Is Proof-Of-Work, out of work?

Let me state this up front – this article is sure to divide the crypto community. In fact divide might be the wrong word; most of the community won’t agree with it, as the message is counter productive to the Bitcoin holdings most of us hold. But let me at least state my case.

Let’s begin with this chart that I put together using the sources shown at the bottom of the chart:

It shows the total energy usage of different systems measured in terawatt hours. The banking industry for example uses 263 terawatt hours of energy per year.

The Bitcoin network already has almost half of the annual energy consumption of the Gold industry despite that fact the Bitcoin market of ~$600bn is far less than the ~$11tn size of the gold market. Now the immediate retort might be that a greater portion of Bitcoin energy comes from renewable sources which could very well be true and lead us down a rabbit hole of finding stats to support this.

However I would argue it does not matter. Electricity markets are divided up into regions around the world. In the US for example, there is the East and West regions; and then Texas has decided to be a region unto itself.

NERC

In a de-regulated (i.e. non government owned) market, different electricity producers, generate electricity and sell it to the power grid for that region. This video explains how the US electricity market is structured and this video gets in the weeds of how a competitive electricity market functions.

But what you need to knows is this: Electricity is generally a perishable good. If you don’t use it there and then , it will get wasted. Finding ways to efficiently store excess electricity so that it can be used at a different point in time, is something the industry has been grappling with for decades with limited success. It is better to predict demand and ensure you produce just enough electricity to meet this demand.

Inversely, there may be times when there isn’t enough electricity to go round at that moment in time, leading to black outs, such as happened in Texas recently.

So supply and demand is very important in the electricity markets, and this also then results in the price of electricity on the open market fluctuating, leading to all sorts of financial instruments being used to hedge against price risks, and present the end user with a fairly stable electricity cost.

A move to an energy intensive process such as Bitcoin mining. will mean the demand for electricity in a region goes up. This will then mean an increase in the price of electricity for all, regardless of whether it is sourced from a renewable source of not.

Higher prices for electricity have other ramifications. It raises that cost of doing business in a country, making it less economically competitive. It can lead to more blackouts during winter months when demand is high.

Pitching the Bitcoin energy debate in terms of the percentage of electricity coming from renewables is therefore a red-herring, designed to obfuscate what is happening. Rather we should be talking in terms of reducing total energy demand as the primary goal, followed by shifting as much energy production as we can to renewables as a goal within that primary goal.

Getting back to the chart I began this post with. There is a solution already in-place: Proof-Of-Stake.

For the uninitiated cryptocurrencies can run on one of two methods (there are other derivations but these are the main two): Proof-Of-Work, or Proof-Of-Stake.

Proof-Of-Work or POW (such as what Bitcoin and the current version of Ethereum use) incentivize power consumption. To put it bluntly the more electricity you can use up per second to solve the cryptographic puzzles, the richer you can become. As a result the computers used to mine Bitcoin have become more and more specialized, and over time those that cannot keep up with the specialized hardware will drop out of the race leading to a smaller and smaller group of relatively unknown and unregulated Bitcoin miners, operating behind the scene and having the enormous power to influence the markets. This is partly why a lot of people celebrated when China banned bitcoin mining as up till then a lot of Bitcoin miners were operating within its borders with no oversight.

Proof-Of-Stake or POS (such as what Cardano uses, and Ethereum is working on migrating to) incentivizes popularity. Instead of miners, we have what are know as Stake Pool Operators in Cardano, and Validators in Ethereum, and they compete with one another to attract the most delegators (that’s anyone that holds Cardano or Ethereum). The more successful they are in doing this, the more money they can make, and then this money is also shared out with their delegators as a rewards for choosing them.

In the case of Cardano this results in a constant competitive tussle between stake pool operators to try and attract delegators (such as yourself), by offering them a greater share of the profit, or donating to charity, or other contributions to society (my stake pool ROBOT for example donates 10% of our profit to an environmental charity every month).

Now some will argue that POS is newer technology that is yet to demonstrate that it is as secure as Bitcoin in practice, over a long period of time (Cardano POS was only launched in 2020), however IOG, the company behind Cardano have performed peer-reviewed academic research to at least make the claim that Cardano is a provably secure blockchain.

The crypto industry may wish to continue waiting to see how secure Cardano and other POS blockchains are, but it should not be waiting indefinitely for fear of moving away from POW.

Conclusion

Bitcoin holders often tout it as a “pristine” asset, the top-dog of all asset classes. Well I’d argue that in a Bitcoin-centric view of the world, if we let it play out, leads to Bitcoin mining being the pristine use-case for electricity. That you should first and foremost try and use electricity for Bitcoin mining and only use it elsewhere if you really really have to. That to me is the logical conclusion of the electricity arms race that is Bitcoin mining.

Blockchains like Cardano, with their alternative incentive structure built on game theory, are far more energy efficient and far more sustainable. In addition a lot of them tend to offer additional advantages such as speed or smart contracts that I won’t go into in this post.

In essence, Bitcoin was a first generation proof-of-concept, devised by the brilliant and anonymous “Satoshi Nakamoto”. But it is time we laid it, and proof-of-work, to rest and moved onto to more energy-efficient proof-of-stake blockchains.

Update:

So here are my thoughts after listening to Harry Sudock of Griid on this podcast, which I was directed to by one reader. He made some really good points about excess energy that I can get behind. In short – electricity companies always have a tough time to match supply with demand. So what they could do is deliberately overproduce electricity, and when actual demand is low, sell it to Bitcoin mining companies such as Griid, and when demand is high they can redirect the electricity back to consumers.

This is the only situation where I can see Bitcoin mining as providing value that could not be obtained in other ways. It does mean though that the supply to miners has to be dynamic – it ramps up and down as need be – not sure if Harry was talking about that. And it also means that Bitcoin mining outside of this scenario would still be considered problematic as per my argument above.

Interestingly Harry’s company is not currently part of the Bitcoin mining council that was set up by Michael Saylor – hopefully he gets added soon.


Published by ReddSpark

Follow me on Twitter: https://twitter.com/Reddspark1

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