A Cost of Production Model for Bitcoin

4 Pages Posted: 21 Mar 2015 Last revised: 10 Jan 2016

Adam Hayes

University of Wisconsin - Madison - Department of Sociology; The New School - Department of Economics

Date Written: March 19, 2015

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

JEL Classification: C51, D58, E42, E47, G12

Suggested Citation

Hayes, Adam, A Cost of Production Model for Bitcoin (March 19, 2015). Available at SSRN: https://ssrn.com/abstract=2580904 or http://dx.doi.org/10.2139/ssrn.2580904

Adam Hayes (Contact Author)

University of Wisconsin - Madison - Department of Sociology ( email )

8128 William H. Sewell Social Sciences Building
1180 Observatory Drive
Madison, WI 53706
United States

The New School - Department of Economics ( email )

Room 1116
6 East 16th Street
New York, NY 10003
United States

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