The environmental impact of cryptocurrencies looms large among the many concerns voiced by sceptics. Earlier this year, Agustín Carstens, who runs the influential Bank for International Settlements, called Bitcoin “a combination of a bubble, a Ponzi scheme and an environmental disaster.”
Carstens’ first two indictments have been challenged. Contrary to his assertion, while the true market potential of Bitcoin, Ethereum and other such decentralized networks remains uncertain, by now it is clear to most people that they are more than mere instruments for short-term speculation and the fleecing of unwitting buyers.
That Bitcoin damages the environment without countervailing benefits is, on the other hand, an allegation still widely believed even by many cryptocurrency fans. Sustaining it is the indisputable fact that the electricity now consumed by the Bitcoin network, at 73 TWh per year at last count, rivals the amount consumed by countries like Austria and the Philippines.
Computing power is central to the success of Bitcoin
Bitcoin’s chief innovation is enabling payments without recourse to an intermediary. Before Bitcoin, any attempt to devise an electronic payments network without a middleman suffered from a double-spend problem: There was no easy way for peers to verify that funds promised to them had not also been committed in other transactions. Thus, a central authority was inescapable.
“Satoshi Nakamoto”’s 2008 white paper proposing “a peer-to-peer electronic cash system” changed that. Nakamoto suggested using cryptography and a public ledger to resolve the double-spend problem. Yet, in order to ensure that only truthful transactions were added to the ledger, this decentralized payments system needed to encourage virtuous behavior and make fraud costly.
Bitcoin achieves this by using a proof-of-work consensus algorithm to reach agreement among users about which transactions should go on the ledger. Proof-of-work means that users expend computing power as they validate transactions. The reward from validation are newly minted bitcoins, as well as a transaction fee. Nakamoto writes:
Once the CPU effort has been expended, to make it satisfy the proof-of-work, the block cannot be changed without redoing the work. As later blocks are chained after it, the work to change the block would include redoing all the blocks after it.
Proof-of-work is essentially one-CPU-one-vote. The majority decision is represented by the longest chain, which has the greatest proof-of-work effort invested in it.
Because consensus is required for transactions to go on the ledger, defrauding the system – forcing one user’s false transactions on the public ledger, against other users’ disagreement – would require vast expenditures of computing power. Thus, Bitcoin renders fraud uneconomical.
Electricity powers governance on Bitcoin
Bitcoin and other cryptocurrencies replace payments intermediation with an open network of independent users, called ‘miners’, who compete to validate transactions and whose majority agreement is required for any transaction to be approved.
The value of Bitcoin’s electricity use
Bitcoin total operating costs do not differ much from those of intermediated payment networks such as Mastercard and Visa. Yet these card networks facilitate many more transactions than Bitcoin: Digiconomist reports that Bitcoin uses 550,000 times as much electricity per transaction as Visa.
However, the number of transactions is a poor standard for judging the value exchanged on competing networks. Mastercard and Visa handle large numbers of small-dollar exchanges, whereas the Bitcoin transactions are $16,000 on average. The slow speed of the Bitcoin network and the large fluctuations in average transaction fees make low-value exchanges unattractive. Moreover, unlike card networks, cryptocurrencies are still not generally accepted and therefore used more as a store of value than a medium of exchange.
Long-term prospects for the Bitcoin network
As mentioned above, comparisons between Bitcoin and intermediated payment networks must be conducted with caution, because most transactions on Mastercard, Paypal and Visa are for the exchange of goods and services, whereas much of the dollar value of Bitcoin transactions has to do with speculative investment in the cryptocurrency and the mining of new bitcoins. Only a fraction of Bitcoin payments involve goods and services.
However, that people are eager to get a hold of bitcoins today shows that some firmly believe Bitcoin has the potential to become more widely demanded.
Is Bitcoin’s electricity use socially wasteful?
Behind claims like Carstens’ that Bitcoin is “an environmental disaster” lies the veiled accusation that the cryptocurrency’s electricity use is somehow less legitimate, or socially less valuable, than electricity use by schools, hospitals, households and offices. Is there any truth to this claim?
Economists have known since at least Pigou that the only way to determine wastefulness in resource use is by examining whether an activity has unpriced externalities which might lead agents to over- or underuse the resource. In those instances, these social costs must be incorporated into the price of the resource to motivate efficient production.
