The Breakdown - Bitcoin Mining and the Return of Realpolitik

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.io, Arculus, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Sunday, April 10th, and that means it's time for Long Reads Sunday. Today, we are reading a couple different pieces about Bitcoin mining, but before we get into that, if you are enjoying the break, Breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dig deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.lea slash breakdown pod. Also a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX.

Starting point is 00:00:56 So you guys know if you are frequent listeners that there is a rule that when Nick Carter writes something, we read it. Now, he wrote a piece a couple of weeks ago for CoinDesk that I haven't had a chance to read yet, and I thought I'd do two pieces this week, slightly different takes on Bitcoin mining, and so let's dive in. Nick's piece is called Crypto Mining, the Energy Crisis, and the End of ESG, how a European war made an argument about mining moot. The tedious and enervating debate regarding Bitcoin's purported environmental costs effectively ended last month with little fanfare.

Starting point is 00:01:29 The cause was not the revelation that miners are the most benevolent industrial consumer. is possible, providing a valuable source of flexible load that will accelerate a green energy transition. Nor was it that the Bitcoin mining industry is more transparent, more sustainable, better understood, and more accountable than it ever has been. No, the energy debate became irrelevant because the world reminded us sharply and brusquely that environmentalist fever dreams are completely out of step with reality. Empowered by the European energy serfdom resulting from the Greens gaining power in Germany and elsewhere, Russia invaded Ukraine. Energy prices already elevated, skyrocketed. The new commodity,

Starting point is 00:02:03 crisis is casting the globalized international system into doubt, setting off in every nation for itself stampede. The world was forced to remember that energy sovereignty matters and that the anti-humanist fantasies that the Greens stand directly in opposition to that. Having politically savage the oil and gas sector, the Biden administration has now resorted to obsequiously asking the Iranian, Venezuelan, and Saudi regimes for accommodation. Anything to avoid admitting the U.S. President made a shocking miscalculation and definancializing our own oil and gas sector and canceling the Keystone pipeline on day one in office. But even the myopic Biden administration cannot deny reality. Without energy security, you have no sovereignty, no industry, and ultimately no ability to feed your

Starting point is 00:02:42 people. The lesson will be learned in blood if high energy prices persist. The maniacal focus on ESG or environmental social and governance that has characterized Western policymaking for decades is being necessarily reconsidered. What will replace it is a more pragmatic approach, focused on national security, energy independence in a de-globalizing world, and a more measured and responsible decarbonization. Abandoned other green fantasies of power systems subsisting solely on solar wind and batteries. These ideas have manifestly failed. Spurning nuclear Germany attempted such a transition, and the Germans simply ended up increasing their carbon intensity due to a dependence on load following conventional generation needed to smooth out intermittent renewables,

Starting point is 00:03:22 and becoming completely dependent on Russian gas to boot. These outcomes were completely predictable, yet the anti-humanist greens insisted on touching the stove to determine if it was hot. Now the house is burning down and with it Europe. It is evident the United States must reverse course and pursue energy abundance and independence with a maniacal focus. Undoing the anti-progress neo-Malthusian attitudes that infected the political left will take work, but it is a necessary transition. The U.S. must once again become an energy exporter, unleashing its bountiful reserves of shale, giving our European allies an alternative to Russian gas. The hounding of the oil and gas sector via the politicization of finance must end, and this industry

Starting point is 00:03:59 must be unleashed to push down energy prices. The U.S. should pursue a decarbonized power grid, but one incorporating abundant nuclear and on a timeline that makes sense. Miners can help here. Global Bitcoin mining uses about 15 gigawatts of power today, around 40% of which is U.S.-based. If the predictions of miners are to be believed, at least 30 gigawatts to 40 gigawatts of expansions are planned in the United States over the next two to three years. Many of these installations will be done in direct partnership with energy firms, including the largest renewable asset owners. Adding Bitcoin mining as an offtake dramatically improves the economics of new wind and solar installations. Despite what critics say, these partnerships are genuine, and these models work.

Starting point is 00:04:37 The critics rarely take grid firming into account. The proof is in the pudding, and there will be plenty of pudding made in the coming months and years. In terms of grid scarcity events, it is well documented that miners represent a unique kind of interruptible load. Virtually all miners engage in voluntary or contractual curtailment when demand outpaces supply and power prices surge. With little fanfare, miners habitually curtail their usage, helping smooth out demand peaks. The growth of this demand response or flexible load capacity directly contributes to grid decarbonization, allowing intermittent renewables to penetrate further than they would otherwise. Miners effectively sell insurance to grid operators.

