How much energy should a monetary system consume?

I caused quite a debate on twitter over the weekend when sharing the supposed fact that one bitcoin transaction uses the same amount of energy as a US household uses over a month.

The fact didn’t come from me but from MIT, the Massachusetts Institute of Technology, a well respected institution. You can find their paper here, which discusses the pros and cons of proof-of-work (PoW) versus proof-of-stake (PoS). Ethereum has moved to PoS and found their energy usage reduce by 99% immediately. The opening paragraph of the piece gives away the sentiment:

Last year, Ethereum went green. The second-most-popular crypto platform transitioned to proof of stake, an energy-efficient framework for adding new blocks of transactions, NFTs, and other information to the blockchain. When Ethereum completed the upgrade, known as “the Merge,” in September, it reduced its direct energy consumption by 99%. Meanwhile, Bitcoin continues to chug along, consuming as much energy as the entire country of the Philippines. 

I wrote about The Merge when it happened and, personally, am conflicted about PoS vs PoW. Proof-of-Stake requires those who validate blockchain blocks to have a stake in the game, with a minimum 32 ETH (around $55,000). Proof-of-Work is purely ensuring you invest in the compute power to mine a bitcoin which, in itself, is fairly complicated. The difference therefore is compute power versus the depth of your wallet. The former requires power usage and the latter does not. More importantly, a key here is that the former requires a person or company to identify themselves versus the latter, which does not. In other words, a more centralised view versus a decentralised view, and the whole vision of bitcoin was to avoid any centralisation. The first line of Satoshi Nakamato’s paper of 2008 is that bitcoin would be a purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Therefore, why would you want the system to be backed and validated by central authorities who stake their capital to back the network?

Well, the reason may be the amount of compute power required to mine coins. According to Amy Castor at MIT:

A single Bitcoin transaction uses the same amount of energy as a single US household does over the course of nearly a month. 

This is where the controversy sparks, as this is a highly debatable comment as bitcoin transactions don’t use energy. Mining bitcoins does. Even then, what is the actual cost of mining a bitcoin?

Well, the figure that Amy is quoting comes from the Digiconomist, and the Digiconomist's Bitcoin Energy Consumption Index estimates that one bitcoin transaction takes 1,449 kWh to complete, or the equivalent of approximately 50 days of power for the average US household. To put that into money terms, the average cost per kWh in the US is close to 12 cents. That means a bitcoin transaction would generate an energy bill of $173.

And here's the fundamental point: a bitcoin transaction does not cost any energy compared to mining a coin. And, on top of this, mining a coin takes up a lot less energy than running a centralised monetary system with central banks, banks and affiliated institutions involved.

That is why there is a lot of contradictory research. For example, according to the Cambridge Centre for Alternative Finance (CCAF), bitcoin consumes around 110 Terawatt Hours per year — 0.55% of global electricity production, or roughly equivalent to the annual energy draw of countries like Malaysia or Sweden. Another paper from Cambridge University makes this even clearer:

The popular “energy cost per transaction” metric is regularly featured in the media and other academic studies despite having multiple issues ... transaction throughput (i.e. the number of transactions that the system can process) is independent of the network’s electricity consumption.

Another very useful paper comes from the FIM Research Centre for Germany, who note that:

Today’s PoW cryptocurrencies do, indeed, consume an amount of energy which may be regarded as disproportionate when compared to the currencies’ actual utility. However, we also argue that the energy consumption associated with a widespread uptake of PoW cryptocurrencies is not likely to become a major threat to the climate in the future.

So, it’s a lot of energy, but how much energy should a monetary system consume? That’s a really good question which the Harvard Business Review featured in a recent article  by Nic Carter – a partner at Castle Island Ventures, a US venture firm investing in public blockchain startups – who tries to answer it. He concludes:

There are countless factors that can influence Bitcoin’s environmental impact — but underlying all of them is a question that’s much harder to answer with numbers: Is Bitcoin worth it? It’s important to understand that many environmental concerns are exaggerated or based on flawed assumptions or misunderstandings of how the Bitcoin protocol works. That means that when we ask, “Is Bitcoin worth its environmental impact,” the actual negative impact we’re talking about is likely a lot less alarming than you might think.

Equally, a key aspect here is to compare Bitcoin with other assets, not countries, in its energy consumption. This puts things in far more context. Rather than saying Bitcoin uses more energy than Denmark, why not say that Bitcoin uses far less energy than banks?

The research referenced in this tweet comes from  research by ESG analyst and investor Daniel Batten, which finds that around 52.4% of all Bitcoin mining relies on renewable energy for its power needs and the trend is expected to continue growing in the coming years as traditional energy sources become more and more expensive.

In fact, on this note, I really liked Jon Danielsson’s analysis. Jon is an economist teaching at the London School of Economics, and his opinion piece opens with:

Cryptocurrencies are as divisive as ever. Crypto supporters disagree on whether crypto should remain true to its anti-establishment roots or integrate into the mainstream financial system, while the financial authorities are unsure if crypto should be extinguished, ignored or harnessed for good. Regardless of how that plays out, cryptocurrencies are set to leave a fine legacy, having had a considerable and positive impact on the financial system.

In other words, whatever you think about crypto, it’s been good for the financial system and its infrastructure to be shaken and stirred into action to change. That’s why CBDCs are here!

 

Note: this piece is the second of two. Find the first one from last year here.