What is the impact of the White House cryptocurrency mining tax on American miners and the environment?

Author: Joshua Gans, Professor, Rotman School of Business, University of Toronto, published on a16zcrypto; Translation: Golden Finance 0xxz

The White House recently proposed a new mining tax. The 30% tax they plan to impose is not on mining but on cryptocurrency mining. However, the proposed "DAME" (Digital Asset Mining Energy) excise tax seems unlikely to achieve any goals laid down by the government to justify it. The purpose of the tax is to reduce the negative impact of cryptocurrency mining on local electricity prices and global pollution. However, while the tax could reduce cryptocurrency mining in the U.S., it is a distant unknown whether other goals will follow from an economic standpoint.

A mining tax is likely to be warmly welcomed by economists. Minerals are a pure gift from the land for which no one has been responsible for the past 100,000 years. While it takes some work to extract and transport minerals, getting a license to mine a piece of land is a stroke of luck. The resulting profit has an economic term called rent. Even if the government imposes a resource rent tax, the land will likely still be exploited. The only difference is who gets the rent – the miners or the government – so the tax is not very popular with miners.

It may not seem fair to compare mining to cryptocurrency mining, but there is a reason why the crypto community has chosen to use the term "mining." In a proof-of-work (PoW) blockchain, what legitimizes nodes (proposing and confirming blocks of transactions at any given time) is that they must prove that they are behaving well and not hindering or attacking the underlying network. Satoshi Nakamoto spent considerable effort outlining the "working" of the Bitcoin blockchain and approaching the blockchain design in a scalable way.

Satoshi’s concept of work was imposed on everyone who wanted to become a node to help run the network — treat it as an entry fee, if you will. To get a chance to confirm a block of new transactions, nodes must compete to solve a simple computational puzzle. The question is meaningless — no one cares about the answer — but it’s neatly baked into the blockchain itself. To win this computational race, miners must find the answer before anyone else. While they can't guarantee success, the more resources -- that is, computation -- they throw at the problem, the more likely they are to win.

What did the miners get for all their hard work? First, get the transaction fee paid by the user. But more importantly, they also get new bitcoins. The profit they make varies over time, but when bitcoins start to have real value, the reward for ten minutes of computational work becomes quite a lot. They search, mine (by providing resources and guessing the answer to the puzzle), and then "extract" (receive tokens if they solve the puzzle)—i.e., mine.

As with mining, the total amount of resources (computation) used for Bitcoin mining is determined by the value of the mining results. The more valuable a bitcoin is, the more competition for computing. If blocks are generated too quickly, fewer transactions can be processed in a single block. Therefore, in order to maintain an average mining time of 10 minutes per block confirmation, the difficulty of the calculation puzzle will be adjusted. The more calculations added to the competition, the more difficult it becomes, and vice versa.

Given that Bitcoin mining competitions are open to anyone with a computer in the world, how do miners make money? After all, games that are more widely popular are driven by free entry. If there is a profit, it will be paid to someone somewhere who puts the processor and electricity bills for the competition. They won't win often, but on average, they're rewarded enough to cover their costs. In fact, Satoshi Nakamoto outlined a more democratic process in his white paper. But from an economic point of view, expected profits will be low and not as predictable as mining diamonds.

As a result, the mining industry has grown larger and miners have formed mining pools to provide a more certain source of income. Miners have also become more professional and sophisticated, growing from a single person in a basement with a single computer to massive data centers with thousands of specialized ASIC processors dedicated to cryptocurrency mining. Of course, the electricity bills of these data centers are also skyrocketing. Power companies (and chipmakers, for that matter) aren't complaining much, though, like shovel makers were during the gold rush.

It is estimated that cryptocurrency mining will eventually consume as much electricity as a small country. What is all this for, the skeptic (or cynic) will ask? To play counting games? To some, cryptocurrencies are like Monopoly money, or worse, like casino chips. What does the rest of society get out of it, other than higher electricity bills and greater local and potentially global pollution? For the past decade or more, the crypto community—at least those focused on proof-of-work—has not had a good answer to this question.

However, despite this, if you ask an economist, they will have a hard time condemning the electricity consumption of cryptocurrency mining relative to other electricity consumption. Yes, cryptocurrency mining may seem like a waste of resources — and if there’s one thing economists don’t like, it’s waste of resources. For example, many have criticized Bitcoin for using the electricity produced by a sizable country like Sweden. But do you know who else is using the electricity produced by a sizable country like Sweden? That is Sweden. Economists don't seem particularly concerned about Sweden. The point is, people are actually paying for the electricity that goes into cryptocurrency mining, and it appears to be voluntary. Who are we to judge?

Clearly, many governments are happy to dictate. Some countries, such as China, have banned cryptocurrency mining altogether (albeit on the grounds of environmental concerns). Biden's proposal, the DAME (Digital Asset Mining Energy) excise tax, while not banning cryptocurrency mining, would raise electricity bills for U.S. cryptocurrency miners by a full 30%. On the face of it, the goal of lowering electricity prices while reducing local pollution and carbon pollution appears to be contradictory.

This tax is not expected to bring in a lot of revenue - just a few billion dollars over the next 10 years - because mining electricity costs are not actually that high; moreover, cryptocurrency mining is globally competitive. Raise the cost that much, and unlike real mining, cryptocurrency miners can migrate to any other place with an internet or satellite connection.

This is where the problem lies. If the goal of this tax is to reduce waste seen as a sin (like tobacco might be taxed to reduce health problems), then this is unlikely to be achieved globally. Cryptocurrency mining exists in the US because it is cheaper to mine in the US than anywhere else on earth. If the tax causes some of these mines to close and others to move elsewhere, the waste will be greater, never less.

But to make matters worse, it is far from obvious how this move will actually reduce global pollution. It may be possible to reduce pollution locally in the US, but the pollution follows the miners to other places, so this is what we call beggar-thy-neighbour results. As the name suggests, this is indeed a bit selfish. Additionally, the massive climate policy passed by the U.S. government last year involved billions of dollars in investments in renewable energy and innovation to mitigate climate damage from energy production. (Not to mention that many proof-of-work cryptocurrency miners have shifted their efforts to areas of potential capacity, or more renewable energy in the mix.)

The DAME tax will cause some users of electricity, a clean energy source, to look elsewhere. Frankly, it's unlikely they'll ever find a "cleaner" place.

In fact, this seems to run counter to the efforts of some in the proof-of-work crypto industry to promote more clean energy. While I'm personally skeptical of some of the implementations claimed by advocates, if mining demand (a region with a large number of potential electricity users) can lead to new investment in renewable energy generation, then in the long run it will Could be a way to push for cleaner energy. Such schemes are being proposed, and the DAME tax could threaten them. If you say to the largest customer of a renewable energy project that 30% of the bill has to go to the government, then most of the cost will probably be borne by the renewable electricity supplier. We do not want to discourage such investments.

The point here is that the DAME tax targets cryptocurrency mining, but the reasons apply to many electricity users*, including those not involved in cryptocurrency mining. Given the globally competitive nature of mining, DAME is unlikely to improve the environment, and may in fact damage it. A better approach would be to tax miners who rely on non-renewable sources of power generation. But it's exactly what it sounds like: a carbon tax. Some in the U.S. government are reluctant to implement such a measure, even though it would undoubtedly help the environment.