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A Cost of Production Model for Bitcoin

Adam Hayes ()

No 1505, Working Papers from New School for Social Research, Department of Economics

Abstract: As bitcoin becomes more important as a worldwide financial phenomenon, it also becomes important to understand its sources of value formation. There are three ways to obtain bitcoins: buy them outright, accept them in exchange, or else produce them by 'mining'. Mining employs computational effort which requires electrical consumption for operation. The cost of electricity per kWh, the efficiency of mining as measured by watts per unit of mining effort, the market price of bitcoin, and the difficulty of mining all matter in making the decision to produce. Bitcoin production seems to resemble a competitive market, so in theory miners will produce until their marginal costs equal their marginal product. Break-even points are modeled for market price, energy cost, efficiency and difficulty to produce. The cost of production price may represent a theoretical value around which market prices tend to gravitate. As the average efficiency increases over time due to competition driving technological progress – as inefficient capital becomes obsolete it is removed while new capital replaces them – the break-even production cost of bitcoins denominated in dollars will fall. Increased efficiency, although necessary to maintain competitive advantage over other miners could serve to drive the value of bitcoin down, however adjustments in the mining difficulty and the regular halving of the block reward throughout time will tend to counteract a decreasing tendency in cost of production.

Keywords: Bitcoin; cryptocurrencies; asset pricing; cost of production models; valuation models; competitive markets (search for similar items in EconPapers)
JEL-codes: C51 D58 E42 E47 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2015-03
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