Cost/Benefit Analysis of Bitcoin

Building a bridge is costly: It takes labor and machinery and raw materials that have alternative uses. Does it follow that building it is a waste? No. Waste occurs when the cost incurred exceeds the benefit attained. Cost greater than zero does not imply cost greater than benefit. Does it follow that the bridge is worth building? No again. A bridge to nowhere might be built even though it is wasteful, if the few beneficiaries don’t bear the costs themselves. To know whether a particular bridge is worth building we need to compare benefit to cost.

To count benefits and costs, we observe market prices and transaction quantities. None of us has access to a god-like perspective. Consequently, for normal private goods where costs and benefits fall on producers and consumers, economists normally defer to the judgments of the market participants who actually bear the costs about whether the benefits of an activity exceed its costs. Buyers presumably value a good more than the price they pay, or they wouldn’t buy, and producers incur average costs that are less than that price, or they would exit the industry. In the case of Bitcoin, the electricity bills for proof of work are ultimately paid by Bitcoin users, just as costs of production for bread and milk are borne by buyers of bread and milk. Bitcoin users pay directly when they pay blockchain fees, and indirectly when new Bitcoin is awarded to miners, enlarging the stock of Bitcoin and diluting the purchasing power per unit compared to what it would have been with a constant stock.

These are the opening paragraphs of Lawrence H. White, “How to Think Straight about Bitcoin’s Social Costs and Benefits,” Alt-M, March 1, 2022.

Larry does a beautiful job of applying basic tools of Cost/Benefit Analysis to Bitcoin. Almost everything we talk about in teaching Cost/Benefit Analysis is present in his succinct post: the role of market prices, the importance of benefits exceeding costs, irrelevant externalities (pecuniary externalities) versus relevant externalities, and deferring to consumers of goods rather than to government agencies.

I recommend this article as a reading on any syllabus that does Cost/Benefit Analysis because it’s such a beautiful application of the basic tools.