Bitcoin and Thermodynamics

Ludwig Boltzmann, a guy who understood stuff

The first law of thermodynamics, also known as Law of Conservation of Energy, states that energy cannot be created or destroyed in an isolated system. The second law states that the entropy of any isolated system always increases and the third law states that the entropy of a system approaches a constant value as the temperature approaches absolute zero. Now what the heck does this have to do with Bitcoin? Let’s explore!

In the Bitcoin network, participants known as miners compete for new Bitcoins in a lottery with fixed very fixed rules. The more hashing power (computing power) a miner contributes to the network, the higher his chances of winning the block reward, a specific sum of Bitcoin that is halved every four years. The difficulty of this lottery, in other words the miners chance of winning, is re-calibrated every 2016th block so that the average time it takes to find the next block is always roughly ten minutes. What this system produces is absolute scarcity, the number of Bitcoins in existence at any moment is always predictable. The more time that passes, the more predictable this number becomes as the block reward slowly approaches zero. By the time it does (around the year 2140) the individual miner’s block reward oriented incentive to mine will, at least theoretically, have been replaced by an incentive to collect transaction fees from the participants of the network. Even now, fees make up a non trivial part of the miners reward. As the Bitcoin network scales through layer 2 solutions such as the Lightning Network, fees are still very low and are expected to stay low for a long time ahead.

Absolute scarcity is a concept that mankind has never encountered before. Arguably, this makes it the first man-made concept to ever be directly linked to the laws of physics! This sounds far fetched I know, but let me elaborate. Everything anyone does requires a certain amount of energy. The very word doing implies that some type of movement, some type of energy expenditure, needs to occur. The value of an action a human can take is an entirely subjective thing. Actions have different value to different people. Even the most basic of actions such as breathing, encapsulate the whole value spectrum. Another breath is worth more than anything on the planet to a desperate person trapped under ice while worth nothing to a person with a death wish in clean forest air on a sunny summer day. How we value different things is also inevitably linked to the supply of that thing. Had the aforementioned winter diver been equipped with a scuba tank then he probably wouldn’t had thought of his next breath as such a precious thing. The price a person is willing to pay for a good, or the sum of one or more other person’s actions, can be derived from two basic variables — the highly subjective demand for the good and the always constrained by time and space supply of that same good. Note that there only needs to be some demand for a good in order for its price to increase if its supply is sufficiently limited.

One could argue that no one needs Bitcoin and therefore it had no intrinsic value. One could also argue that there’s no such thing as intrinsic value since demand is always subjective. In any case, there will always be a cost to mine a Bitcoin and the more mining power in the network, the higher that cost. This cost, ensured by the Bitcoin network’s Proof-Of-Work algorithm, is as close to a pure energy cost as human activity gets. Once the mining rig is in place it is energy in, scarce token out. If the cost of production exceeds the current price of the token, the miner can just choose to not sell, thereby limiting the supply of Bitcoins in circulation even more and eventually selling them for other goods whenever he so sees fit. In this sense, Bitcoin is a battery. Not only that, but arguably the best battery ever invented. Storing and moving electrical energy had always been costly and wasteful. We haven’t got many efficient ways to do this. Bitcoin offers a way of converting energy into a small part of a specific number. A mathematical battery, if you will. It is important to remember that it does not convert energy into value directly but rather electricity into digital scarcity. Digital scarcity which then can be programmed to express value.

Energy cannot be created or destroyed in an isolated system as the first law of thermodynamics clearly states. Bitcoin though, can express how much energy that was sacrificed in order to acquire a share of a limited supply. You can of course, also acquire Bitcoins by buying them rather than mining them, but in doing so you also spend energy. You somehow acquired the money you bought the Bitcoin with and that somehow came to be because someone sacrificed time and energy somewhere. Bitcoin lets you express that you see that there’s a connection between value and scarcity by sacrificing effort to be a part of the network.

The excitement of us so called Bitcoin Maximalists is not primarily because of the enormous gains that the maximalist attitude has granted to those of us that hopped onto the freight train early enough have been blessed with. Nor is it because we’re in it for the technology which opponents of the viewpoint often sarcastically accuse us of claiming that it is. Those of us that preach the near divinity of this invention do so primarily because we see the philosophical impacts of absolute scarcity in a commodity. The idea of a functioning solution to the double spending problem in computerized money is too great an achievement of humanity to be ignored. The world changing potential of this invention cannot be understated. Not in the long run. The more you think about it, the more the thought won’t give you any peace of mind. If this experiment works, if it’s real, it will take civilization to the next level. What we don’t know is how long it will take. Right now, debates in the Bitcoin space are about its functionality as a medium of exchange and its potential as a good store of value. We might be missing the point. We cannot possibly know if a type of monetary token for which you’re completely responsible with no third party protection will ever become a preferred medium of exchange for all transactions. Neither can we know if the price of Bitcoin will follow the hype-cycle path that we all want it to follow, so that it can become the store of value that most maximalists already claim that it is. Maybe we’ve been focused on the wrong things all along. Maybe Bitcoin’s greatest strength is in its functionality as a unit of account. After all, this is all that Bitcoin does. If you own 21 Bitcoin, you own one millionth of the world’s first absolutely scarce commodity. This might not make you rich overnight but it just might have something to do with the opportunities that will one day present themselves to your great, great grandchildren. Who knows?

To conclude this little mental excursion, here are some words from the late, great Frank Zappa:

“Time is money, but space is a long, long time”