Greening the Crypto revolution
By Marion Laboure
LONDON – In May 2021, Tesla founder Elon Musk announced that his company would no longer accept Bitcoin, owing to its massive energy consumption and heavy reliance on fossil fuels. Musk had a point. The mining process to validate a single Bitcoin transaction leaves a larger carbon footprint than nearly 1.8 billion Visa transactions, and the evidence suggests that more than 70% of Bitcoin’s global energy consumption is generated from non-renewable sources such as coal. As Bitcoin’s market capitalization grew from $70 billion to over $1 trillion between November 2018 and November 2021, its annual global energy consumption increased fourfold, to more than 200 terawatt-hours (TWh).
Although Bitcoin’s adverse environmental impact was barely mentioned at the United Nations Climate Change Conference (COP26) in Glasgow last November, it remains a key issue for crypto users and policymakers. Regulators are working on new environmental, social, and governance (ESG) frameworks and rules for financial services, including those involving digital assets like cryptocurrencies. European policymakers, for example, will focus on the environmental impact of crypto-assets during the ongoing negotiations over the proposed EU Markets in Crypto-Assets (MiCA) regulation, the aim being to integrate the new rule into the wider regulatory framework for sustainable finance.
In the private sector, however, initiatives to set industry standards and best practices for sustainable crypto activities have been rare. While coalitions like the Crypto Climate Accord aim to decarbonize the industry by using greener blockchain technology, carbon accounting, and carbon offset procurement, such initiatives are the exception that proves the rule.
To date, 197 countries have signed the Paris climate agreement, which aims to limit global temperatures to 2° Celsius – but preferably 1.5°C – above pre-industrial levels, by systematically reducing greenhouse-gas (GHG) emissions. Since the agreement was concluded in late 2015, a growing number of companies across all industries have issued pledges to become carbon-neutral by some future date. And as of March 2021, 64% of sovereign wealth funds had adopted an ESG policy, up from 46% in 2017.
Yet the growth of crypto has already threatened to offset this progress. According to a 2018 study, Bitcoin mining operations alone could generate enough emissions “to push warming above 2°C within less than three decades.”
In September 2021, China banned cryptocurrency mining after discovering that Bitcoin miners were siphoning electricity from state-owned public institutions at a time when the country was already experiencing an energy crisis. As a result of this crackdown, China’s contribution to global Bitcoin mining activity appeared to fall from 75% to zero (officially), though many believe that miners are still operating there and using virtual private networks (VPNs) to hide their locations. According to a November 2021 Chinese state media report, up to 10% of crypto-related businesses that were operating before the ban were still in operation.
Outside of China, official IP network traffic in August 2021 indicates that most global Bitcoin mining (35%) occurs in the United States, whereas Kazakhstan accounts for 18%, followed by Russia (11%) and Canada (10%). But a noticeable increase in mining traffic in these countries after China banned Bitcoin suggests that some share of it still comes from Chinese miners using VPNs.
Cryptocurrencies’ rising market cap indicates that despite government crackdowns like the one in China, people will find a way to mine, trade, and use cryptocurrencies, especially in an unregulated market. The more computing power that miners have at their disposal, the greater the chance they have to validate transactions (by solving an algorithmically generated puzzle) and receive freshly minted cryptocurrency. Thus, when the value of cryptocurrencies goes up, there is an even stronger incentive for miners to invest in more powerful computers that require even more energy consumption.
Bitcoin and many other cryptocurrencies are energy-intensive by design. Bitcoin, like gold, has a finite supply (21 million), and more computing power is required to mine each additional unit. (As of April 2022, more than 19 million Bitcoins had already been mined.)
This escalating energy requirement is a second-order effect of many fully decentralized, peer-to-peer crypto networks. With Bitcoin consuming more than 200 TWh of energy as of December 2021, a single Bitcoin transaction could power the average US household for 61 days. And in addition to the massive carbon footprint left by this energy consumption, the electronic waste generated by Bitcoin’s computational demand is equivalent to throwing away a brand-new iPhone with each transaction.
Meanwhile, Ethereum, the second-largest cryptocurrency by market cap, now consumes approximately 95 TWh of electricity annually. Together, the two cryptocurrencies would rank 15th in terms of global energy consumption – using almost as much energy as the entire population of Mexico.
The Economics of Crypto Mining
Why, exactly, do cryptocurrencies consume so much energy? The basic reason is that many popular cryptocurrencies – including Bitcoin and Ethereum – use a consensus protocol called “proof-of-work” (PoW).
Cryptocurrencies use a digital ledger technology called blockchain to store transaction data. When a new block in the digital ledger is added (mined), the PoW consensus protocol requires all existing blocks in the chain to confirm the transaction information (such as account balances and the order of transactions).
This defining feature of blockchain technology allows cryptocurrencies to function as decentralized, peer-to-peer networks. However, as a blockchain becomes longer, more computing power, and therefore more energy, is required to process new transactions, and it is miners who bear the energy and equipment costs of adding new blocks.
Originally, Bitcoin could be mined using an everyday computer. But now, the computational power requirements have increased to the point where mining a new Bitcoin with a laptop would be tantamount to winning the lottery. Most modern crypto-mining rigs rely on application-specific integrated circuit (ASIC) machines that cost $7,000-$11,000 each – and $15,000-$19,000 over the course of the machine’s lifetime.
These amounts assume a four-year operating life for a machine running nonstop with electricity costs at 5.5 cents per kilowatt-hour. Using ASIC machines, it takes a miner approximately four years to mine a single Bitcoin, so the profitability of a mining operation depends heavily on the price of Bitcoin and electricity costs at a given time.
