How would the economy of currency backed by electricity work?

Question

Let us assume that a country on one of the moons of Mars uses this currency called 'Sol Credits'. And 1 Sol Credits is the price of 1 MWh of power. In other words, for every 1MWh of power that your house use, you will pay 1 Sol Credits and this will never change. This power is generated through the use of solar panels, fusion reactors and sterling engines.

In a way, it is similar to how countries used to allow you to exchange your banknotes with actual gold. Except in this system, your 1 Credit can be exchanged with 1 MW of electrical power. This question is not about using electricity as currency, but using electricity to back the currency. Imagine that you can use USD1 to buy 1 gallon of crude oil, but you're not going to, it just means that if you want to, you can.

In everyday lives, you can probably use 1 cent to buy a kilogram of wheat flour. This is assuming that that 100 cents (1 sol credit) is equal to the value of importing or producing 100 kilogram of wheat.

What would happen if the cost of producing power becomes much cheaper or much more expensive after this exchange rate was established? How would the economy react to this cost increase or cost reduction of power production?

EDIT following Raditz request: As the power generator relies on solar panels and sterling engine, the power produced by these generators will fluctuate throughout the year. It will increase if Mars is near the sun and the generators face the sun. Power generation will reduce or become zero if the moon is blocked from receiving photon and heat by the mass of Mars being in between it and the sun. We are assuming that this is not far in the future (around 2030 to 2050) and the use of fusion reactors is not widespread or commonly accepted, working only as backup generator to supplement the batteries previously charged.

Answer 1

So you have a LETS

What you are describing is a LETS: Local Exchange Trade System, where energy — either primary energy, like electricity, or buffered energy _(*) — is among the goods and services being traded, and energy is being used as the price index for everything else.

A local exchange trading system (also local employment and trading system or local energy transfer system; abbreviated LETS) is a locally initiated, democratically organised, not-for-profit community enterprise that provides a community information service and records transactions of members exchanging goods and services by using locally created currency. LETS allow people to negotiate the value of their own hours or service.

So to cut the Gordian Knot: this is a real world thing already.

How would it be affected by energy being harder to produce?

This would make the price index shoot up. Since energy is harder to come by, you have to give more of other goods and services to get the same amount of energy. In brief: it would make all the prices go up.

_{(*) Buffered by for instance using electrolysis to split water into hydrogen and oxygen for fuel cells}

Answer 2

Its really important to delineate here between power (MW) and energy (MWh). You use them interchangeably in your questions but they're very different and have very different implications on how this would work.

Let's look at energy first. If the credits are created (brought into circulation) when energy is converted into electricity, and taken out of circulation when electricity is consumed, then the total amount of liquid money supply you have at any given time is equal to the total MWh of electricity that has been generated but not consumed i.e. the number of MWh is being stored (in batteries or capacitors or whatever) which means your money supply is proportional to your energy storage. This probably isn't what you want because in a well functioning grid most of the electricity is transmitted directly from where it is produced to where it is consumed without ever being stored. It is also bad because the amount of electricity stored on the grid is highly variable (high after a long day of sunshine, low the next morning before sunrise), and that means your money supply will expand and contract daily which will cause inflation and deflation in the prices of other goods on a daily cycle. For example bread would be more expensive in the afternoon when there is lots of credits and less expensive in the early morning when there are not a lot of credits. Generally this kind of price instability is undesirable.

The easiest way to avoid these price instabilities is to aggregate the energy over some time period which gives you a measure of power. So if we say the total amount of credits in circulation is equal to the total MWh of electricity produced in the last year, then the size of our money supply is expressed in MWh/Year which is a measure of power (1 MWh/earth year = ~114 W). Of course on the martian moon you would use the relevant year, but on earth the longest repeating cycle in energy consumption is 1 year. In this system your money supply is proportional to your average energy production capacity, rather than your total stored energy, which is more stable and probably closer to what you want. Rather than credits entering circulation as electricity is generated they would enter circulation as more electrical generation capacity is added, which happens at a much slower and more steady pace which would help with price stability of things that aren't electricity. It should be noted that in real life the total power consumption of the global economy (of all forms of energy, not just electrical) is generally proportional to global GDP

In terms of the detailed implementation probably the easiest would just to have it be a fiat currency like dollars and force the central bank to bring credits in and out of circulation to keep the money supply proportional to the average power consumption over the last rolling year (probably +/- some wiggle room since its hard to control money supply perfectly). This avoids the problems around electricity changing price because it doesn't force the price of a given unit of electrical energy, rather it basically just pegs the money supply to the capacity of the grid, which is probably quite good since the capacity of the grid is likely to be proportional to the GDP of the area served by that grid.

