[For CoinDesk's Tax Week, I wrote about taxing proof-of-work, the mechanism used to secure Bitcoin. I'm still not 100% sure how to design the tax. In my CoinDesk article I suggested a one-time tax on purchases made at regulated exchanges. Another option is a continual tax on holding bitcoin, like a property tax. Give it a read and tell me what you think.]
The Case for Taxing Proof-of-Work
Bitcoin is an energy-intensive protocol designed for serious cypherpunks. Alas, bitcoin has been mobbed by unserious speculators, pushing up its price and blowing up its electricity usage. It’s time to enact a tax on proof-of-work. The tax would drive the tourists away, bring proof-of-work consumption back to a balanced level and make bitcoin cheap again for cypherpunks.
The Bitcoin network provides bitcoin owners with a unique sort of security – proof-of-work. Proof-of-work, or PoW, is a method for securing a network in a decentralized manner. The process, however, is incredibly energy-intensive, requiring thousands of competing processors, or miners, to perform redundant calculations. Other forms of security, say that underlying instruments listed on the Nasdaq stock exchange, rely on cheaper centralized methods.
Think of bitcoin as an M1 Abrams tank. A Nasdaq-listed stock is a zippy little Toyota. Most of the time a cheap Toyota works fine. But there are times and places when an expensive M1 Abrams is needed.
There is a small community of cypherpunks – hobbyists and technologically informed individuals – who like to consume bitcoin's tank-like security. They make PoW-secured transactions and eschew non-PoW-secured transactions. These cypherpunks are well-versed in self-custody. They have a deep understanding of what bitcoin is and can clearly articulate why they prefer PoW-based security.
Then there is the great unwashed.
Most of the people buying bitcoin these days are not cypherpunks. They are casual users. These “tourists” don't particularly want to make peer-to-peer bitcoin payments. They don't care about the Bitcoin network's tank-like level of security. They are quite content to keep their bitcoins lodged at Coinbase or Binance. They couldn't write a lucid paragraph on PoW if their lives depended on it.
What these casual users are after is "number goes up" – they want to get rich. And it's because of this influx of speculators that a tax on proof-of-work could end up being necessary.
We can all agree that it'd be overkill to routinely drive an M1 Abrams tank to shop at the local corner store. The odds of getting held up just for one's butter and eggs just doesn't justify the costly security of an M1 Abrams. A Toyota will do just fine, thank you. The same goes for proof-of-work. For most people, consuming expensive proof-of-work security is akin to using an M1 Abrams to go shopping. It's unnecessary, even frivolous. A cheap Nasdaq penny stock should suffice.
The sheer physical cost of filling up an M1 Abrams with gas is a major impediment to casual tank usage. Alas, this "brake" doesn't operate with proof-of-work. Casual bitcoin users get to enjoy bitcoin’s tank-like security without incurring any out-of-pocket costs.
The reason that casual bitcoiners don't feel the immense expense of bitcoin security is because the mining bill is (mostly) paid for with new bitcoin. Every 10 minutes, 6.25 new bitcoins are created to compensate miners. Issuance of new bitcoins doesn't hurt the price of the bitcoin in tourists’ wallets. The timetable of new bitcoins was built into the price of bitcoin ages ago.
And so the casual bitcoin tourist gets bitcoin's gold-plated security without having to endure any associated costs. It's as if they get to drive an M1 Abrams tank to Walmart, for free. If you could drive an M1 Abrams to Walmart for free, wouldn’t you?
Proof-of-work should never have been more than a neat niche product used by cypherpunks and other associated outsiders. Thanks to an influx of casual buyers, the Bitcoin network now uses a massive 141 terawatt hours per year of electricity, about 0.63% of the world's electricity, according to the Cambridge Centre for Alternative Finance. That’s more electricity than many countries and industries.
Bitcoin’s energy consumption could grow to much larger proportions. Say that casual buyers push the price of bitcoin up to $380,000 in 2023. That's 10 times the current price, a move that bitcoin has done many times before. With bitcoin at $380,000, the total market value of all bitcoin ever mined would be $7.8 trillion, just a little less than the value of all gold ever mined.
