Bitcoin, energy and the Texas stars align

By Parker Lewis and Gideon Powell  |  May 1, 2022  |  Unchained Capital

While people outside the energy industry often take the complexity of its downstream benefits for granted, minerals don’t simply emerge from the earth, magically become refined and miraculously get delivered to consumers in varying forms and in countless end markets. It requires work — as well as money to coordinate economic resources and complex energy supply chains. While not well understood, money and energy exist as the first and second-order goods in the production and delivery of all other economic goods.

In that equation, very few appreciate the function of money, and practically everyone on earth has taken it for granted, even more so than energy. Prior to bitcoin, virtually no one woke up and asked, “What is money?” In fact, the hardest thing to understand about bitcoin actually has very little to do with bitcoin. Bitcoin is hard to understand because money is hard to understand. But that is because few people have ever questioned money at a fundamental level — what it is, why it exists, why it is valuable. While these questions are fundamental to a deeper understanding of bitcoin, this article focuses on a higher level: why energy is relevant to bitcoin and why Texas is strategically positioned to be the bitcoin mining capital of the world.

What is bitcoin?

In simple terms, money is a technology that allows humans to better organize their time and resources through trade and the specialization of labor. Bitcoin is designed to be a better form of money, enabling humans to send value across time and space on a permissionless basis, without the need for a financial intermediary. It was announced to the world on Oct. 31, 2008, and launched Jan. 3, 2009. Bitcoin has been operating without any centralized control for over 13 years, and today approximately $750 billion in wealth is stored in the bitcoin network.

The fundamental value in bitcoin derives from the fact that there will only ever be 21 million (18.9 million in circulation today). Each bitcoin can be divided into very small fractions (divisible to eight decimal points), ensuring it can support adoption by billions of people, but in total, there is a finite supply of bitcoin. Said another way, bitcoin is valuable because it has a fixed and known currency supply, which is not controlled by any centralized third parties. As opposed to government currencies whose supply can be easily increased by a central bank, no one can print more bitcoin. There is no CEO of bitcoin. There is no government or company that controls it. Bitcoin’s fixed supply is enforced by pure economic incentives on an entirely decentralized basis, without anyone needing to trust third parties.

While bitcoin may be hard to understand, just ignore for a second that it is bitcoin. Imagine that there existed a form of money that had a finite and fixed supply. No one could create more — not any individual, not any bank, not any government. Would that be valuable relative to other currencies with unpredictable and ever-increasing supply? That is what bitcoin represents. Its true zero-to-one innovation is finite scarcity.

The full explanation for how it happens is a subject for another day, but bitcoin ultimately provides a completely voluntary, opt-in alternative for anyone who values protecting their wealth in a form of money that cannot be debased, inflated or made less scarce. Bitcoin is also global, permissionless and resistant to all forms of censorship, which means anyone in the world can access and benefit from it.

Bitcoin mining and the energy industry

Think about the concept of bitcoin mining as the network’s security function because mining is core to how the currency’s fixed supply of 21 million is enforced. In more technical terms, mining represents computer processing power that is being run for the express purpose of enforcing the rules of the monetary system, and that processing power requires energy. Visualize a data center full of computers running software specialized for bitcoin and being plugged into a power source with the sole purpose of providing security to the bitcoin network.

In return for security, bitcoin miners get paid in bitcoin, and the bitcoin network demands and consumes more energy as adoption increases. In short, a more valuable monetary network demanded by more people as an alternative to government currencies naturally demands more energy for security. That energy ensures that there will only ever be 21 million bitcoin and that only valid bitcoin transactions are processed.

The compensation for energy — security — comes in the form of new bitcoin being issued as well as transaction fees. Once all 21 million bitcoin are issued, transaction fees will continue to be paid to miners as incentive to secure the network. Just as with energy, bitcoin requires work to be produced and transferred. That is not true of the legacy currency system, which relies on trust in a central bank rather than proof-of-work performed by bitcoin miners.

Importantly however, owners of natural resources and power producers do not need to know why bitcoin miners and the bitcoin network demand their energy. It would be similar to a power producer not needing to know exactly why any end demand for power is valued. It costs [x] to extract natural resources + produce power and someone is willing to pay me [y]. To energy producers, bitcoin is very simple in that way. But the nature of bitcoin’s energy demand happens to be distinct from all other end markets, which makes it particularly attractive from a supply side. While all other energy demand supports the manufacturing of some end production or consumption good, bitcoin energy demand secures a monetary network 24 hours a day 7 days a week and represents incremental baseload.

Bitcoin mining is also the most fungible manufacturing operation in the world with the largest operating expense being cost of power. Because of this, bitcoin incentivizes the development of the lowest cost power, period. Work is performed on-site with very little data transmission required, which means demand can be situated in an optimal way based on the energy inputs — namely the location of natural resources and the conversion of those resources to power. Through bitcoin, there now exists a demand for — and an incentive to develop — energy resources with the ability to export those resources to the rest of the world with merely a reliable internet connection rather than a pipeline, shipping lane or transmission line.

Lastly, while bitcoin’s global energy demand represents 24/7 baseload and can be situated optimally based on the location of cheap power, bitcoin miners are not powering a home, an operating business or a manufacturing plant, which have critical and acute needs. Each and every bitcoin miner across the world is securing the bitcoin network at all times. The bitcoin network is the 24/7 source of demand; bitcoin miners are distributed suppliers to one aggregate source of demand, which means individual mines can be turned up and down intermittently depending on whether it may be more profitable to sell power to the grid or whether there exists an economic incentive to help stabilize a grid, all without impacting the overall functioning of the network.

Because of this, bitcoin miners can be responsive to the rest of the market more so than other sources of demand and can help balance the total demand for energy in any one geography, at any point in time. While energy professionals do not need to understand bitcoin, as more do, it will become apparent that bitcoin is far more to them than money. Bitcoin represents the transfer of energy, and it will transform both money and energy.

Bitcoin mining in Texas

The energy industry is better suited than any other technology industry to both understand and capitalize on the benefits of bitcoin because of its complementary capabilities and assets, namely the complexity of energy exploration and development. Bitcoin will ultimately be transformative to the energy industry as a whole, but particularly the power sector, because it represents a fundamentally new and uniquely differentiated end market for demand than has existed before. Permissionless access to the bitcoin network will democratize innovation beyond Texas, but the stars today are without doubt aligned in the Lone Star State.

Texas in particular is emerging as the epicenter of bitcoin mining for very logical and strategic reasons. To provide some context, the bitcoin network consumes approximately 18 gigawatts of power today, a figure that has grown 10x in the last four years as bitcoin adoption continues to increase rapidly. The market is real, it’s expanding quickly and the economic impact is significant. While historically a large percentage of mining was produced out of China, recently the Chinese Communist Party unsurprisingly took measures to curtail an industry that secures a form of money outside its control. Free markets were going to out-innovate in the end, but this move accelerated a shift that was always destined to happen.

Find the cheapest power, produce it at scale and be able to deliver it to market with the greatest reliability and certainty. That is the game. The inputs are natural resources, technology, human capital, regulatory certainty and the greatest incentives to innovate. Texas has everything and in a way that is practically impossible to replicate. Bitcoin mining will certainly expand and fuel innovation all over the world, but the macro factors at play in Texas are driving the global shift to the Lone Star State being the bitcoin mining capital of the world.

8 Reasons Texas is King

Driver Texas Energy Dynamic Bitcoin Relevance
1. Quantity of natural resources God blessed Texas with copious amounts of natural resources. The largest energy producer in the U.S., Texas produces 23% of the country’s energy, including 42% of crude oil and 26% of natural gas. (1) Natural resources are the necessary first inputs to cheap energy. The energy resources in Texas allow for power production at scale, which enables bitcoin miners to drive down the principal operating expense — power.
2. Diversity of natural resources Texas has a very diverse set of natural resources that contribute to power generation, including natural gas (45%), wind/solar (29%), coal (18%) and nuclear (8%). (2) The diversity of natural resources allows producers to draw on a variety of intermittent and base supply, which combined contributes to cheaper power sources in aggregate. West Texas is also the one place in the U.S. that is both in the Sun Belt and the Wind Belt, which will allow for greater capture by bitcoin mining as a solution to intermittent supply of renewables and intermittent demand.
3. Private ownership of natural resources Mineral rights in Texas are practically all privately owned, with less than 2% controlled by the federal government. (3) Competition and innovation contribute to the production of cheap power at scale — both important to bitcoin mining. The ability of Texas mineral owners to direct and monetize assets however best serves individual interests will accelerate allocation of resources toward bitcoin mining based on pure economic incentives with minimal federal red tape.
4. Energy grid There are three energy grids in the United States: East, West and Texas. The Energy Reliability Council of Texas operates the Texas energy grid and manages its reliability, mostly free from federal regulation. (4) Texas is the only state with its own grid. Texas has greater control than any other state over its energy grid, allowing it to better manage needs of the grid and to work with bitcoin miners to improve grid stability without the uncertainty of less friendly federal regulators. Greater certainty to bitcoin miners is particularly attractive given the large scale and capital investment of bitcoin mining sites.
5. Deregulated energy market The Texas electricity market is deregulated. While transmission is owned by utilities and regulated by ERCOT, private contracts for power can be negotiated between producers and consumers. A deregulated energy market allows private contracts that can be tailored to the nature of bitcoin mining power demand, while also enabling economic incentives tied to demand response to help stabilize the grid.
6. Regulatory environment The rule of law in the United States combined with Texas being a state that is friendly to the development of natural resources and power production incentivizes private energy investments in Texas. The governor and ERCOT are both openly friendly to bitcoin mining. (5) With recent bans in China and unfriendly actions from states like New York, regulatory certainty comes into play at many levels. Certainty over long time horizons influences decisions today as bitcoin mining farms are looking to allocate tens of billions of dollars in capital over the next several years.
 7. Human capital Texas is home to the energy capital of the world — Houston — and has an incredibly high concentration of expertise across all segments of the energy industry. Human capital is the foundation of all energy innovation, and Texas has it in droves. Human capital specific to energy is critical to bitcoin mining, whether producing power on-site, manufacturing facilities or procuring power from a grid. Bitcoin requires a diverse set of human capital knowledgeable in energy and energy supply chains to select sites, drive innovation and reduce cost.
8. Culture of citizenry and state Energy is core to the Texas economy, and the state has taken proactive measures to protect the energy industry. (6) Texas has strong property rights, values freedom as well as independence and fosters an entrepreneurial spirit that drives innovation around energy. Bitcoin mining is very similar to wildcatting for oil. It takes a certain breed of innovator and risk-taker. Bitcoin needs an energy-minded culture and entrepreneurs properly incentivized and equipped to innovate. Texas has both.

In summary, the forces driving bitcoin mining to Texas are many and compounding in nature. Many of those individual factors are difficult, if not impossible, to replicate, but in aggregate, no other jurisdiction can compete at scale due to a combination of factors related to Texas’ geography, strategic assets, regulatory certainty and deeply rooted culture formed over generations.

Bitcoin provides an economic incentive to monetize and develop otherwise uneconomic or underutilized resources. The competition will be fierce, and the network is permissionless. There is a land grab of sorts underway, and while Texas has a strategic advantage, the energy renaissance will be broad-based. People all over the world now have an incentive to develop natural resources with the ability to functionally export those resources — through power — to the rest of the world over a communication channel. That has profound implications for the entire energy industry.

Bitcoin might seem confusing or niche from the periphery, but for those who see the forest through the trees, it is about money and energy. Recall that all fundamental value in bitcoin derives from the fact that there will only ever be 21 million. Finite scarcity translates to the hardest form of money the world has ever known, but that scarcity is only achieved through — and secured by — real-world energy. Bitcoin and the energy industry are rapidly converging for that reason, and the shift will only accelerate as a function of time.

ENDNOTES:
1. eia.gov/state/print.php?sid=TX
2. eia.gov/state/print.php?sid=TX
3. taxfoundation.org/federal-mineral-royalty-disbursements-states-and-effects-sequestration
4. texastribune.org/2011/02/08/texplainer-why-does-texas-have-its-own-power-grid
5. bloomberg.com/news/articles/2022-01-27/texas-governor-eyes-bitcoin-mining-to-fortify-the-electric-grid
6. texastribune.org/2021/05/03/texas-house-fossil-fuel-oil-divest



Sign up to get notified for future blog articles.