Honestly wouldn't be a bad system IMO since it wouldn't be naturally deflationary like a gold standard and wouldn't suffer out of control inflation like our current untethered central banking system.

Answer 3

This answer is in regards to your question about power generation becoming more/less efficient.

If your power becomes cheaper to produce, the people producing the power will make a lot of money. They will trade as much electricity as possible to get as many Sol Credits as they can. They will use part of this money to invest in more solar panels.

If power becomes harder to create, such as smog development that blocks solar panels, either the people who generate power will go bankrupt and the electricity side of the currency will collapse, or people will have to get less power for the same amount of credits.

I think it is a bit unreasonable to say that people will always get the same amount of power for 1 Sol Credit if the amount of electricity available fluctuates. In your story, you treat electricity as a separate currency that can be traded with Sol Credits. On Earth, we have exchange rates for currencies because their relative values fluctuate with the economy.

Answer 4

I would simply assume that the value of a Sol Credit would be proportional to how much power you have and are generating. I'm not sure how it works right now with the American Dollar backed by Oil but I can dream.

Basically as more power is available, the value of a Sol Credit lowers and less power means the value of a Sol Credit is higher. The reason I say this is because power is a critical component of any developed city. It powers literally everything you have and its going to keep you alive (depending on your atmosphere). So if power is rare, people are willing to trade more things for it and its value goes up and when there is plenty of power, its value drops because people know there is a surplus and traders will want to move power off their grids/storage and generate income, rather than holding it back (well atleast some money savy person will drop their price, and once they do it everyone will).

Another way to look at it would be to compare it to the fallout series and the value of bottlecaps. The value of a bottle cap was decided to be 1, because the people who could generate clean water decided they wanted to. They backed the price using an essential need, so suddenly everyone had to use it because it was required if you wanted to live.

In terms of actual processing, people will always be trying to expand how much power they can generate. A solar panel is basically free power right? But as more and more people generate power, the value of a single Sol Credit or 1MWh drops. This means everything is basically going to cost more and more money. Eventually the value of a single Sol Credit is too low to be profitable unless you have already invested a large sum of money into it and are able to generate and store a considerable amount of volume.

You could kind of see this sort of investment and money generation happen with bitcoin and ethereium. There was an initial investment into equipment by many people when it was profitable. As more and more was generated and more was available, the value dropped because people wanted to move their bitcoins that they mined rather than hold onto it. People undercut other people, people sold all their bitcoins they stored, etc etc and the price comes down. Now if you want to invest into it, you realise you need a lot of capitol to make a profit. The value of bitcoin has dropped so much that you only make returns on initial investments after several months. People who have already invested and have paid off the inital cost still find it profitable. They can increase their farms because their profit covers the setup cost and do so at a steady pace. They make enough to factor into maintenance and large corporations who farm the coin can do this so efficiently that no normal person can keep up. Eventually the value will settle down, with only minor fluctuations due to changes in production, demand, security, etc, etc.

I'm ignoring a large section of the reason crypto increased so fast, but basically if you say 1MWh is worth 1 Sol Credit, the value of a Sol Credit will fluctuate until it reaches a steady state. It will be profitable for big organizations but not small ones or individuals because the startup cost to make a profit would be incredibly high because people would undercut each other to shift the power they are making and get returns. So at the start 1 Sol Credit might be worth 1 piece of bread, but when it settles it could be 100 Sol Credits for 1 piece of bread or 1000 Sol Credits for 1 piece of bread due to it being necessary, a sudden surge as everyone tried, a large drop as competitive pricing drove the value down and then a increase when small players dropped out followed by a steady state where only the big players are left.