As the price of bitcoin rises, the real value of the 6.25 BTC mining reward increases, attracting more miners that burn ever more electricity. With bitcoin's price at $380,000, the Bitcoin network would be consuming a whopping 1,400 terawatt hours or so of electricity, around 6% of the world's electricity (I'm using a simple linear interpolation from today's price and energy consumption.)
That would be a tragic mistake. We shouldn’t be sacrificing 6% of the world's energy to produce tank-like levels of security for speculators who don’t need that security. There are far better uses for scarce energy resources than pure price speculation.
That's where the tax comes in.
Sometime before bitcoin hits $380,000, a tax on bitcoin purchases should be implemented. It would apply at regulated venues like Coinbase and Kraken and on large professional actors, like hedge funds. Casual speculators would finally feel some of the burden of producing bitcoin's security. To avoid the tax, they would likely select other types of volatile instruments, ones with a much lower electricity requirements. They might, for instance, purchase proof-of-stake cryptocurrencies, Nasdaq penny stocks, three times-levered exchange-traded funds or out-of-the-money Tesla options.
The tax would make most people better off than before (or at least just as well-off).
Casual tourists would remove bitcoin from their menu of bets. But there are hundreds of thousands of speculative instruments offering wild price gyrations, and so the tourists are effectively no less well-off than before. They would get Nasdaq levels of security rather than Bitcoin-levels of security, but for casual bettors that's fine.
Cypherpunks are better off. By purchasing their bitcoin on unregulated venues like Bisq, they wouldn’t have to pay the tax. They would also benefit from casual buyers being pushed out of the bitcoin market, and the subsequent decline in the price of bitcoin. When copper or lead falls in price, users of these commodities benefit: They can consume more metal than before. Likewise for bitcoin. A tax-induced plunge in the price of bitcoin would allow cypherpunks to acquire and consume bitcoin-the-commodity at a far cheaper price than before.
Finally, the rest of the world would be better off. Pushing casual bitcoin tourists away from unnecessary consumption of PoW would free up huge amounts of electricity – both renewable and non-renewable – to be consumed by other industrial purposes. It’s win-win-win.
The actual energy expenditure happens in countries where mining happens. The taxes you are proposing are where the onramps and offramps are domiciled. Whom are you taxing for whose actions?
ReplyDeleteThe logistics of being fair in this particular tax are going to be crazy.
It would be a tax on casual consumers of PoW, but the effects of the tax would flow through to countries where mining happens. The tax would nudge casual consumers onto cheaper speculative vehicles. This would reduce bitcoin's price, which would reduce the mining reward, which would convince miners to shut down, which would reduce electricity being devoted to PoW.
DeleteI think its hard to distinguish between the effects of tourists vs hodlers on the price of Bitcoin. Tourists might go to other trinkets if there were a tax, but hodlers would not. Unless you start a new hodl-tax (similar to a wealth tax). But enforcement would get incredibly painful (by design).
DeleteSo, yeah - as a thought experiment, this is interesting.
You know what else is interesting as a thought experiment - Bitcoin as free speech, and how that would go about in a court of law where US 1st amendment like protections exist.
"Unless you start a new hodl-tax (similar to a wealth tax). But enforcement would get incredibly painful (by design)."
DeleteA wealth tax is another option. (Or a combination of a tax on purchases and a wealth tax.) (And it may just be something that gets levied on coins stored at exchanges.)
The tax doesn't have to be perfect. It needs to be capable of deterring enough buyers so that bitcoin can't rise above $100,000 or so.
You're simply trying to impose your values on others. Embrace liberty not authoritarianism.
ReplyDeleteCorrecting for market failure using market-mechanisms like taxes and permit trading systems is a normal function of liberal democracies.
DeleteYou need to define 'market' because I believe most people would disagree with your characterization of taxation being a 'market-mechanism'.
DeleteWhat I'm describing is Economics 101: market failure. I may have made some logical mistakes with my economics, but nothing you've said is refuting it. The counter-arguments I'd be expecting in a good-faith debate is why PoW consumption is not market failure. Or why, even if PoW consumption is a type of market failure, a tax won't fix it. But I'm not getting any of that from you.
DeleteAre you familiar with the idea of market failure?
