Implications of the Narratives about Bitcoin`s Energy Consumption and China`s Mining Ban
Even though the topic of Bitcoin’s high energy consumption has been discussed for years, it came into the spotlight again after Tesla’s retreat from accepting it as a means of payment. While it is true that the process of Bitcoin mining is consuming a lot of energy (approximately 0.14% of the global electricity usage), there are many misconceptions about it. It is important to put things in perspective, especially in the context of China`s mining ban, announced shortly after the Tesla news.
In some sense, the question whether Bitcoin uses “a lot” of energy or not is quite subjective. A lot of criticism comes from those who believe that Bitcoin is purely a speculative bubble. Those who see Bitcoin as the next evolution of sound money are more likely to see the energy consumption as justified.
It is also interesting to compare the energy consumption of the Bitcoin network to other store of value alternatives, such as gold. While mining $1 worth of gold costs $0.52 at current prices, mining $1 worth of bitcoin costs $0.10. A recent study by Galaxy Digital further concluded that Bitcoin mining is using less than half the energy than the baking system and gold mining does.
Why is Bitcoin using so much Energy in the first place?
The source of Bitcoin’s high energy consumption is the consensus mechanism it uses. Consensus mechanisms are at the core of every decentralised blockchain protocol.
Satoshi Nakamoto, Bitcoin’s founder(s), designed the Proof of Work (PoW) consensus mechanism, the first solution that avoided the flaws of previous attempts (such as double spending, or fraudulently altering transactions). In a PoW blockchain, miners who validate transactions compete against each other to mine the next transaction block and therefore receive the block reward of currently 6.25 Bitcoin per block plus the transaction fees. For every new block to be mined there is a random number that miners need to guess to earn the right to validate that block. The more computing power a miner has the higher the chance that they guess the correct number faster and receive the block reward.
With Bitcoin’s increasing adoption and price appreciation, this has led to a race in computing power. While in 2012 one could mine Bitcoin on a laptop and have a good chance to validate the next block, nowadays one needs storage halls full of servers to be competitive. A by-product of this race for increasing computing power is the energy consumption of increasingly powerful mining machines (nowadays almost exclusively ASICs — application specific integrated circuits).
Energy Consumption Vs. Environmental Impact
A lot of the criticism of Bitcoin’s high energy consumption comes from those who claim to be concerned about its environmental impact. These commentators are advocates of renewable energy sources. It is also important to note that not the energy consummation is the most relevant factor but rather the energy sources.
So, it is relevant to point out that various studies already place the portion of wind, solar and geothermal energy sources used to mine Bitcoin between a third and three quarters of the total energy used for Bitcoin mining, and this is set to grow.
Mobility and Flexibility of Bitcoin Mining
An important aspect of the Bitcoin network is the complete flexibility with regard to where miners are located, and the relatively easy mobility of mining operations. This contrasts with precious metals, for example, where mining needs to occur where the gold deposits are located.
Bitcoin miners can operate anywhere as long as there is a stable internet connection. Getting the cheapest electricity has been an important driver for choosing a location. As electricity costs vary over time, and fluctuate seasonally in some places, Bitcoin miners have been used to relocating their operations accordingly, and some miners keep their ASICs in containers so they can be easily moved.
The recent ban on Bitcoin mining in Chinameans that a lot of miners are looking to relocate. As approximately 65% of hash power is estimated to be located China, the dilution of this regional concentration of Bitcoin mining will be beneficial in itself as it increases decentralization of the network.
But more importantly, as the market currently values renewable energy sources, the Chinese ban is helping Bitcoin by compelling miners to relocate. As China still heavily relies on coal for its energy needs, if a significant portion of Bitcoin mining relocates to jurisdictions with a greater focus on renewable energies, especially if miners specifically seek out renewable energy sources — as they appear to be doing — this can quickly shift the perception about Bitcoin’s “environmental impact”.
Alternative Consensus Mechanisms
It is important to note that Bitcoin’s high energy consumption does not mean that cryptocurrencies in general have a problem with high energy requirements. Quite the contrary. The majority of new protocols use the Proof-of-Stake (PoS) consensus mechanism rather than Bitcoin’s Proof of Work.
In PoS protocols, miners validate blocks based on the number of tokens that they stake as opposed to computing power as in PoW. This means that dramatically less energy is needed for validating blocks.
Tezos, for example, (one of the largest PoS blockchains) uses over two million times less energy than Bitcoin. Also, Ethereum the world’s second largest cryptocurrency protocol is currently going through an update to switch from PoW to PoS which will reduce its energy consumption by at least 99.96%.
Cryptocurrencies in general do not have an energy problem. The issue is quite specific to PoW blockchains, and in particular Bitcoin. As cryptocurrencies are very flexible and adaptable, Bitcoin can also go down the path of changing its consensus mechanism. Alternatively, it may turn out that the certain advantages of the PoW mechanism will be seen to outweigh the disadvantages and the market will continue to favor bitcoin in its current form, especially if it adapts to the prevailing renewable energy paradigm.
Bitcoin’s energy consumptions needs to be viewed in the context of the value this new form of money brings which is very subjective. Also, Bitcoin’s energy consumption also compares favorably to other store of value assets such as gold.
In addition, Bitcoin has already adapted to the prevailing narrative favoring renewable energy sources — these already account for approx. half of Bitcoin’s energy consumption, and this is set to grow as Bitcoin mining moves away from China and prices for renewable energy decreases.
Finally, high energy consumption is not an issue for the majority of cryptocurrencies. Most protocols nowadays use the PoS consensus mechanism which has minimal energy requirements or are in the process to change to PoS such as Ethereum.
And the fast pace of innovation in the crypto industry, and the flexible, adaptable nature of these protocols means that today’s problems and obstacles may get resolved tomorrow.
This document is purely for educational purposes and has been issued by Sygnum Group. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a marketing communication. It does not constitute an offer or a recommendation to subscribe, purchase, sell or hold any security or financial instrument. It contains the opinions of Sygnum Group, as at the date of issue. These opinions and the information contained herein do not take into account an individual‘s specific circumstances, objectives, or needs. No representation is made that any investment or strategy is suitable or appropriate to individual circumstances or that any investment or strategy constitutes personalized investment advice to any investor. Therefore, you must verify the above and all other information provided in the document or otherwise review it with your external advisors. Some investment products and services, including custody, may be subject to legal restrictions or may not be available worldwide on an unrestricted basis. The information and analysis contained herein are based on sources considered as reliable. Sygnum Group uses its best efforts to ensure the timeliness, accuracy, and comprehensiveness of the information contained in this document. Nevertheless, all information indicated herein may change without notice.