Starting point is 00:05:12 As grids incorporate more variable renewables, they will require more active management, and operators will need to buy more insurance. The template here is Erkot in Texas, already the most renewable electric grid in the U.S. Texans lead the pack when it comes to procuring these ancillary services which miners are uniquely suited to produce. As the U.S. re-onshores manufacturing and heavy energy-intensive industry in a de-globalizing world, a capacious grid will be essential. Clean energy campuses built on stranded energy sites by Bitcoin miners will become a vital

Starting point is 00:05:41 part of our industrial future. Even if Bitcoin disappears, these sites will be repurposed for other industries, from clean hydrogen electrolysis to other forms of location agnostic computing. Recent events also make Bitcoin's utility starkly clear, even as its energy impact rises. In the 1970s, when the U.S. defaulted on its promise to maintain the gold peg, and inflation ran rampant as a consequence, the price of gold soared from $35 an ounce to $675, or a factor of nine in real terms. Counterintuitively, the resource costs associated with gold extraction increased when gold lost

Starting point is 00:06:12 its official status. The more gold was worth, the greater the bounty available to miners. so production increased dramatically, as did the associated energy and ecological costs. Does this mean that gold had or has an ESG problem? Because gold extraction and refinery maintains a considerable emissions footprint, does this make gold an ESG unfriendly asset to hold? And does it require moral justification on the part of holders? Of course not.

Starting point is 00:06:34 No more than any individual relying on any commodity with an instantiated energy cost should feel ashamed of their emissions. Gold is identical in this respect to steel, concrete, nickel, copper, zinc, or any of the other metal that is costly to produce, and produces emissions. Bitcoin, though synthetic, is no different. It is a monetary tool that makes life easier for humans. The externalities of its use should be considered alongside those of every other commodity that makes life worth living on the planet. Just because you can't touch or feel it doesn't make it unreal or an unsound store of value. You can't touch domain names or intellectual property or

Starting point is 00:07:04 most stocks for that matter, but these clearly hold value. Bitcoin is no more or less deserving of moral opprobrium relative to other commodities simply because it is new or intangible. The typical response on the left to this obvious point is that Bitcoin and cryptocurrency is useless, and hence all the resources expended to maintain an issue at a constitute a waste. But with inflation at 10% in the U.S., interest rates sitting at negative 7%, and wholesale monetary repression underway, the usefulness of hard assets is no longer in doubt. Today, investors are forced to appreciate the difference between liability impregnated inside money and liability-free outside money, as Bretton Woods two disintegrates outside money is king. There is no doubt that sensor-resistant global money

Starting point is 00:07:43 offers very tangible usefulness today. The Ukrainian resistance to Russia got a tremendous boost from 50 million in global crypto donations, 12 million of it in Bitcoin form. Thanks to Bitcoin's liquidity profile and market access, the Ukrainian government was able to utilize these donations with immediate effect. Ukraine was also the fourth highest crypto-adopter nation in 2021, according to chain analysis. Undoubtedly, a significant fraction of the millions of refugees fleeing the country will benefit from access to liquid wealth that they can store on their person and cannot be frozen by banks or governments. Everyday Russians, too, now excluded from global finance through financial institutions employing broad-based sanctions now find cryptocurrency as their only lifeline. There is no longer a plausible

Starting point is 00:08:22 case for Bitcoin denialism. The time for that has expired. The empirical reality simply weighs too heavily. Sound, global, apolitical money is an absolute necessity for tens, if not hundreds, of millions of people worldwide in its current form. It requires no change, development, or alteration. Bitcoin works today for anyone who needs it. Most importantly, the dollar system can no longer plausibly claim to offer sound property rights. Formerly unimpeachable, the FX reserves of all nations holding dollar assets are now on notice. Lest anyone think the U.S. will reserve its financial warfare only for rogue states. Recall that it's sanctioned to the UK, its ally, as recently as is 1956. India and China, collectively holding 1.4 trillion of U.S. debt, are staunchly agnostic

Starting point is 00:09:02 on the matter of the Russian conflict. They will look to further divest their U.S. dollar assets, worry of offending an increasingly erratic U.S. regime. Geopolitics is about interest, not morality. Whether or not you think the seizing of Russia's reserves was prudent or warranted, it undermines the integrity of the dollar. It may be that an end to the dollar system was long overdue. If strategists like Luke Gromon are to be believed, ending the post-1971 petrodollary reserve system could restore an American trade surplus and revitalized domestic manufacturing. If that's true, the U.S. will need a vast, responsibly renewable, and high-energy grid to support a modern manufacturing base. So it's time to accept reality, abandon Neo-Malthusian ideas of degrowth

