Why not all cryptocurrencies are alike, and why you should care and (re)act 

Introduction

My original vantage point is being an expert within banking- and retail payments infrastructure. Being highly curious about all matters digital, especially within my profession, I’ve added distributed ledger technology, blockchain, tokenization, cryptocurrencies, as well as central bank digital currencies to my areas of subject matter expertise.

And now that every Tom, Dick, Harry, and sadly, El Salvador, have gotten into cryptocurrencies, and both Mastercard and Visa enable real-life spending of these, I thought it relevant to add serious food for thought to those that have, or consider, engaging in the cryptocurrency space.

The basics of cryptocurrency

Before diving into what cryptocurrencies such as Bitcoin, Ether (ETH) or Dogecoin are (besides not being money), one needs to understand some basics.

A blockchain

The foundation for cryptocurrencies is the blockchain database. As the name suggests, data is stored in blocks with blocks added together in a long, never-ending chain of blocks, hence the term blockchain. The blockchain (the ledger) is distributed onto many, independent computers and is an example of Distributed Ledger Technology or DLT.

Ensuring block legitimacy

For an individual block to get connected or chained to the existing chain of blocks, it requires that the block is validated to ensure that the parties transacting is who they say they are, that they have the authorization to transact, that transactions happen in order and that no double spend of an asset happens.

On a blockchain the method of validation is called the consensus method, meaning that all computers of the blockchain, may have a say-so and role in the validation of the addition of a block (of data). A computer validating a block receives a reward for the trouble. On a blockchain, this reward is called its cryptocurrency.

Types of block validation

Mostly, either of two consensus models are used:

Proof of Work (PoW):

First introduced on the Bitcoin blockchain, Proof of Work describes an approach in which computers on a blockchain may compete in solving a complex, mathematical "riddle" by employing ‘brute force’, i.e., by contributing computational power to validate transactions and create a block’s hash, close it and add it to the blockchain. This is called mining.

The computer that solves the riddle first, receives the above-mentioned block reward in the form of the blockchain’s cryptocurrency. The larger the perceived value of the reward, the more incentive to apply computational power. In the case of the Bitcoin blockchain, the PoW mathematical riddle (or algorithm), gets more complex the more computers take part in solving the riddle - which in turn, demands more computational power. In the case of the Bitcoin blockchain, the financial reward of solving the riddle is 6,25 Bitcoins (at time of writing) or the equivalent of appr. 200,000 USD!

Proof of Stake (PoS):

Instead of all computers spending computational power at the same time on solving the riddle and ‘hashing’ blocks, each computer may enter a lottery of sorts where the computer is chosen at random. The more lottery tickets, the higher the chances of being chosen and receiving the reward. In other words, the higher the stakes, the more chance of reward, hence, the name Proof of Stake. The lottery tickets are the blockchain’s cryptocurrency. As it is random which computer is chosen to solve the riddle, it entails a lot less total computational power than PoW.

Why Bitcoin is bad

Bitcoin and ETH (Ether) make up the vast majority of cryptocurrency transactions. And a  great number of the other estimated 10,000 cryptocurrencies, are built on the Ethereum blockchain.

Bitcoin (and until 2022, the Ethereum blockchain) is based on PoW where increased traffic and interest, directly translates to required computational power and thus, higher energy use. And in the case of Bitcoin, this is a considerable amount of energy! Some Bitcoin miners focus solely on this reward, and have built massive “mining” farms, essentially consisting of thousands of powerful computers competing to solve the riddle and receive the Bitcoin reward. Mining operations are a huge drain on the electrical grid to the extent where some mining operations have gone as far as to reactivate discontinued coal power plants!

At time of writing, traffic and one year’s use of the Bitcoin blockchain alone, made up 205 TWh of the global energy consumption of 166,000 TWh (almost 75% of this being oil, coal, gas or nuclear). Over a year, Bitcoins uses (at time of writing):

• 1 out of every 800 lightbulbs lit
• 17 times the energy of Google and all of its operations (12 TWh per year)
• 41 times the energy of Meta (Facebook, etc.) (5 TWh per year)
• The equivalent of the annual energy usage of Thailand

How to reduce energy on cryptocurrencies?

There are other methods of validation that Pow and PoS such as delegated proof-of-stake (dPoS), proof-of-authority (PoA), proof-of-burn (PoB), proof-of-developer (PoD), and more. 

They all reward the chosen, validating computer, with a cryptocurrency tied to that blockchain. Each method has its pros and cons, but none as dependent on computational power (thus, energy usage) as Proof of Work!

On September 15, 2022, Ethereum moved from Proof of Work to Proof of Stake consensus and thus, reportedly, reduced the Ethereum network's energy consumption by 99,95%!

When it comes to Bitcoin (which makes up 2/3 of the PoW based traffic pre-2022), the genie is sadly out of the bottle. By design, nobody controls Bitcoin, so replacing its built-in PoW is not possible. Only by way of regional/global scale regulatory measures could it perhaps be possible to affect the Bitcoin blockchain or other PoW based blockchain cryptocurrencies. China and a few other countries have implemented such measures. EU's MiCa 2022 legislative initiative, originally had a PoW ban, that ultimately did not make it into the final legal text.

Epilog

Blockchain is a very exciting technology which has the potential to radically change our world. Provided regulation (and thoughtful, sustainable application), blockchain and even cryptocurrencies have a role to play concerning the digital exchange and management of assets and securities. But the proliferation and blind use and application of blockchain based on PoW does not bode well for the world.

One of my astute, fellow experts in especially CBDCs, Lasse Meholm, also published an article on the [lack of] sustainability behind crypto assets. Read his blog here [machine translated from Norwegian].

I invite you also to read my other blog on why cryptocurrency is not money.

Disclaimer: DLT, blockchain, and cryptocurrencies are not static subject matters and as such, some of the above text may be factually- and contextually outdated from time of writing.