Two environmental issues are involved in crypto mining: energy consumption and the carbon footprint. According to a University of Cambridge study, most miners (70%) determine which cryptocurrency to mine based on its spot price rather than on the amount of energy required to mine the token.
By contrast, the carbon footprint depends on the type of energy source used to mine the cryptocurrency. The electricity needed to mine Bitcoin, for example, can be generated by fossil fuels or by low-carbon alternatives, such as nuclear, hydropower, wind, and solar. But renewable energy sources (including low-carbon options) currently account for just 39% of the total energy used to mine cryptocurrencies. Most miners (76%) say they use at least some renewable, clean energy sources in their operations; but, owing to a lack of economic incentives, they mostly rely on traditional, carbon-emitting sources.
There are several ways to approach cryptocurrency decarbonization. These include shifting more electricity generation to renewable energy sources, imposing taxes to discourage carbon-fueled crypto mining, switching from PoW to proof-of-stake (PoS) protocols that verify transactions off the blockchain, or pre-mining the tokens.
Historical experience suggests that overhauling industries to rely on greener energy sources usually requires government intermediation. For example, in 1980, the US government introduced a large tax break for natural gas producers and invested $137 million in gas research, which drove down prices. As a result, US consumption of coal-generated electricity declined from 57% of the total in 1985 to 19% in 2020, while consumption of electricity generated by natural gas increased from 12% in 1985 to 40% in 2020. But for countries to meet the Paris agreement’s goal of reducing net GHG emissions to zero by 2050, they would need to cut natural gas consumption and move entirely to renewable energy sources.
Instead of adopting policies that cover all energy consumption, governments could focus on pushing the cryptocurrency industry toward greener alternatives. For example, under the crypto-friendly administration of President Nayib Bukele, Bitcoin miners in El Salvador have started using geothermal energy from volcanoes, which generates 22% of the country’s energy supply.
But El Salvador’s experiment has yet to prove whether geothermal energy is an efficient power source for large-scale crypto mining. In fact, it took the country three months to mine just 0.00599 Bitcoin (valued at about $269 in October 2021) using this energy source. Nonetheless, El Salvador is investing more in geothermal energy to mine Bitcoin, and in November 2021, the government announced plans to create “Bitcoin City,” to be located near, and powered entirely by, the Conchagua volcano.
It is unlikely to work. For comparison, the US has five times as many volcanoes as El Salvador, but geothermal power plants account for less than 1% of total US energy consumption. Because geothermal energy relies on a limited number of springs and volcanoes, it tends not to be as practical or as scalable as solar and wind energy.
Taxes, Credits, and Protocols
According to a Brookings Institution report, a $50 per ton carbon tax that increased by 5% per year would take the US 90% of the way to its emissions-reduction target. But a carbon tax is not a one-size-fits-all solution. Because many energy companies still rely on carbon sources to generate electricity, imposing a carbon tax before those companies are equipped for renewable energy sources would raise costs for producers – costs that would most likely be passed on to consumers.
A carbon tax that hit large energy consumers, such as cryptocurrency miners, would raise the cost of crypto transactions and probably make the blockchain less economical. If policymakers deem that outcome to be undesirable, another option is to require cryptocurrency mining companies to offset their energy usage with tradable carbon credits, which represent the right to emit one metric ton of carbon in exchange for reducing or removing an equal amount of carbon from the atmosphere.
Some crypto companies are already doing this on their own. In November 2021, BitMEX, a cryptocurrency exchange, purchased $100,000 worth of carbon credits to offset its annual carbon footprint (7,110 metric tons).
Replacing PoW with PoS also would help to reduce emissions. PoS turns the transaction-validation process over to cryptocurrency users who already have a certain amount of the cryptocurrency (a stake) and thus have an incentive to ensure that the network functions smoothly. PoS consumes less energy than PoW, but it is less secure, and it centralizes mining power among users who have already mined the most cryptocurrency. Nonetheless, many believe that switching to the more energy-efficient method is necessary for cryptocurrencies to achieve scale and widespread adoption. That is why Ethereum is moving to a PoS system with its closely watched “Merge,” which is expected to be completed this year.
Another technical solution is to handle more Bitcoin transactions off the blockchain on a two-tier layer, following the model of the Lightning Network. As the chart below shows, the Lightning Network uses significantly less energy to process transactions than other payment methods do. This energy reduction is accomplished by requiring only two parties – rather than a majority of all parties on the blockchain – to agree on the veracity of a transaction.
This approach might even use less energy than a traditional payment processing network like Visa, which acts as an intermediary between merchants, consumers, issuing banks, and acquiring banks.
Finally, there is the option of pre-mining, in which all of a cryptocurrency’s tokens are issued at once. Unlike Bitcoin, which is still issuing new coins as they are mined, the cryptocurrency XRP has already pre-mined all its currency and thus requires no more energy for that purpose.
The drawback to pre-mining is that a cryptocurrency’s creators could stockpile tokens for themselves, thereby artificially driving up the cryptocurrency’s value before selling their hoard. By gaming the system, they would generate distrust and cause extreme price volatility – a problem that already plagues cryptocurrencies, owing to their illiquidity. If an unregulated crypto asset is owned and controlled by just a few people, it would be more prone to this type of self-dealing. But since such scams are already prevalent, this risk simply reinforces the case for more regulation and oversight to protect not just consumers and investors but also the planet.
Marion Laboure is a lecturer at Harvard University.