Starting point is 00:09:40 or energy shame and lean into America energy supremacy. Abandoning green dreams and accepting the hard realities of physics are vital first steps. Following that, let's leave these broken ESG ideas, stop the politicization of finance, and unleash the Bitcoin miners. Now, there is a lot to dig into here, and I'm sure that there are many of you out here who are like, well, I'll take that second part, but maybe not the first part, and I'm still not sure about the third part, because Nick is going in here. And I think all I want to add, because I want to just let this be its own content for you to debate and think about yourself, is that I think what we're witnessing in part is a return of real politic in the context of a world which can no longer assume peace. That sounds big, but I think that that's actually what's happening right now.

Starting point is 00:10:28 people are reimagining the assumptions that they had in the context of a unipolar world order. And that means that the weight that they put on environmental or climate goals has to be reconciled against, once again, national security considerations that for lots and lots of years were allowed to be secondary. I don't think you have to come to the same conclusions that Nick does to understand just how big a change that is and how much it's going to shape the conversation in the political discourse going forward. for ways to step up your crypto game, then go with Nexo. For starters, you get free crypto for each

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Starting point is 00:12:19 There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCS, you pay no gas fees. Download the FTCX app today and use referral code breakdown to support the show. Our second piece is by Ben Caslin, the head of research and strategy at AAX, and it's called why Bitcoin mining is a matter of national security. Let's start with a simple fact. Buying and holding Bitcoin the asset is not what gives people power over the Bitcoin network.

Starting point is 00:12:57 Holding Bitcoin simply means being able to benefit from the network's adoption and growth expressed in price appreciation, and it affords users with such features as ownership of a scarce bearer asset that can be transacted quickly, cheaply, and without permission from any intermediaries. However, the security, integrity, and evolution of the network rests with coders, miners, and the thousands of individual nodes who track the blockchain continuously. In other words, rather than holding Bitcoin as shares, when it comes to influence it's about having a stake in the network itself, most importantly, as a miner. The significance of holding power over a global network should be obvious.

Starting point is 00:13:28 Whether it's OPEC, Swift, the Strait of Hormuz, or internet infrastructure, it's clear how well-positioned stakeholders can leverage their measure of control over a network to exert influence. With Bitcoin, however, much of the authority rests in hash power. That's where mining comes in as a matter of national security. National security is a term often used and misused to justify policies of surveillance, military deployments, technologies or other legal implementations.

Starting point is 00:13:52 In its most benign form, national security is a defensive stance aimed at ensuring the safety, stability, and sovereignty of a given jurisdiction, and is a stepping stone towards a more equitable global power distribution and possibly peace. As the Bitcoin network grows from an internet curiosity to a global settlement layer that's open to all,

Starting point is 00:14:08 potentially even sanctions evaders like Russia or North Korea, nation states may come to realize they want a greater say in the direction and overall operations of the network. To this end, having a stake in global hash rate is key. By fostering rather than banning domestic mining industries, nations can ensure that control over the network does not fall into the hands of their enemies. Power on the Bitcoin Network The amount of influence a Bitcoin miner gets as proportional to the amount of computational power or work they put into the network. That's called hash power. It's an overall calculation of computational work. More work means more influence. It should be noted, however, that influence is limited. Miners cannot create extra Bitcoin, steal coins, or change the underlying code. Rather,

Starting point is 00:14:47 influences what guarantees that transactions actually go through and get included on the blockchain. Proof-of-work mining is integral to how the Bitcoin blockchain works. Around the world, miners look for cheap energy sources to run their mining rigs at maximum capacity at the lowest possible cost. The more hashpower miners can muster, the higher the chances they will win a next block. Receiving the reward of 6.25 newly minted Bitcoin, and, crucially, add their version of transnational truth to the global Bitcoin ledger. In this system, roughly every 10 minutes, a new block of records is added to the blockchain. And only when a block has been verified and validated will transactions become permanent. It should be stressed that individual nodes around the world need to accept the new

