Biden should not tax crypto’s electricity use

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 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 justification for the tax is to reduce harmful external costs that pollution from this industry inflicts on others. But in practice, the effects of the tax may not be so simple. Energy use in itself 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 the unbanked or underbanked.

The proposed tax is also likely to favor proof of stake (PoS) models of transaction verification over proof of work (PoW) models. PoW is the method currently used by Bitcoin; as mentioned, it involves solving complex mathematical problems. PoS, on the other hand, obligates 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 political changes. For example, last year EthereumETH made a big transition to the PoS model from PoW. There has also been a shift towards using more renewable energy sources to mine cryptocurrency. A 2020 study found that around 39% of the energy consumed by PoW cryptocurrencies comes from renewable energy sources, up from 28% reported in a previous study. This percentage is likely to rise as renewable energy becomes 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 meant to deny the legitimacy of concerns about energy use within the cryptocurrency sector. But even if a political reaction is justified, the proposed tax on electricity use may not be the best solution. An alternative would be to tax the industry’s greenhouse gas emissions directly. This will not discriminate against all electricity use without exception – including the use of electricity generated by renewable energy – but rather encourage industry to find greener energy sources as well as incentivize less energy use.

Finally, given the nascent nature of the industry, any hefty tax has a real risk of harming innovation. Promoting PoS over PoW models of verification, as a tax on electricity use is likely to do, may seem like a good idea if one only considers damage to the environment. However, this is not the only factor to consider. PoW systems have certain advantages, such as increased security and decentralization, which undoubtedly make currencies based on these platforms more stable and democratic. This explains why not all cryptocurrencies have switched.

There are smart ways to encourage the crypto industry to become greener, but a tax on the industry’s electricity use is probably not one of them. A better approach would be for the government to continue on its current path of stimulating the development of renewable energy sources, while allowing the crypto industry to find its footing.

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