It’s All a Game - April 10, 2022

A number of the geniuses who have won a Nobel Prize in Economics for their ideas are not economists by training, or even by temperament. John Rawls for his Veil of Ignorance, Ronald Coase for the Problem with Social Cost, and Daniel Kahneman for the ways humans depart from rationality in their decisions all provided insights that have benefitted economists ever since.

John Nash is one of my favorites. In a short Ph.D. thesis at Princeton that totaled less than 30 pages, Nash defined one of the most important concepts that myriad others use today. The notions of a negative sum game and a race to the bottom were concepts developed by Nash. Of course, he is forever compared to Russell Crowe from the movie “A Beautiful Mind” that described his experiences. 

These notions both describe the fundamental challenge of economics. Why does the economy and society repeatedly do things that frustrates its long run interests, and why, when we know better, we still cut off our nose to spite our face?

The fundamental premise of economics is to expand the economic pie. We search for gains in efficiency that benefits the economy and hence these benefits can be distributed to make us all better off, or some much better off without hurting anyone else. 

Economists are invariably frustrated by the practicalities of the political world that instead caters to subsets of the economy because, well, that’s where the votes are (which is not unlike Willie Sutton’s explanation for why he robbed banks - that’s where the money is). 

Any economist can rattle off myriad ways in which the economy can invest in ways that pay dividends well into the future that well-exceed the costs today. We can show how so many of our policies are inefficient overall even if they may be popular for the chosen few. We recognize how we must get ahead of economic shocks to make a stitch in time to save nine. And if we recognize how to make a better mousetrap, perhaps some entrepreneur will run with the idea, although they often do so in a way that restricts access to those willing to pay enough for the idea, rather than for the common good. 

Many of the lowest hanging fruit items have long since been picked in our free market economy. Some of the more subtle ways to expand the economic pie are nerdy and complicated, and hence need champions in the public sector to assist. That is where the divergent perspectives of economics and politics frustrate our potential. There is a built-in headwind in trying to bring complicated ideas to fruition when political scientists explain they have to be obvious and relevant to a sufficiently large number of people who might then influence their elected officials. It’s tough to explain atmospheric science to the layperson. 

Let’s use an example. A number of you may be enthusiastic supporters of Bitcoin. A few of you are adamantly opposed to it. Many of you don’t understand it and don’t feel it will be useful to you. 

Those who don’t think it will be useful to you probably don’t understand the fuss. You are probably correct. All cryptocurrencies take advantage of an innovation called a blockchain that will be as evolutionary to recording transactions as Lotus 123 was to accountants. But, it won’t be revolutionary. The hype that it will expand the economic pie is just that - hype designed to encourage you to buy Bitcoin. 

But these evolutionary, and not revolutionary innovations are not worth the cost. Bitcoin mining is a relatively low tech (plug-and-play) application of a high-tech concept that converts electricity to new coins. Every ten minutes one of about ten million Bitcoin machines wins the lottery. They make money if they can pay less for electricity than they receive in their share of rewards. The cheaper the electricity, below the barely profitable cost of about ten cents per kilowatt-hour, the greater their profit. If a miner can receive about ten cents on average per kilowatt-hour they purchase for mining, but pay out only six cents at the industrial rate to their electric company, they are profiting about four cents per kilowatt-hour for each kilowatt they can procure. 

Here is why this is a negative sum game. For their five cent profit per kilowatt-hour, we subsidize their cheap power to the tune of eleven cents. Because their electricity demand forces our economy to rely more on short term fossil fuels, we pay an additional seven cents because we become more dependent on fossil fuel power instead of the cheaper-in-the-long-run solar, wind, and nuclear power. We also suffer five cents in environmental damage, and those who own Bitcoin pay another eleven cents as an inflation tax because mining expands the Bitcoin money supply. That’s about thirty-four cents in costs to earn a miner less than five cents of profit. This is a negative sum game. 

If New Yorkers transact with Bitcoin at the same rate companies here mine Bitcoin, the sum of these costs per day from Bitcoin is over nine million dollars to support less than eighteen thousand transactions. That works out to over $500 per transaction. At forty-four cents, I think I will stick to my debit card. 

I don’t want to burst anybody’s balloon, but this is just bad economics. Compounding this bad policy is the Bitcoin mining arms race that causes more miners to pile in to try to get their share of the five cent profit each hour for the kilowatt-hours they procure. Since China shut down this scheme, the United States has quickly become the Bitcoin mining haven, and New York ground zero in the U.S. 

Regulators who are inspired by “Fortune Favors the Brave” Superbowl ads, mammoth crypto exchanges that earn a fee with every transaction, and miner manufacturers that participate in a miner arms race are all complicit with this false economy. Few are pointing out that this technology costs $500 per transaction, or imposes costs on the rest of us more than six times higher than the profits of miners. Indeed, manufacturers keep pumping out cheaper and more powerful machines that do nothing at all to lower the cost of mining and hence only fuel planned obsolescence and wasteful mining.

Nash described to us negative sum games and races-to-the-bottom, which he called the “prisoner’s dilemma.” It's up to adults in the room to use this understanding to protect all of us from some of us. But, boy, those Superbowl commercials are inspiring, aren’t they? We’ve done a lot of stupid things when we got caught up on “only the bold” marketing campaigns. Fortunately, a coalition of unlikely allies, from responsible cryptocurrency exchanges to Greenpeace, have come together to "Change the Code, Not the Climate," to encourage us to sit down and figure out a way to solve these problems that at this point really only apply to Bitcoin in any significant way. We need not through the baby out with the bathwater.