Why Bitcoin is energy intensive

By Aditya Chhatre

Humans have specific beliefs and subjective ideologies. Historically, there are very few things which have unanimously wired large number of humans in the world. Yuval Noah Harari explains in his book “Sapiens”, that monetary, imperial and religious orders are the three constructions that have successfully unified humankind. The definition of a financial systems has evolved from brass, silver or gold coins to the newest form of notes with national leaders and symbols printed on it. Money in the form of gold, notes, coins or whichever prevalent form, is a platform to value an object or a service. It is only valued because humans as a community accept commodities in the form of ‘money’ and believe the exchanged commodity shall be valued. With cryptocurrencies around the corner for a decade, do we have another structural shift in its form?

Our lives revolve around digital systems and finance systems are not far off. Governments have implemented policies to make financial systems digital and cashless. This has raised speculations on hard cash gradually might decelerate and go extinct. The centralized financial system has an alternative now to be decentralized in the form of cryptocurrencies. The first cryptocurrency was Bitcoin developed in 2008-09 by Satoshi Nakamoto. Within the last decade many such cryptocurrencies were created and the concept of decentralized financial system has been put in use. Although, in recent times, as bitcoin got popular, there are discussions that the working of these cryptocurrencies is energy intensive and with more users it will make things worse. It is essential to unfold this big debate to understand the energy consumptions of cryptocurrencies and figure out a way to find the electricity consumption of bitcoin.

Understanding bitcoin mining in 4 setups

The energy consumption of any cryptocurrency lies in the way a cryptocurrency works with its algorithm. This algorithm which runs in a processor, consumes energy for creating the blockchain. Cryptocurrencies(crypto) have mainly 2 components – its algorithm which creates a block for the blockchain. It is important to understand the structural concept behind creating a blockchain. In these decentralized systems users have individual ledgers and all transactions for that specific cryptocurrency are updated in every user’s ledger. Each transaction is converted in a block after its verification. This verification and creation of a block is the role of a miner and this is popularly known as mining. In return miners are rewarded with transaction fees in the form of crypto coins.

4 steps of bitcoin mining can be classified as:

  1. Transaction of the payment
  2. Digital signature
  3. Miner verifies and creates a block
  4. Adding the block to the Blockchain
Figure 1. Blockchain and bitcoin mining

Algorithms and its energy consumption

Algorithms for creating the blockchain are termed as consensus mechanisms. The most prominent algorithm for mining the bitcoin is ‘proof-of-work’ which is also the algorithm used by bitcoin. This algorithm is a method where every miner gets the transaction and starts with a premutation to find the number to achieve a specific output. Large number of processors are required to carry out these combinations. The one who gets it first creates the blocks and earns coins. This algorithm is energy intensive because it is designed such that all miners need to run their processors simultaneously for creating a block and only one of them is incentivized with coins. This is more of a processing competition which accounts for a lot of energy waste. Recent debates about bitcoin being energy intensive is mainly because of this nature of its algorithm.

There are many such consensus algorithms which are gaining some space within cryptocurrencies. An alternative approach which has been popular to counter the energy intensive approach of bitcoin is ‘proof-of-stake’. In this method every miner has to bid currencies at the beginning to take part. The one bidding higher has better chances to get the opportunity to create the block and earn rewards. The main difference between these two types is the one following proof-of-stake algorithm only needs a single processor to work which reduces the electricity required. Comparing based on the electricity requirements, ‘proof-of-stake’ clearly consumes way too less energy than ‘proof-of-work’ mainly because of the structure of its algorithm.

Figure 2. Proof of work vs Proof of stake

What do miner’s say?

The electricity consumption of bitcoin mining is a central issue which miners have to face. Although, miners believe that the energy needed for mining has advantages and it is worth the amount of electricity it consumes. Miners claim that the mining facilities have a supplementary role in energy transition and utilizing the excess generation from the renewable energy resources. Renewable energy resources such solar and wind are highly dependent on weather conditions which makes them volatile. There are instances of excess electricity generation wherein these plants have to be shut down. Generation from hydro power plants also face the same issue of excess electricity generation. Miners affirm that this shut down of plants and electricity waste can be avoided by using the excess electricity for mining which makes these plants more efficient and improves grid stability. Also, they claim a high share of renewables in the electricity used for mining. For this reason, recently, the bitcoin mining council has agreed to publish the renewable energy share in the electricity used for bitcoin mining globally.

To figure out the electricity needed by the mining pools globally, we need a brief understanding of various elements affecting bitcoin mining. As we discussed, energy consumption of the bitcoin is majorly dependent on its blockchain algorithm. The speed of the transaction depends on the processing power of the miner to make permutations as fast as possible. Every permutation or attempt to create a block is termed as a hash and the speed of a processor is measured in hash rate. So, the hash rate could give a clearer picture about the amount of energy consumed at any given moment. The highest electricity demand of global bitcoin mining in the past has been 125 TWh. In Fig.3 we see a strong co-relation between the hash rate and the energy consumption of bitcoin.

