A new mining tax on crypto?
The White House recently proposed a new mining tax. Their 30 percent tax will be imposed not on the mining of minerals but on the mining of cryptocurrencies. But the so-called DAME Tax seems unlikely to accomplish any of the goals that the administration has laid out to justify it. The intention is to reduce any negative impact from cryptocurrency mining on local electricity prices and global pollution. However, while a tax can reduce crypto-mining in the US, it is far from obvious, from an economics perspective, that the other goals will follow.
Mining taxes can be popular amongst economists. Minerals are a pure gift from the land that no one who has been around for the last 100,000 years was responsible for. While it takes some effort to extract and then ship minerals, some great luck is involved in having the license to mine a particular tract of land. The economic term for the profits that flow from this is called rent. Even if the government imposes a resource rent tax, the land will likely be mined anyway. All that changes is who gets the rent – the miner or the government – which makes the tax less popular amongst miners.
It seems perhaps unfair to compare mineral mining to crypto mining, but the crypto community chose the name for a reason. In Proof of Work blockchains, what legitimizes nodes – which propose and confirm blocks of transactions at any given time – is that they have to demonstrate that they are there to behave well and not obstruct or attack the underlying network. Satoshi Nakamoto went to some considerable effort to outline what might constitute “work” for the Bitcoin blockchain and to design it in such a way that it could scale.
Nakamoto’s notion of work was imposed on everybody who wanted to be a node to help run the network – an entry fee if you will. To get the chance to confirm a block of new transactions, nodes would have to compete to solve a simple computational puzzle. The puzzle was meaningless – no one cared about the answer – but it was integrated neatly into the blockchain itself. To win this computational contest, miners had to find the answer before anyone else. While they couldn’t guarantee that outcome, the more resources – that is, compute – they applied to the problem, the more likely it was that they would win.
And what did miners get for their trouble? Transaction fees paid by users, for starters. But, more significantly, they also received new bitcoins. Just how much they earned changed over time, but when bitcoins started to be worth some real money, the prize for ten minutes of computational effort became significant. They searched and dug (by offering resources and guessing puzzle answers), and then “extracted” (by receiving tokens if they solved it): mining.
Like mineral mining, the total amount of resources (compute) devoted to Bitcoin mining was dictated by the value of the outcome. The more bitcoins were worth, the more intense the computational contest. If blocks were minted too quickly each one would process fewer transactions per reward. Thus, to keep mining to an average of 10 minutes per block confirmation, the difficulty of the computational puzzle would adjust. The more compute added to the contest, the more difficult it became, and vice versa.
Given that the contest to mine bitcoins is open to anyone with a computer worldwide, how did miners make money? After all, the outcome of the broader game was driven by free entry. If there were profits to be had, it would pay someone somewhere to devote a processor and their electricity bill to the contest. They wouldn’t win often, but on average, their winnings would cover their costs. Indeed, Nakamoto outlined in his whitepaper a more democratic process. But economically, expected profits would be low, and not at the more predictable level of diamond mines.
Consequently, the mining business became big, and miners formed pools to provide a more certain stream of income. The miners also became more sophisticated, evolving from a person with a computer in their basement to big data centers with thousands of specialized ASIC processors devoted to crypto mining. The electricity bill from those data centers grew. Electricity companies (and chip makers) weren’t complaining, though – any more than shovel makers did during the Gold Rush.
One result is that, by some estimates, crypto mining was consuming as much electricity as a small country. And for what, skeptics (some might say cynics) asked? To play a computational game? For cryptocurrency that seemed to some like monopoly money or worse, casino chips? What did the rest of society get from this other than higher electricity bills and increased pollution locally and potentially globally? For the past decade or more, the crypto community – at least those focused on Proof of Work – hasn’t really had a good answer to that question.
Yet, despite this, if you were to ask an economist, they would be hard-pressed to condemn crypto mining-based electricity consumption relative to any other electricity consumption. Yes, crypto mining might look like a waste of resources – and if there is one thing economists don’t like, it is wasted resources. Many critiqued Bitcoin, for instance, for using the electricity generated by a reasonably sized country like Sweden. But you know who else is using the electricity generated by a reasonably sized country like Sweden? Sweden. And economists don’t particularly seem to mind Sweden. The point being that people are actually paying for the crypto-mining electricity and seemingly of their own free will. Who are we to judge?
Apparently, many governments are happy to judge. Some, like China, have prohibited crypto mining altogether (albeit for reasons beyond environmental concerns). The Biden proposal, called the DAME (Digital Asset Mining Energy) excise tax, stops short of prohibition but would mark up US crypto miners’ electricity bills by a flat 30 percent. The goals are, ostensibly, to lower electricity prices and, although this seems contradictory, to reduce both local and carbon pollution.
The tax is not expected to be a big revenue generator – just a few billion over the next decade – because mining electricity bills aren’t actually that large; and also, crypto mining is globally competitive. Raise costs by that much and, unlike minerals, crypto miners can relocate to anywhere with an internet or satellite connection.
Therein lies the issue. If the goal were to reduce what was regarded as sinful waste (in the same way one might tax tobacco to reduce health problems), it is unlikely to happen at a global level. Crypto mining exists in the U.S. because it is cheaper to mine there than anywhere else on the planet. If the tax causes some of those mines to shut down and others to open elsewhere, there would be more, not less, waste produced.
But it is even worse than that. It is far from obvious how this change will actually reduce global pollution. Reducing local pollution in the U.S. may be possible, but that pollution will follow the miners somewhere else, so this is what we would call a “beggar-my-neighbour” outcome. As the name suggests, it’s kind of selfish. Moreover, the U.S. government’s massive climate policy that passed last year involved billions of dollars of investment in renewables and innovations to make energy production less climate-damaging. (Not to mention that many Proof-of-Work cryptocurrency miners have been locating their efforts in areas where there is latent capacity, or mixing in more renewable energy.)
The DAME tax will cause some of the users of that cleaner energy to go elsewhere. Frankly, it is highly unlikely they will end up in a cleaner place.
Indeed, this seems counter to the moves by some in the proof-of-work crypto industry to try and promote more clean energy. While I am personally skeptical about some of the ways advocates claim this might be done, if mining demand, as a large potential user of electricity in a region, can underwrite new investment in renewable generation, then this is a way that approach to crypto may spur cleaner energy in the long run. Such schemes are being proposed – and the DAME tax may threaten them. If you take a renewable project’s biggest customer and say that 30 percent of the bill must go to the government, much of the cost will likely come off the bottom line of the renewable electricity provider. That is not an investment we would want to deter.
The point here is that the DAME tax targets crypto mining for reasons that would otherwise apply to many electricity users – including those not involved in mining cryptocurrency. Given that mining is globally competitive, it is unlikely to move the needle on the environment and could, in fact, subvert it. A better approach would be to tax miners who rely on non-renewable electricity generation. But that sounds like what it is: a carbon tax. And some in the U.S. government are loath to impose such a measure, even though it would undoubtedly help the environment.
Joshua Gans is a Professor of Strategic Management at the Rotman School of Management, University of Toronto and Chief Economist of its Creative Destruction Lab. His forthcoming book is The Economics of Blockchain Consensus (to be published by Palgrave/Macmillan in July). Joshua Gans is not associated with a16z, nor has he referred to any work or persons at a16z. All views are his.
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