How green should a blockchain be?

Recently the ECON discussed the possibility of banning crypto-assets that rely on a Proof-of-Work consensus mechanism, due to its ecological footprint. Would such prohibition be in line with the goals set by MiCA Regulation Proposal?

1. Introduction

EU’s proposal for a regulation on a market in crypto-assets (MiCA) has been under the spotlight, with many fearing a potential ban of crypto-assets that rely on a Proof-of-Work consensus mechanism (e.g. Bitcoin (BTC) with a market cap of roughly $782B).  

If one of the main purposes of this regulation would be to protect consumers and guarantee market integrity, should this approach be even considered as plausible?

2. Basics of blockchain: participants and consensus mechanisms

The trust in which blockchains rely upon are greatly enhanced by the Distributed Ledger Technology (DLT). DLTs contain a public register of every transaction that was executed on the network, which are grouped in blocks, validated (hashing) and replicated by all the participants in the network (nodes).

Consensus mechanisms allow participants to agree on the right ledger version to rely on, containing both new and old transactions. The trustworthiness of the blockchain is achieved by preventing the so-called double spending and arbitrary changes to the ledger, and by allowing transactions’ confirmation and broadcast (distribution) by all nodes. Miners are full nodes, i. e. besides being able to confirm all transactions by downloading and maintaining a full register of the transactions, they may also create new blocks from their local memory pools (pools composed by transactions which have not yet been validated and broadcasted to the blockchain). Different from those are the already mentioned nodes or light nodes (the participants in the blockchain which only validate information/transactions) which, instead of downloading the entire blockchain, only download limited data to verify new transactions.

These miners compete among themselves for registering those new blocks in the blockchain, by solving an algorithmic problem (cryptographic puzzle) in exchange for a reward. The winner will then register both the new block and the solution to that problem in the blockchain, receiving a newly created crypto-asset (e.g. a bitcoin) that goes straight into the winner’s wallet address. The remaining miners will also include that new block in their blockchain data, allowing the network to reach a consensus.

There are several consensus mechanisms, namely Proof of Work (PoW), Proof of Stake (PoS), Delegated Proof of Stake (DPoS), Proof of Service (PoSe), Proof of Elapsed Time (PoET) and Practical Byzantine Fault Tolerant (PBFT).

In practical terms, the most well-known blockchain, BTC, works with a PoW consensus mechanism – a mechanism which relies on miners and nodes to keep the chain  up-to-date maintain its integrity and. Ethereum (ETH), although still relying on PoW mechanism, is about to phase-out to a PoS mechanism, which depends on validators (instead of miners). Validators must be holding a certain amount of a given crypto-asset (e.g. 32 ETH) to be able to confirm and validate new blocks. Therefore, there is no competition but instead a random selection on the participant (miner) which will perform the confirmation and validation of new blocks.

3. Crypto-mining: a growing market

How big is the crypto-mining industry? According to a Brandessence report, by 2021 this market was valued at $2285,4M, and it is estimated to reach $5293,9M by 2028.

First, it is important to stress that the level of difficulty of cryptographic puzzles solved by miners is adjusted by the network itself, depending on the computational power (hash power) of the network at a given time. In case of BTC, it must take an average of 10 minutes for a new block to be validated – if the rate is lower, the difficulty level will increase. An Application-Specific Integrated Circuit (ASIC) miner is basically hardware, tailor-made to mine crypto-assets that rely on a PoW mechanism. Although it may offer a greater efficiency on solving algorithmic puzzles, its power consumption is still very high (one mid-range ASIC may use about 3250 watts per hour).

4. PoW ban proposal in the ECON

BTC network power demand is estimated to render an annualised consumption of 136,87 TWh. In 2021, the New York Digital Investment Group (NYDIG) published a study, which reported that, in 2020, BTC operations produced 33 million metric tons of CO2 emissions. It is also expected that, by 2024, such emissions may peak to 130,5 million metric tons of CO2 emissions.

Due to mining’s ecological footprint, this issue was brought to the Committee on Economic and Monetary Affairs (ECON) meeting, that took place in mid-March. These concerns were raised by three parties: S&D (Socialists & Democrats), Greens and GUE (The Left in the European Parliament), who have proposed amendments to the MiCA Draft Compromises, namely Article 2a and Article 68.

However, it should be noted that Europe has a residual participation in mining activities worldwide. Only Germany stands out, by fostering the largest crypto-miner company in Europe – Northern Data AG. The USA has a leading position worldwide with a share of 35,4% (which has been strengthened even further after China’s mining activities ban, in June 2021), followed by Kazakhstan, Russian Federation and Canada.

According to Northern Data AG president, Cristopher Yoshida, the company mines about €20M of BTC and ETH per month, and it runs almost entirely on renewable energy sources (a rare approach within this industry).

The proposed amendments were rather concerning. Article 2a aimed to set an environmental sustainability standard on consensus mechanisms supporting crypto-assets that were to be issued, offered or traded in the EU hence excluding any crypto-asset based on the PoW mechanism (namely BTC and ETH).

Moreover, Article 68 required for crypto-assets to set up and maintain a phased out rollout plan to ensure compliance with such requirements – hard to envisage in relation to BTC blockchain. In turn, crypto-asset service providers would be also compeled to phase-out crypto assets relying on PoW, and thus stamping out major crypto-assets from their platforms.

In this regard, does the position from the referred Members of the European Parliament (MEP) makes any sense at all? Such proposals are antagonistic with the essence of consumer and investor protection. In practical terms, it would not only hurt mining activities but if BTC or ETH [ 1] were banned from the EU, holders of that crypto-assets would be left in a grey area, i. e. they would be as vulnerable as they are today.

Moreover, [ 2] such proposals could make sense, if the EU was supporting the burdens of a high intense energy consumption activity of mining, as did China before the crypto ban. However, this does not appear to be the case. Even mining rig manufacturers are increasingly investing in new products that improve energy efficiency in mining activities, which will further contribute to reduce its ecological footprint. Taking into consideration the above, these proposed amendments were not approved. Nonetheless, mining activities and their environmental impact will be addressed separately, by 2025, in the EU Sustainable Finance Taxonomy classification system, according to Article 2a of the the MiCA final compromises. It should be noted that the final draft version of MiCA was approved with 31 votes in favor, 4 against and to 23 abstentions.

This draft version will be now negotiated between the Parliament (EP), the European Council and the European Commission, in their trialogue discussions.

5. Final remarks

Technology neutrality is a principle that shall guide regulators and their policymaking activities, by avoiding technology-specific considerations to be included in regulations, tending to advocate for certain technologies over others. Although neutrality does not exclude addressing specific harmful events that may be aggravated by a particular technology[ 2], for the time being the EU is not facing substantial environmental damages from crypto-assets that rely on a PoW consensus mechanism that would justify their absolute ban. In fact, the harms would be greater when considering market integrity and stability, and consumer protection, especially taking in consideration the goals and scope of MiCA regulation.

The EU should keep its innovative and unprecedented regulatory approach to crypto-assets, which can set a regulatory example for many other countries. Balancing conflicting interests, instead of choosing one over another, it is not an easy task. Nevertheless, in the current conditions, restraining the power that decentralization has brought to consumers and investors should not be considered.

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