Welcome to our Friday mailbag edition!
Every week, we receive great questions from your fellow readers. And every Friday, I answer as many as I can.
Up first, reader Jeff S. asks a most excellent question…
Why doesn’t the Fed just stop QE?
– Jeff S.
Hi Jeff, thank you.
Technically, the Fed has stopped fabricating new money in return for buying bonds. That means it’s in a holding period, or has stopped the active quantitative easing (QE) process.
That said, the fact that the Fed still has a book of about $8.6 trillion worth of assets means that the QE support for the banks and the market remains in play.
If the Fed were to actually stop QE altogether, and sell off all of its book of bonds, it would cause a massive liquidity crisis.
It would mean the Fed would have to actively sell its bonds to Wall Street.
And Wall Street would either have to come up with the money to buy them… Or more likely, not have the money or want to buy them.
That would cause a major sell-off in the bond markets and a plummeting of the stock market. That means at some level, QE remains in place as a backstop or cushion.
Next, reader Thomas R. makes an observation on a common topic in these pages – the U.S. government’s runaway debt…
Nomi, you’re doing a bang-up job for me and all your readers! I would like to point out that the U.S. Treasury doesn’t pay any interest on their debt. They just issue more bonds to cover their payments.
–Thomas R.
Hi Thomas, thank you for your kind words and comment. That’s a good point during these times.
The U.S. Treasury does issue more new debt per year now than it has to pay in interest. So in that respect, you’re completely correct.
That’s also why the more debt we have, and the higher the interest rates on it, the more debt the U.S. will have to issue just to keep up.
It’s a very scary prospect.
And on another note, Thomas is also skeptical of a common argument against Bitcoin…
Nomi, hope this finds you well. I have an observation concerning Bitcoin mining’s energy use. Actually, it is concerning the total electricity the legacy financial system uses.
I find it nearly impossible to accept the claim that Bitcoin mining uses more electricity than the entire legacy financial system. There has to be literally millions of computers and large computer systems running to keep track of all the money that flows all over the Earth!
One big bank probably uses as much electricity as all Bitcoin miners combined!
– Thomas R.
Thomas, you make some really good observations.
As I mentioned in a recent essay, Bitcoin miners are the “energy buyer of last resort.” In other words, a guaranteed buyer of cheap energy that nobody else wants to buy.
If there is a stranded or inaccessible source of cheap energy that can’t be economically transported – say an isolated source of hydroelectric power – Bitcoin miners will be there to provide a bid.
The legacy financial system doesn’t enjoy this advantage.
It can’t make use of isolated energy sources all over the world like waterfalls, running rivers or creatable dams. It still needs electric grids that are located close enough to residential or industrial areas “to keep track of all the money”.
And you’re right… all this money moving takes millions of computers and extensive computer systems running on massive amounts of energy to happen.
With that in mind, I agree – the legacy financial system is probably much more wasteful than Bitcoin. The jury is still out, but there are some numbers to back that…
Take the Cambridge Bitcoin Electricity Consumption Index (CBECI). It estimates that Bitcoin consumes roughly 122 terawatt-hour (TW/H) per year.
That number drops to 89 TW/H per year if you adjust for the average lifespan of Bitcoin mining machines, as well as the rate at which new modern machines are created. That’s according to a payments specialist from consultancy Value Chain.
His research estimated that the banking sector uses 56 times more energy than that.
He took into account the creation of money, transporting money, physical banking infrastructure, energy consumption, and other factors. And he arrived at a figure of 4,981 TW/H.
Finally, reader Chris L. wants to know more about the math behind Bitcoin…
I have frequently been told that before a Bitcoin miner can submit a new block to the network, they must compete to solve complex mathematical problems. My question is: who sets these mathematical problems?
– Chris L.
Thanks for writing in, Chris. This is a good question.
The mathematical problems you’re talking about are just different flavors of the same single “problem” built into the Bitcoin protocol.
That said, the “complex mathematical problem” analogy used in so many places isn’t quite accurate.
See, Bitcoin mining is more like a lottery that’s based on random trial and error rather than complex math.
And it requires an enormous amount of specialized computer hardware, processing power, and electricity to solve these problems.
Just to be in the game (of solving these problems), you need racks of specialized equipment created solely for the purpose of mining Bitcoin. These are called Application-Specific Integrated Circuits (ASICs).
Depending on their computing power, ASICs can cost anywhere from $500 to over $10,000 apiece.
Plus, Bitcoin miners do consume an enormous amount of energy, and as I pointed out above, need access to a cheap source of electricity to stay profitable.
In other words, miners must incur significant real-world costs to solve these problems. If they aren’t following the protocol, or are otherwise being dishonest, the network will easily detect and reject them.
The dishonest miner would have wasted a significant amount of money on electricity alone, only to receive no rewards.
That’s the genius of Bitcoin’s incentives and security model.
And you always need to have the latest generation of ASICs to stay on top of the mining game.
That’s because of something called Bitcoin’s “Difficulty Adjustment.”
The Bitcoin protocol automatically adjusts the difficulty of the math problems miners must solve so that, on average, it takes about 10 minutes.
Thanks to the Difficulty Adjustment, the more miners – and thus competing power – that are dedicated towards solving these problems, the more difficult they become, and vice versa.
And that’s all for this week’s mailbag. Thanks to everyone who wrote in!
If I didn’t get to your question this week, look out for my response in a future Friday mailbag edition.
I do my best to respond to as many of your questions and comments as I can. Just remember, I can’t give personal investment advice.
And if there are any other topics you’d like me to write about, I’d love to hear from you. You can write me at [email protected].
Happy investing… and have a fantastic weekend!
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins