Crypto Investors Face Jevons Paradox Challenges

Crypto investors can learn a valuable lesson from the Jevons paradox, which posits that increased efficiency in the use of a resource can lead to greater consumption of that resource. This phenomenon has been observed in various industries, from steam engines to modern technology. For instance, as cars became more fuel-efficient, people drove more, and as lightbulbs became more efficient, people installed more of them. This is often referred to as a "rebound effect," where some of the expected savings from efficiency are offset by increased usage.

The digital revolution has brought the Jevons paradox into sharp focus. As computing costs have decreased due to Moore’s law, the use of computers has increased even faster. This has made industries like semiconductors and cloud computing both great businesses and great investments. The current craze for investing in AI is similarly based on the idea that more efficient GPUs will enable a disproportionately large expansion of usage. Microsoft’s Satya Nadella has expressed confidence in this, stating that the Jevons paradox is at play again with the advent of DeepSeek, which has so far seen efficiency gains offset by increased demand.

However, the Jevons paradox does not always result in profitable investments. Investors in airline and telecommunication stocks can attest to this. In both industries, efficiency rose, costs fell, and usage increased disproportionately, but investors still lost money. Airline traffic has increased exponentially since the 1950s, with the real cost of air travel falling by 1.7% per year on average, while air traffic grew by 4.4% per year. Despite these favorable numbers, airline stocks have been notoriously poor investments, with Warren Buffett calling them the "worst sort of business" and a "deathtrap for investors." Similarly, many who predicted the explosion of internet traffic in the 1990s lost money investing in companies that hosted that traffic, such as Level 3 Communications, Global Crossing, and WorldCom.

In the crypto world, the assumption is that more efficient, lower-cost blockspace will lead to an exponential increase in demand for that blockspace. So far, the results have been mixed. Cheaper blockspace has led to an explosion of activity on blockchains like Solana and Ethereum layer-2s like Base, but this has mostly been due to memecoin trading, which is not a sustainable long-term growth story. For a clearer picture of blockspace demand without memecoins, one might look at Ethereum. Early hopes that moving execution off-chain would lead to Ethereum collecting more fees in settlement and data availability than it lost in execution have been disappointed. The cost of transacting on Ethereum has fallen over 90% from its 2021 peak, but the number of transactions remains close to unchanged. Furthermore, the combined fees paid on all Ethereum-aligned layer-2 blockchains do not offset the loss of fees on layer-1 Ethereum, indicating that the ecosystem as a whole does not appear to be an instance of the Jevons paradox.

Despite this, the crypto ecosystem is not necessarily headed for failure. The airline and telecommunication industries have provided significant positive externalities for society, even if shareholders have suffered. This serves as a reminder that while the Jevons paradox can be a powerful force, it does not guarantee profitable investments. Crypto investors should be cautious and consider the broader implications of increased efficiency and usage in the industry.