The technological shift in the processors for mining has been drastic within the years 2009-2012. The energy needed for central processing units (CPUs) in 2009 for mining was huge and its improvement in 4 years to Application-specific integrated circuit (ASIC), made mining a realistic option. Since then, there are improvements in the speed of ASIC processors but there has not been a significant technological change. If bitcoin is intended to grow the proof-of-work algorithm inherently would need higher hash rates and this would result in higher energy consumptions. This is a concern, especially now when discussions in all fields are about reducing energy consumption and moving towards greener sources.

Figure 3. Bitcoin Hash rates and energy consumption

Incentives of cheap electricity

The mining pools are sensitive to the cost of electricity. Following monetary incentives, geographically the mining of bitcoin has been concentrated in the regions where the electricity is cheaper. China has one of the cheapest markets of electricity which and helped to have a share of 65% of bitcoin mining in 2020. Germany, on the other hand, has the highest electricity prices in the world and has only 3% of bitcoin mining. Fig. 4 shows a clear trend wherein the share of bitcoin mining is inversely proportional to the average electricity prices. The prices of electricity are found to be low where the markets have higher percentage of electricity from fossil fuels and low contribution from renewable energy resources. The price has been low in China because the grid still has 71% of its electricity generated through fossil fuels.   A group of universities, examined that 40% of the electricity used by mining of bitcoin in China is from coal power plants. Although, in China, the mining share has dropped to from 65% in 2020 to 50% in 2021. This drop in the share is because Chinese authorities speculated power concerns in the last couple of months and regulated to shut down some of the mining pools. Similarly, in Iran, during summer months the power department was overburdened and the additional burden was concluded to be caused by bitcoin mining. As a result, all bitcoin mining facilities were shut down for 4 months in the country till the summer ends. The claim of renewables as a source for mining brings up a question about how the electricity prices vary with the increasing share of renewables in the energy market.

Figure 4. Bitcoin mining and average electricity price

Paradox of low-cost renewables and high electricity prices

With the reducing cost of solar panels and wind turbine blades, one can surely be misled to conclude that the electricity prices would drop with higher share of renewables in the grid. Apparently, the increasing share of renewables has been found to cause rise in the electricity costs in the market. This paradox of renewable energy getting cheaper and the electricity prices getting higher is critical to understand. According to the analysis by Forbes,  the transmission and the ancillary costs in this phase of transition accounts for more than 50% which makes the price higher than expected. The energy to land ratio of solar and wind plants is low compared to conventional resources. So, as energy transition needs high number of renewable power plants, it also needs grid expansion to access the electricity from power plants. The costs of grid expansion has been included in the electricity prices. This effect of higher prices of electricity due to higher share of renewables is expected to be play a significant role to decide electricity prices till the grid connects all renewable power plants in the future. Germany, with high share of solar and wind installations, has reached a 45% share of renewables in its electricity mix. With the effect discussed, the grid expansion has made the electricity price in Germany to be highest in the world. So, the high prices do not appeal bitcoin miners and this reflects with just 3% of the bitcoin mining done in Germany.

Figure 5. Annual electricity consumption (in TWh)

Conclusion

Through these energy debates, the conventional ‘proof-of-work’ strategy, has faced a lot of criticism. The coins working with ‘proof-of-stake’, an alternate less energy intensive approach, have become popular. Some established coins such as Ethereum have officially decide to migrate from proof-of-work to a proof-of-stake consensus mechanism mainly to reduce the electricity consumption in mining the cryptocurrency. Although, at the moment it is difficult for Bitcoin to migrate to ‘proof-of-stake’ considering the imposed cost and the risks on individual miners by the changes in the ecosystem.

Energy use of the bitcoin mining is a function of inter-related factors such as mining hardware, hash rates, complexity of blocks and electricity prices. There are published graphs (Fig. 5) depicting extreme scenarios of bitcoin consuming electricity more than some of the countries. Even though bitcoin mining needs a lot of electricity, comparing a technology to countries electricity consumption might not be a fair comparison. A better approach would be to compare the bitcoin mining energy use to the energy consumption of our current financial system. The electricity use of data centers, as shown in the figure, is higher than bitcoin, which means we consider data centers worth the energy it uses. A collective belief in these decentralized solutions in the form of cryptocurrency could be another prominent change. Even tough the issue of energy consumption of the first cryptocurrency, bitcoin, is a matter concern, through constant improvements and with alternate algorithms these decentralized financial systems, would adapt to better opportunities in the future.

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