Why not all cryptocurrencies are the same and why you should care and (re)act
For as long as I’d like to admit, I’ve developed experience in the banking and retail payments infrastructure. Being very curious about all digital subjects, especially within my profession, I have added distributed ledger technology, blockchain, tokenization, cryptocurrencies as well as central bank digital currencies to my areas of subject expertise.
So now that all Tom, Dick, Harry, and unfortunately El Salvador have gone into cryptocurrencies, and Gucci, as well as Mastercard and Visa, allow their real-life spending, I thought it important to add some serious thought to those who have or consider getting involved in the cryptocurrency space.
The basics of cryptocurrency
Before diving into what cryptocurrencies like Bitcoin, Ether (ETH) or Dogecoin are (besides not being money), you need to understand some basic concepts.
The basis for cryptocurrencies is the blockchain database. As the name suggests, data is stored in blocks with blocks added in a long and endless chain of blocks, hence the term blockchain. The blockchain (the ledger) is distributed on many standalone computers and is an example of Distributed Ledger Technology or DLT.
Ensuring the legitimacy of the lock
In order for an individual block to be connected or chained to the existing blockchain, the block must be validated to ensure that the transactional parties are who they say they are, that they are authorized to transact, that transactions occur in order, and that no expenditures are incurred. double of an asset happens.
In a blockchain, the validation method is called the consensus method, which means that all computers on the blockchain can have a say and a role in validating the addition of a (data) block. A computer validating a block receives a reward for the inconvenience. On a blockchain, this reward is called a cryptocurrency.
Block validation types
Mainly, one of two consensus models is used:
Proof of Work (PoW):
First introduced to the Bitcoin blockchain, Proof of Work describes an approach in which computers on a blockchain can compete in solving a complex mathematical puzzle by employing ‘brute force’, i.e. contributing computational power to validate transactions and create the hash of a block, close it and add it to the blockchain. This is called mining.
The computer that solves the puzzle first receives the aforementioned block reward in the form of blockchain cryptocurrency. The greater the perceived value of the reward, the greater the incentive to apply computational power. In the case of the Bitcoin blockchain, this is encouraged by the reward of 6.25 Bitcoins (at the time of writing) or the equivalent of approx. 200,000 dollars!
Proof of Participation (PoS):
Instead of all computers expending computing power at the same time to solve the puzzle and hashing blocks, each computer can enter a type of lottery where the computer is chosen at random. The more lottery tickets, the greater the chances of being chosen and receiving the reward. In other words, the greater the bets, more chance of reward, hence the name Proof of Stake. Lottery tickets are the cryptocurrency of the blockchain. As it is random which computer is chosen to solve the puzzle, it involves much less total computing power than PoW.
Why Bitcoin is bad
Bitcoin and ETH (Ether) make up the vast majority of cryptocurrency transactions. And a large number of the estimated 10,000 other cryptocurrencies are built on the Ethereum blockchain.
The Bitcoin and Ethereum blockchains are based on PoW, where increased traffic and interest in a cryptocurrency directly translates to applied computing power and therefore greater energy usage. And in the case of Bitcoin and the Ethereum platform, this is a considerable amount of energy! Some Bitcoin miners only focus on this reward and have built huge “mining” farms, essentially consisting of thousands of powerful computers competing to solve the puzzle and receive the Bitcoin reward. Mining operations are a huge drain on the electrical grid as some mining operations have gone so far as to reactivate discontinued coal plants!
At the time of writing, just one year’s traffic and usage of the Bitcoin blockchain accounted for 205 TWh of the global energy consumption of 166,000 TWh, with 70% of that being coal, gas or nuclear. Over a year, Bitcoins uses (at the time of writing):
- 1 in 800 light bulbs lit
- 17 times the energy of Google and all of its operations (12 TWh per year)
- 41 times the energy of Facebook (5 TWh per year)
- The equivalent of Thailand’s annual energy use
How to reduce energy in cryptocurrencies?
There are other validation methods than Pow and PoS, such as delegated proof of participation (dPoS), proof of authority (PoA), proof of writing (PoB), proof of developer (PoD) and more.
They all reward the chosen computer, the validator, with a cryptocurrency linked to that blockchain. Each method has its pros and cons, but none are as dependent on computational power (hence energy usage) as Proof of Work!
Ethereum is planning to fully migrate to the Proof of Stake consensus in late 2022, which is reportedly 99.95% more energy efficient than Ethereum’s current Proof of Work.
Regarding Bitcoin (which makes up 2/3 of the traffic based on PoW (2022), unfortunately the genie is out of the bottle. Nobody controls Bitcoin, so replacing your built-in PoW is not possible.
through large [global] regulatory measures of scale, it may be possible to affect the Bitcoin blockchain or other PoW-based blockchain cryptocurrencies.
A 51% attack exploiting the PoW consensus model might also do the trick for a PoW-based blockchain.
A global agreement with 100% of countries and territories agreeing to make PoW (cryptocurrency mining) illegal is also an option. However, this seems very unlikely.
A final option would be if the world’s major card schemes made it more difficult, not easier, to switch between PoW cryptocurrencies and real-world money. However, they seem increasingly focused on getting a “piece of the action” and partnering with exchanges and issuers, trying to leverage their global networks to facilitate real-life use of Bitcoin and other cryptocurrencies that require PoW power.
Both Visa and Mastercard leverage Bitcoin as a driver for their entry into the cryptocurrency space. However, this puts MasterCard’s encryption program in clear conflict with sustainable growth, as stated in the “Mastercard Manifesto of Purpose” and Visa’s encryption program in conflict with “Visa’s values” of “protecting the planet”. ”.
Blockchain is a good and very exciting technology and it has the potential to radically change our world. With regulation (and sustainable and thoughtful enforcement), blockchain and even cryptocurrencies have a role to play when it comes to digital exchange and asset and securities management. But the proliferation and blind use and application of PoW-based blockchain does not bode well for the world.
One of my astute fellow experts especially in CBDCs, Lasse Meholm, also published an article about the [lack of] sustainability behind crypto assets. Read his blog here [in Norwegian].
I also invite you to read my other blog on why cryptocurrency is not money.