper layers, the recycling cost or transaction fees can be very small in particular through Lightning second-layer technology that opens funded (time locked) channels between parties. This allows final settlement at a later date, as is also the case with most fiat transactions.
Fees on the Lightning network are measured in Sats, each one hundred millionth of a Bitcoin, and currently since $1 is about 5000 Sats, 100 Sats or 2 cents is a reasonable fee level. This second layer allows Bitcoin to eventually scale beyond even the Visa network, to support purchase of that proverbial cup of coffee.
Lightning does this today but is in the early stages of adoption. There are about 18,000 active Lightning nodes currently, and they are visualized at: https://1ml.com/visual/network. If you like recycling and reuse, you should love the combination of Bitcoin and Lightning. It has the potential to run circles around Visa.
Fiat system is Circular for insiders
Fiat currency is insufficiently circular. On average, the money stock turns over 1.1 times per year. And on average, that M2 money supply grows at about 6% per year. Monetary velocity has been falling since the Great Financial Crisis in 2007/08 from about 2.0 to close to 1.0. This is due to debt and demographics overhang in the economy, with low interest rates and slow growth on average for most of the period. There was a huge uptick in M2 with the COVID response, and a weak uptick in the velocity after its collapse during the depths of the initial COVID crisis.
Essentially to support the American economy, its fiat currency has to double in supply every 12 years, and the last doubling took only 8 years. Now you may say this is just numbers in ledgers, but inflation has a real impact on the value of people’s salaries and savings. Population growth is under 1% per year, and productivity growth barely over 1%. Inflation of 8% or 9% is disruptive against a backdrop of low population growth, low productivity, and negative real interest rates.
By contrast, in the circular Bitcoin economy, the money supply is currently growing at just 1.7%, thus exhibits better reuse while supporting an annualized monetary velocity of 1.2 as of a recent 24 hour sample. In other words a similar velocity is supported but without the requirement to continually pump up the money stock. And Bitcoin’s supply issuance rate is cut in half each four years, with the Halvings (the next one is expected in May 2024). With the next halving, Bitcoin’s supply inflation will decrease to below 1%. The doubling time for Bitcoin supply going forward is infinite, since some 90%, over 19.15 million Bitcoin out of the maximum 21 million, have already been created.
Bitcoin’s credentials as a circular monetary asset will eventually rest on the cost of transactions in the longer term future. As long as Bitcoin is growing or reasonably stable in value long term, and as long as second layer solutions such as Lightning continue to grow in scale, the outlook is very favorable. As Bitcoin’s market cap continues to increase, volatility should continue to lessen.
Bitcoin is a forcing function for circularizing the finance industry that today is largely overhead and bureaucracy, and is typically engaged in rent-seeking including front-running its customers. The largest US banks have paid almost $200 billion in fines in the past two decades, for nearly 400 separate violations of the law.
“The types of financial crime banks engaged in include money laundering, bribery, massive fraud in the sale of mortgage-backed securities, credit card and checking account abuses, and foreclosure and debt collection violations, the report describes. Also included were breaches of fiduciary duty, antitrust violations, market manipulation, enabling Ponzi schemes, and election law violations.” — Article in news.bitcoin.com in 2020, quoting Better Markets CEO Dennis Kelleher
We have a financialized economy that works best for insiders. The banking industry has the government charter to print money, gaining seigniorage and first touch, extracting fees and capital from customers. It denies credit to the disfavored and rewards insiders with favorable terms. It corrupts governments to gain favorable regulation and receives bailouts while frequently engaging in outright fraud.
Summary
A circular economy should have a circular monetary technology as a foundation. Bitcoin is highly reusable and quasi-eternal since it is based on Hal Finney’s reusability enhancement of proof of work. Bitcoin creates a public highly decentralized ledger that is open to inspection and audit by all. It has an honest process for money creation that enforces unrivaled security and a deterministic money supply policy converging to a finite supply with high divisibility to accommodate growth in use and transactions of all sizes.
ESG critics always get it wrong by ignoring the fact that 99% plus of the energy goes into creating a productive, valuable, eternal asset. Bitcoin’s defenders, who focus on the greener nature of Bitcoin electricity supply are making a correct secondary argument but missing the main point of substantial value creation.
Next time someone complains to you about the energy usage of Bitcoin, ask them a few questions:
What percent of Bitcoin electricity usage and miners’ fees do they think goes to transaction fee committal versus creation of new Bitcoin for each block?
Does money get more valuable when you spend it or save it, when the velocity rises or falls?
When inflation rises and interest rates are low, what to people do with their extra money?
What is Bitcoin’s current supply inflation rate?
What do they think about the banking industry?
References
https://en.wikipedia.org/wiki/Circular_economy — Circular economy article, Wikipedia
https://en.wikipedia.org/wiki/Proof_of_work# — Proof of work article, Wikipedia
https://www.academia.edu/5761579/How_to_Make_a_Mint_The_Cryptography_of_Anonymous_Electronic_Cash — Law, Sabett, Salinas 1997. NSA employees’ essay on electronic cash design concepts
https://bitcoinminingcouncil.com/wp-content/uploads/2022/05/Bitcoin_Letter_to_the_Environmental_Protection_Agency.pdf — Bitcoin Mining Council letter to the EPA (makes the production of value point, but not strongly enough)
https://news.bitcoin.com/200-billion-fines-mega-banks-rack-up-penalties-illegal-activities/ — Article describing Better Markets report on extensive megabank fraud in US