Starting point is 00:15:23 block, which they will do automatically if all the rules that the Bitcoin protocol have indeed been respected, and no double spending or manipulation has occurred. Meddling with the record is extremely costly. First of all, even with a large stake in global hash rate, probability dictates that this is not guarantee winning each block. Second, if a corrupted block of transactions was indeed to go through and was consequently rejected by the majority of nodes, any reward associated with that block would be annulled. Nonetheless, while Bitcoin's decentralized nature affords it, its status as the most secure network in the world, its security would be severely compromised if, say, a given minor, perhaps acting on behalf of a state actor, were to gain the majority hash rate, i.e. 51%. Technically,

Starting point is 00:16:00 this would open the network up for the potential for censorship of other miners and transactions in similar forms of overreach. But to really see the argument and understand how having a stake in global hash rate supports national security and eventually adds the geopolitical equilibrium, we have to look at the incentives for participation from a number of different angles. Game theory and action. In 2019, the world's largest crypto exchange, Binance, suffered a hack that saw $40 million worth of Bitcoin scuttled from its coffers. The company's CEO, Chang Ping Zhao, or CZ, then publicly floated the idea of, quote, rolling back Bitcoin's blockchain, which would recover the stolen funds back into Binance's custody, and reverse all

Starting point is 00:16:35 transactions on the blockchain that had occurred since the theft. Doing so would require convincing a majority of Bitcoin miners and node operators to follow his plan. Pushback from the Bitcoin community was immediate, and no rollback was attempted. From the onset, consensus was against Binance and the company had to take the loss and fix its internal systems instead. Imagine if geopolitics could be as straightforward. Consensus in the industry isn't always conservative, despite a great degree of emphasis being put on the blockchain's immutability. Changes can be made, as was the case in 2016, after the Ethereum community voted to fork the chain to recover 50 million and stolen ether following the Dow hack. Consensus was that the move was vital for the rehabilitation

Starting point is 00:17:11 of the nascent blockchain, although a sizable portion of the community did reject the intervention. The Ethereum network we know today, which Microsoft, JPMorgan, Amazon, and other corporate giants are reportedly already using, and with a market cap of over $300 billion as a result of that rollback. Technically, it's an offshoot. Its predecessors, the original Ethereum chain where the hack has not been undone, is now known as Ethereum Classic. It is a market cap of a little over $3.5 billion. The same mechanism that helps ensure blockchains are difficult to change is essential when it's time to upgrade the network. Hash power drives both integrity and change and represents a type of influence in being able

Starting point is 00:17:44 to enforce norms and preventing abuses on the network, all of which requires consensus. Currently, the U.S. is home to the most hash power, a position it earned after China forced miners within its borders to shut down. I'd argue it was a mistake for China to drive out its domestic mining industry because the more hash power that resides in a given country, the more influence the state could have in protecting its interests. And let there be no misgivings, Bitcoin is held and still thrives among Chinese investors. Imagine, for argument's sake, the U.S. house zero miners, and instead all hash power resided in Russia. This would not bode well for Bitcoin investors or investors in publicly traded companies exposed to Bitcoin like

Starting point is 00:18:17 micro-strategy and Tesla, in the U.S., given that Russia is both a technologically savvy country and profoundly undemocratic. Similarly, what if none of Bitcoin's hash power resided in Russia but was denominated by the U.S. and its allies. This would discourage Russian elites from storing their wealth in Bitcoin and hamper potential efforts on Russia's part around using Bitcoin for global trade. Granted, not all power resides with miners. Without the agreement by a majority of individual nodes, Bitcoin cannot be easily weaponized or subject to intervention. However, if, say, North Korea were to hack an exchange, as it is allegedly done before, and was intent on using these funds to stage a devastating nuclear attack on the world, it's likely that even the most fanatical

Starting point is 00:18:52 proponents of freedom and financial agency, stalwart bitcoiners, could be persuaded to support and intervention in the blockchain. What's of interest here as well as how individuals are able to participate freely in this global consensus network. We can see a direct link of reasoning and incentive that runs all the way from engaged individual participants spread out across the world to industrial-scale miners that have the potency to become integral to geopolitics. That said, miners residing in a shared jurisdiction does not necessarily share the same values, nor should we assume agreement between miners and the state. But we can foresee the formation of clusters through the establishment of associations, such as the Bitcoin Mining Council,

Starting point is 00:19:26 mining facilities such as in El Salvador, or even certain regulations with which at least public mining companies would have to comply. In the end, consensus is not about homogeneity, but about maintaining a balance of power, one that cuts across countries and viewpoints. Unless an entire population decides to stay away from Bitcoin, each jurisdiction is incentivized to gain a stake in global hash rate, just as domestic miners vie for local hash power. On Russia's end, this might be to mine new Bitcoin for local wealth generations, secure an avenue for trade, and also to protect the asset of its citizens, invested corporations, and in future, potentially, its national reserves.

