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Taxing bitcoin: Incentivizing the difficulty adjustment mechanism to reduce electricity usage

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  • Podhorsky, Andrea

Abstract

This paper develops a model of the bitcoin market that views the bitcoin as a tradeable commodity whose supply is managed by the Bitcoin protocol. Miners utilize equipment and electricity to solve complex computational problems and the first miner to solve a problem is rewarded with bitcoins. The protocol adjusts the difficulty of the problem to target a constant growth rate in the supply of bitcoins over time. The model demonstrates that an increase (decrease) in the difficulty works in effect like a government’s placing an ad valorem tax (subsidy) on the price of a commodity. The rents that would have arisen from limiting supply, however, are wasted as electricity costs. It is shown that an actual tax on the price of the bitcoin can be used to displace the electricity costs. Using data from March 2014 to January 2019, it is estimated that the difficulty adjustment mechanism resulted in net welfare losses to the miners and buyers of bitcoins of 373.8 million USD. Average initial tax rates of 35% and 347.5% would have fully displaced the electricity costs and maximized their reduction, respectively.

Suggested Citation

  • Podhorsky, Andrea, 2023. "Taxing bitcoin: Incentivizing the difficulty adjustment mechanism to reduce electricity usage," International Review of Financial Analysis, Elsevier, vol. 86(C).
    • Handle: RePEc:eee:finana:v:86:y:2023:i:c:s1057521923000091
    DOI: 10.1016/j.irfa.2023.102493
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    References listed on IDEAS

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    More about this item

    Keywords

    Bitcoin; Cryptocurrencies; Fintech; Supply management; Difficulty adjustment; Proof of work; Social welfare;
    All these keywords.

    JEL classification:

    • O33 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Technological Change: Choices and Consequences; Diffusion Processes
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General

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