What market failure? Bitcoin market is doing great- why so salty?
DeleteThe more orthodox ideological crypto enthusiasts would hardly be fans of this proposal, as they seek largely to have the crypto markets function as a force that can usurp the power of the US dollar and enter maximized usage. While they may be not particularly keen on the distorting effects of rampant speculation, they'd be even less amenable to efforts to have the government discriminate against PoW in tax policy. In their view the problem isn't so much that there's largely increased adoption, but that the system is unable to handle the large volume of transactions without the aid of centralized entities like exchanges. There's been various solutions to try and fix this like the Lightning Network, adjustable block sizes, etc, but the core belief is that the goal is increased adoption not less.
ReplyDeleteBesides, the comparison to commodities is *very* obviously faulty. Nobody in Russia is cheering on the ruble suddenly becoming far cheaper to own due to inflation, money =/= copper/iron/oil as its meant to have a stable value so that it may function as a medium of exchange.
Regardless, I don't really understand why you even bother even trying to appeal to this demographic, its a very small slice of the broader public at large and not particularly amenable to regulation to begin with. You might get some curious individuals who like reading economics blogs, but that's a small slice of a sliver of a minority.
"The more orthodox ideological crypto enthusiasts would hardly be fans of this proposal..."
DeleteMy guess is that there's some portion of the orthodox (aka maximalist) bitcoin community who'd get behind this. Bitcoin is entirely usable at a lower price. With Wall Street and all of the speculators driven away (just like Jesus drove away the money lenders), the network would once again be the playground of nerds and hobbyists.
"...the comparison to commodities is *very* obviously faulty. Nobody in Russia is cheering on the ruble suddenly becoming far cheaper to own due to inflation."
I'd suggest that the folks I'm addressing (i.e. a certain group of bitcoin maximalists) treat their bitcoins as more than just rubles. They also treat them as sacred objects, perhaps collectibles. By driving away the speculators, the price of bitcoin falls, and at a lower price their budget allows them to own much more of their sacred object.
"My guess is that there's some portion of the orthodox (aka maximalist) bitcoin community who'd get behind this..."
DeleteThe whole appeal of it that attracted all the nerds and hobbyists in the first place was the prospect of it being a competitor to the traditional banking system. Anyone of an orthodox bent would rather jump ship from bitcoin to other cryptocurrencies instead of cheering this on.
At the end of the day, even if bitcoin transactions are expensive or most people don't really care about the ideology, all the strain that the PoW system puts on the status quo as well as the wild price fluctuations from the speculative mania help destabilize the current status quo. From the very beginnings of Bitcoin in the old days, the project was meant to be a revolutionary movement to topple the old banking order back in 2008, not simply to be a limited domain for niche purposes, ala a "playground of nerds and hobbyists".
"They also treat them as sacred objects, perhaps collectibles."
That's not how orthodox crypto ideologues think at all, NFT quackery is hardly representative of that sentiment. You typically have two different schools of thought amongst those I'd say qualify as orthodox:
-the small block party (PoW crypto as a limited but high value network ala gold with larger volumes of small transactions handled by other off chain operations, akin to a neo-gold reserve system), a notable example being bitcoin
-the big block party (crypto with large volumes of on-chain transactions done without the need for large exchange entities), notable examples being bitcoin cash, monero, and others
The former focuses more on long term appreciation and growth of bitcoin as a reserve asset (HODLers) while the other one considers transaction volume its primary mandate (i.e. tail emission crypto monetary policy or etc). Neither of these groups would appreciate regulatory crackdowns aimed at reducing adoption, money and/or "digital gold" as an asset benefits from network effects in utility.
A PoW cryptocurrency inherently limited in its userbase would be equivalent to trying to use Twitter when 95% of its users were purged from it. Sure the system would be far less capacity constrained, but it'd also be significantly less useful as less people are willing to accept it and operate on the network, reducing utility.
JP why!?!?
ReplyDeleteYour analogy of M1 Abrams and Toyota is asinine. Nasdaq and any equity are custodied with DTCC.
Bitcoin is a bearer asset, the point is you dont know when you’re going to need it. everyone should aspire to enough bitcoin as to prevent them from ruin if being censured.