Google Labels Bitcoin "Unacceptable Content"

Google is apparently not a particularly fond of Bitcoin. When trying to enable Adsense for this blog, they denied the application on account of "Unacceptable site content".

Google appears to think that there is something dishonest or immoral with Bitcoin. Granted that Bitcoin can be used for several illegal, illegitimate or morally questionable activities, but all currency can.

But I wanted to make it clear: this blog is about things I find fascinating at any one time. At the moment, Bitcoin intrigues me. Another day, it will be something else. I'm just a regular nobody writing stuff on a scale between "meh" and "EPIC".

For the record, Mr. Google, I do not advocate, condone or support any illegal, illegitimate or immoral activity - whether it is paid in Bitcoin, US dollars, Japanese Yen, Russian Rubles or monopoly money. And I do not care much for the insinuation.

Bitcoin: Natural Gas Equivalence Price, Coal Equivalence Price and Oil Equivalence Price

The previous post established that the energy to generate a Bitcoin is currently around 19 kWh/BTC. Although it may not be obvious to all, this gives a straight-forward way to calculate possible anchor points for the Bitcoin exchange rates by looking at electricity, natural gas, coal and oil prices - both regionally and globally.


If Bitcoin be considered an energy-dependent product, much like fertilizer, the price should theoretically follow developments in energy markets very closely - just like fertilizer prices.


Note that the following anchor points are estimated using the current difficulty level and energy prices.

Electricity
The current US wholesale market for electricity gives a marignal cost of $0.83/BTC, as shown in our previous post. Residential prices are different from the wholesale market, however, and the current EIA short term market outlook report cites a US residential average of around 12 cents per kWh, giving a marginal cost of roughly $2.30/BTC.

Maybe somebody with more insight can tell me if residential/commercial US consumers easily can gain access to electricity close to wholesale prices?

European wholesale markets are around €60-€70/MWh, giving a marginal cost of around €1.24/BTC. Several places in Europe, it is fairly easy to get access to electricity at wholesale prices (plus a small margin), so a clever miner may have a marginal cost quite close to this.

Natural Gas
Natural gas can be used as a power generation fuel, and anchor points for natural gas could theoretically become anchor points for Bitcoin. So what is the natural gas equivalence price?

Natural gas is also a regional commodity, with large variations throughout the world. Current US prices are around $3.7/MMBtu, which translates into a marginal cost of  $0.53/BTC, assuming 45% power plant efficiency.

European natural gas is around €25/MWh, equivalent to a marginal cost of €1.06/BTC.

Coal
Coal is particularly interesting in this respect, because it is a power generation fuel that is priced globally (more or less). Current coal price (CIF ARA, API#2) is around $117/tonne, which gives a marginal cost of $1.12/BTC.

Oil
Since oil is priced globally, it is interesting to try the same exercise with oil. A current price of $109/bl gives a marginal price of around $3.50/BTC - which is quite high, mostly owing to the inefficiency of burning oil for power generation.

Conclusion
Someone with access to an efficient gas-fired power plant in the US and wholesale gas markets, miners could get a marginal cost of $0.53/BTC. With access to wholesale electricity markets miners could achieve a marginal cost of $0.83USD/BTC or €1.24/BTC. And at current exchange rates, that is a very lucrative proposition. Even at US consumer electricity prices, the value of mining currently appears positive, although much more costly at $2.30/BTC.

The main conclusion, however, is that Bitcoin could in theory follow energy prices. Natural gas, oil and coal often move in parallel - and since Bitcoin can be considered an energy-dependent product, much like fertilizer which tracks developments in energy markets very closely, it should in principle also track energy markets.

As the commodity best reflecting global energy prices, will oil be the commotidy to track for Bitcoin traders?

Bitcoin Price Drivers

The value of a Bitcoin seems hard to peg, with the exchange rate to USD reaching above 30 USD/BTC earlier this year, and dropping to below 3 USD/BTC a few months later.

The main question discussed in this post is: what determines the value of a Bitcoin? And how significant are the different factors? Yes, we are searching for the Bitcoin price drivers, and we intend to analyse Bitcoins relationship to wholesale energy prices.

Around every 10 minutes 50 BTC are mined, which is the collective target rate of the Bitcoin network. That means 7200 BTC are created per day, and at the current rate, that translates to around $20,000 USD/day. And with approximately $100,000 worth of Bitcoins exchanged on the exchanges each day, miners cashing in could account for up to one fifth of the current daily traded volume. This then stands to be a large portion of daily volume, and has the power to be the main price determinant. It should be considered more closely.

Mining also has costs denominated in conventional currencies, and therefore also helps tie the Bitcoin value to conventional currencies. The hardware and energy used for Bitcoin mining must both be purchased with conventional currency. The hardware constitutes a fixed cost, and the energy is the variable cost. Considering that the hardware is a sunk cost for current miners, it will be profitable for them to mine when energy costs are below the value of the resulting Bitcoins, and it will be unprofitable to mine when energy costs are above the value of the resulting Bitcoins.

The behaviour of the miners is therefore determined by the difference between energy cost and Bitcoin value. This is well-known amongst miners. But the aggregate market dynamics it creates is not well investigated, so this is an interesting topic for Bitcoin traders.

Electricity is the commodity consumed by miners, and the wholesale price of electricity is generally determined by a combination of the price of coal, the price of gas, the price of oil/gasoil or the weather. Electricity, energy commodities and weather all have heavily traded futures markets, so discovering a relationship would have great implications for Bitcoins.

So let us try to relate Bitcoin to energy numerically.

Expected payout for a miner is (h*B) / (D * 2^32), where h is the number of hashes computed, B is the number of Bitcoins received per block and D is the difficulty. A block pays out 50 BTC and the difficulty is currently 1468195 - which means a miner would currently have to compute around 1.26*10^14 hashes per Bitcoin. A Radeon HD 6990 is estimated to manage about 1.84*10^6 Hashes per Joule, meaning a 6,8541,843 Joules are spent per Bitcoin mined, or just above 19 kWh.

In an ideal world, the miner would have access to a wholesale electricity market, say the PJM, where a futures contract for Nov 11 is trading a little below $44 USD/MWh. With this price, you would get a marginal cost of generating 1 BTC at 0.836 USD.

That means, for those with access to wholesale, or near-wholesale, electricity prices, mining is worthwhile at this difficulty level. A sophisticated miner could have access to lock in electricity rates on the spot market, and would continuously monitor the spot electricity price, the network difficulty, and the exchange rate between Bitcoin and the local currency.

Although this could very well be a profitable strategy, it would probably be a mistake, with all due respect, to assume that miners are running such a sophisticated setup.

Using the EIA residential sector electricity prices, around 12 cents per kWh for US average throughout 2011, we get an estimated cost of around $2.30 per Bitcoin, which seems much less lucrative, but is still below the current exchange rate.

Electricity prices vary from region to region, so it would be difficult to find a single one that acts as a price driver for Bitcoin - but many energy and power markets move in parallel, and such moves could theoretically influence the Bitcoin exchange rate by influencing the marginal cost of mining.
But Bitcoins are currently traded way above this marginal cost of wholesale mining, which means there is either a limiting factor in play here, or the demand rate for Bitcoins simply exceeds 50 BTC/10 minutes.

We will go more into detail on this in a later post - stay tuned!