Vast amounts of electricity go into feeding the Bitcoin delusion. Fortunately, it's unlikely that the digital currency will survive long enough to generate the environmental disaster that would arise if it became a major part of the financial system, writes John Quiggin.

The digital currency Bitcoin has been seen by many as a source of threats, as potentially facilitating terrorism, money laundering, and drug dealing; undermining taxation systems; and rendering monetary policy unworkable.

While these threats have raised concerns, it appears that all can be managed with appropriate regulatory and law enforcement strategies.

By contrast, only a handful of insiders (most notably Guy Lane of BitCarbon) have noticed a threat inherent in the very design of the Bitcoin system: that of ever-increasing environmental damage from the electricity used in the 'mining' of Bitcoins.

Even more striking, this same design feature ensures that Bitcoin cannot, in the end, provide a stable store of value.

In essence, the creation of a new Bitcoin requires the performance of a complex calculation that has no value except to show that it has been done. The crucial feature, as is common in cryptography, is that the calculation in question is very difficult to perform, but, once done, is easy to verify.

In the early days of Bitcoin, the computations in question could be performed on ordinary personal computers. Nowadays, however, 'miners' use special purpose machines optimised for the particular algorithms used by Bitcoin. With these machines, the primary cost of the system is the electricity used to run it. That means, of course, that the only way to be profitable as a miner is to have access to the cheapest possible sources of electricity.

Most of the time that means electricity generated by burning cheap coal in old plants, where the capital costs have long been written off. Even in a large grid, with multiple sources of electricity, Bitcoin mining effectively adds to the demand for coal-fired power. Bitcoin computers run continuously, so they constitute a 'baseload' demand, which matches the supply characteristics of coal (and nuclear). More generally, in the process of decarbonising the energy supply system, any increase in electricity demand at the margin may be regarded as slowing the pace at which fossil fuels can be phased out.

The cost of coal-fired electricity can be as low as 5c/kWh for industrial users; mining with electricity costs above 10c/kWh is usually unprofitable. With the coin price currently a little above $US200, optimized systems can break even with electricity requirements of around $150 for each coin. At 5c/kWh, that's three megawatt-hours (MWh) per coin. That corresponds, in turn, to about three tons of carbon dioxide for coal-fired electricity. Even at 10c/kWh, each Bitcoin mined using coal-fired power is associated with 1.5 tons of CO2 emissions.

The average US household uses 10 to 12 000 kWh in electricity each year, about the same as would be required to generate four Bitcoins worth a little under $1,000. But the same average household has about $6,000 in cash on hand and savings accounts, and around $15,000 in credit card balances. Switching even a small part of a typical household's financial transactions to Bitcoins must therefore entail a massive increase in electricity use.

Fortunately, it's unlikely that Bitcoin will survive long enough to generate the environmental disaster that would arise if it became a major part of the financial system. The same design feature that requires the use of so much electricity is the fatal flaw in Bitcoin as a currency.

The creation of a Bitcoin requires costly calculations. But these calculations are of no use to anyone. If they were valuable, then they would be performed for their own sake, with Bitcoins as a free by-product. That would undermine the whole system.

By contrast, all viable currencies are underpinned by the fact that the currency has a use outside its role as a medium of exchange. This is obvious in the case of metallic currencies such as gold and silver coins, and of paper currencies that are convertible into gold. But it is also true of 'fiat' currencies, not convertible into precious metals (the case with the US dollar since 1971).

The external value of fiat money is more subtle than that of a metal coin. It is inherent in the fact that the government issuing the currency is willing to accept it in payment of taxes and other obligations. If the US government ceased to exist, people might choose to go on using US dollars as a medium of exchange for a while. Ultimately, however, all currencies without an external source of value must share the fate of the Confederate dollar and similar former currencies, becoming, at best, collectors' items.

In the end, Bitcoins will attain their true economic value of zero. But as long as Bitcoin, and similar 'crypto-currencies' persist, the mining process will continue to damage the environment by wasting energy to no purpose.

The sooner this collective delusion comes to an end, the better.

Professor John Quiggin is an ARC Laureate Fellow in economics at the University of Queensland.