In his latest budget for Fiscal Year 2024, President Biden has proposed a new tax on electricity use from cryptocurrency mining. If the budget becomes law, a 30% tax will be phased in over three years. The proposal aims to address the growing concern about the environmental impact of cryptocurrency mining.
Cryptocurrency mining is the process of verifying transactions on a blockchain network by solving complex mathematical problems using computer hardware. The process requires a significant amount of energy, and the majority of this energy comes from fossil fuels such as coal and natural gas. According to the Cambridge BitcoinBTC Electricity Consumption Index, the annual energy consumption of Bitcoin mining alone is estimated to be around 120 terawatt-hours, which is higher than the electricity consumption of some countries.
A theoretical reason for the tax is to reduce harmful external costs that pollution from this industry imposes on others. However, in practice the effects of the tax may not be so straightforward. Energy use per se is not bad, especially when there are clear benefits associated with it. While crypto markets have had their share of problems, their benefits include faster and cheaper cross-border transactions, increased financial privacy and financial inclusion for those who are unbanked or underbanked.
The proposed tax would also likely favor proof of stake (PoS) models of transaction verification over proof of work (PoW) models. PoW is the method currently used by Bitcoin; as noted, it involves solving complex mathematical problems. PoS, on the other hand, obliges users to stake their own cryptocurrency as collateral to verify transactions. The PoS method requires significantly less energy than the PoW method and is therefore—at least for now—more environmentally friendly.
PoS may be the direction the industry is heading regardless of any policy changes. For example, last year EthereumETH made a major transition to the PoS model from PoW. There has also been a shift toward using more renewable energy sources to power cryptocurrency mining. One 2020 study found that around 39% of the energy consumed by PoW cryptocurrencies is from renewable energy sources, up from 28% reported in a previous study. This percentage is likely to rise as renewables become more affordable in the future.
Additionally, there have been efforts within the cryptocurrency industry to develop more energy-efficient mining hardware. One example is the development of application-specific integrated circuits, which are often used for cryptocurrency mining and require significantly less energy than traditional computer hardware.
None of this is intended to deny the legitimacy of concerns about energy use within the cryptocurrency sector. However, even if a policy response is warranted, the proposed tax on electricity use may not be the best solution. One alternative would be to tax the industry’s greenhouse gas emissions directly. This would not discriminate against all electricity use without exception—including use of electricity generated by renewables—but rather would encourage the industry to find greener sources of energy in addition to incentivizing less energy use.
Finally, given the fledgling nature of the industry, any heavy-handed tax runs a real risk of harming innovation. Promoting PoS over PoW models of verification, as a tax on electricity use is likely to do, may appear to be a good idea if one considers only harms to the environment. This is not the only factor to consider, however. PoW systems have certain advantages, such as increased security and decentralization, which arguably make currencies founded on these platforms more stable and democratic. This explains why not all cryptocurrencies have made the switch.
There are smart ways to encourage the crypto industry to be more green, but a tax on the industry’s electricity usage is probably not one of them. A better approach would be for the government to continue on its current path of incentivizing the development of renewable energy sources while leaving the crypto industry to find its footing.
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