“Those who project the most kinetic power in the most clever way, earn the right to set the state and chain of custody of limited resources… it happens all the time in nature, animals will grow random power projection mechanisms out of their foreheads to set the chain of custody, they’re called antlers.”
– Jason Lowery, United States Space Force
As we say goodbye to 2021, here is a different topic to tackle for the final Early Look of 2021! I am making a slight pivot this morning to discuss crypto and Bitcoin specifically, two key parts which will be a VERY important in the year to come for Hedgeye.
The genesis for this piece was “Crypto Night in America” televised by CNBC on December 29, 2021. The goal here is to present facts and logic and let investors decide for themselves, versus attempting to steer the debate via misinformed virtue signaling. Buckle up.
I turned the television off within the first two minutes.
Once again there was the tagline that “Bitcoin and other proof-of-work (PoW) systems consume a massive amount of energy and that the ESG funds don’t like that.” So many feelings here. To be explicitly clear, YES, they do consume a lot of energy! So do washing machines and clothes dryers, Christmas lights, the U.S. military, and private jets heading to Davos. Shouldn’t the energy consumption be judged relative to the utility (or lack thereof) that the network provides?
Let’s set aside the fact that the real ESG issue here may be with the methods of energy generation vs. how the energy is used, saving that for another day. We need to have a deeper conversation here than simply “energy use is bad.” Lots of very valuable things in society use energy, so the use and purpose of that energy is critical to evaluating crypto broadly and Bitcoin specifically.
Back to the Crypto Grind…
First and foremost, we need to understand the context around the amount of energy used by the Bitcoin miners. Fortunately, there is actually very good and useful data being produced by the industry. Unfortunately, it is hardly ever cited or used.
The Bitcoin Mining Council (BMC) was formed in early 2021 and began aggregating data from the major players in the industry. Bitcoin mining consumes an estimated ~12bps of the world’s total annual energy production (see figure below), and the industry is focusing on and gradually eating into the 50k TWh of wasted or “stranded” energy being produced but not used.
Estimates are that ~60-65% of the energy consumed by global Bitcoin mining is from renewable or sustainable sources, and efforts are underway industry-wide to increase that penetration. China’s ban of Bitcoin mining will likely be additive to that process given that country’s heavy reliance on coal-generated power.
Now turning to the question of “why does Bitcoin consume so much energy?” Put simply, Bitcoin Application-Specific Integrated Circuit (ASIC) miners use electrical energy to perform computational work and solve cryptographic puzzles, ordering and assembling transactions into the popularized “blockchain.” In doing so the miners perform the “security work” needed to maintain the network and thwart outside attacks such as censoring transactions, re-ordering the blockchain, producing empty blocks, etc., any of which would likely render the network worthless as a way to immutably store value.
In exchange, they are compensated in BTC via transaction fees and newly minted BTC (the block subsidy) until all 21 million coins are mined. At that point, the “security budget” will be paid in transaction fees only. The more miners operating, the more secure the network, the costlier it is to execute an attack, and the less likely an attacker is to succeed. The miners are Bitcoin’s “army.”
Borrowing from MIT National Defense Fellow, Jason Lowery, the miners and the related energy use function as “antlers,” with the biggest rack of antlers the least likely to be challenged. This is akin to establishing military bases around the world or maintaining a large and modern navy – if you project enough kinetic power, your adversaries are less likely to mess with your stuff. For example, China must devote enormous monetary, natural, and human resources to stand up a navy able to challenge the United States’ dominance of the seas.
Similarly, a private or nation state attacker must expend MASSIVE financial resources on computer hardware and electricity usage to execute a “51%” or other attack on Bitcoin. With ~$1 trillion now on the line in the Bitcoin network, and each newly mined ~$50k bitcoin generating over an 80% gross margin given the current cost of production, the “antlers” are becoming ever more important.
That’s the purpose of Bitcoin’s energy consumption. We cannot and should not evaluate the merits and risks of Bitcoin without a base-level understanding of why so much energy is used. Now it’s up to investors to decide for themselves if it’s a worthy cause.
Or tune into the next CNBC pundit parade to entertain you. Your call!
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 10yr Yield 1.50-1.55% (neutral)
UST 2yr Yield 0.62-0.77% (bullish)
SPX 4 (bullish)
NASDAQ 14,944-16,128 (bullish)
RUT 2138-2297 (bullish)
Tech (XLK) 164.90-179.84 (bullish)
Consumer Discretionary (XLY) 191-211 (bullish)
Housing (ITB) 76.10-84.37 (bullish)
REITS (XLRE) 49.28-52.32 (bullish)
VIX 14.87-23.05 (bearish)
USD 95.70-96.71 (bullish)
Here’s to a wonderful 2022 Hedgeye Nation!
Rob Simone, CFA