Starting point is 00:19:58 For the U.S. or the European Union, it is not just about protecting its investors. It's really about retaining regulatory clout. U.S. President Joe Biden's Executive Order of March 9th, calling for a unified approach to U.S. crypto regulation, may impact legacy and find easy implementation at the surface layer of applications around crypto. We saw this recently when Ethereum Wallet Metamask and NFT platform OpenC, both U.S.-based projects, unilaterally blocked Iranian and Venezuelan users from their services.

Starting point is 00:20:22 However, unlike these apps and the majority of cryptocurrencies, Bitcoin has no CEO or home base. It is an open and decentralized network. And so any attempt at regulation or level of protocol around security requires hash power to reside in the concentrated jurisdiction. No hash power, no say. It goes without saying that any jurisdiction exposed to Bitcoin either through its citizens and corporations it resides over as a part of sovereign wealth funds, having a stake in global hash power is vital. Towards geopolitical equilibrium. An important aspect of this argument is to recognize that Bitcoin's share of the global financial system is growing rapidly. It may seem to be more.

Starting point is 00:20:55 marginal today, but global adoption of Bitcoin the asset continues to unfold at a faster pace, even in the growth of the internet witnessed in the late 1990s. We know the reasons individuals and corporations may wish to save in Bitcoin or place their assets on the balance sheet. Over the past two years especially, we've seen more everyday people, billionaires, corporations, hedge funds, and even countries warm up, if not fully embrace Bitcoin. It should become increasingly clear why the next phase of the growth in this network in asset class is likely to induce a race for hash power, in conjunction with the realization by both investors and regulators that participating in the operation of the network itself is the best way to secure public interest in the

Starting point is 00:21:27 long run. Bitcoin does not just offer an investable asset, where holders benefit from its scarce supply and freedom for arbitrary policymaking and money printing. More broadly, it offers a global network for the settlement of an internet-native currency that falls outside of the control of any single entity. It offers an alternative base layer for the development of a more equitable global financial system, which is both borderless and democratic by design. It constitutes the disarmament of finance while still allowing for bottom-line moral imperatives to impact on consensus and execution. As the global community of investors in Bitcoin continues to expand, the significance of having hash power grows daily, as do the risks of not having it. That makes mining Bitcoin a matter of

Starting point is 00:22:03 national security. Now, I will be candid here. I disagree pretty fundamentally with the premise of this. I think that history has shown over and over that power does not, in fact, reside with miners. It relies with community consensus as expressed by nodes. Ultimately, that community decides which Bitcoin to run, and that fact alone makes the potential for any sort of attack or influence on the network an extremely short-lived problem. This was, in fact, one of the oldest fuds. It was the original China fud. The original China fud was not about China banning Bitcoin. It was about China exerting influence on its network of miners to somehow compromise Bitcoin. As time has gone on, this became a less and less realistic problem, and one made completely irrelevant by the decision

Starting point is 00:22:48 of China to ban Bitcoin mining entirely. However, I believe that, it wasn't an existential problem as the way that it was proposed even back then. Why I think it was relevant to share this, however, is that it gets at the same point that I was making before, that we were having new discussions around national security, real politic, the power of nations relative to one another, and of course, Bitcoin has a seat at that table. I think that there are plenty of other reasons why the U.S. should see domestic mining as a matter of national security, including some hinted at a Nix piece around grid balancing, and some hinted to the at here in terms of Bitcoin's potential as a neutral settlement layer for global trade.

Starting point is 00:23:26 There is lots more to explore on these big think topics, but for now, I just want to say thanks again to these two great authors for their pieces. Thanks to my sponsors, nexus.com. Arculus and FTX for supporting the show. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. Hey, breakdown listeners. Come join CoinDesk's Consensus 2020, the festival for the decentralized world this June 9th through the 12th in Austin, Texas. This is the only festival showcasing and celebrating all sides of blockchain, crypto ecosystems, Web 3, and the Metaverse, and is designed for crypto newbies, investors, entrepreneurs, developers, and creators.

Starting point is 00:24:10 Don't miss speakers like Kathy Wood, SBF, CZ, Punk 6529, and Joe Lubin to name just a few. Use code breakdown to get 15% off your pass at coindesk.com slash consensus 2022.

The Breakdown - Bitcoin Mining and the Return of Realpolitik

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