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The real cost of bitcoin

Posted on: February 21st, 2018 by Dean North

You will do well to have not heard of bitcoin these days. But just in case you have been lost at sea or living under a rock for the last 10 years, here is a quick summary.

What is bitcoin?

Bitcoin is a cryptocurrency. That means it doesn’t physically exist except as encrypted data shared across the internet. Bitcoin is like any currency in that it’s only worth what someone is willing to pay for it in either goods, services or other currency.

Why does bitcoin exist?

All traditional currencies are controlled by a single governing body. This means that they can control how much of their currency they want to put into circulation and can put rules in place to control how the currency is used. The primary goal of Bitcoin is to democratise currency. Having a currency that is decentralised and accessible to all means it can’t be controlled by any single party.

When I buy Bitcoin, who am I buying them from?

If you want to buy some bitcoin using a traditional currency you will need to go to a cryptocurrency exchange and provide them with proof of identity and your credit card details. They will then allow you to transfer some of your money into an account of your traditional currency held by the exchange. Once your money is there, you can buy bitcoins from other users of the exchange who want to sell their bitcoins.

But how did they get their bitcoins to start with?

This is the crucial question and the answer exposes the true cost of bitcoin. When bitcoin first started there were only 50 coins. The bitcoin system only works because there are multiple people running the bitcoin software scattered around the world. If no one ran the software, the system wouldn’t work. To encourage people to run the software that runs the network, they are rewarded with bitcoins. This is called “mining”. Mining is computationally expensive and is referred to as “proof of work”. The computations are similar to how you would brute force a password. You try every guess until you hit the right password. It takes you a lot of work to get to the right guess, but it only takes a fraction of a second for someone to confirm that the password is correct.

This “proof of work” is more like “proof of waste”. The computation done isn’t work. It doesn’t benefit anyone. All it does is consume electricity. Vast amounts of it. Digiconomist has calculated the annual energy consumption as 47.65 TWh. That’s more energy than several small European countries produce.

Bitcoins are therefore awarded to whoever can prove that they have used the most electricity. And by extension, whoever has damaged the environment the most.

Is bitcoin going to destroy the planet?

The short answer is, it depends. There is a lot of uncertainty with the future of bitcoin in particular but the majority of cryptocurrencies out there are based on this “proof of work” concept. It is this concept that causes the huge waste of electricity. So even if bitcoin dies, unless a better cryptocurrency system is designed that doesn’t rely on “proof of work” then while it is profitable to do so, miners will continue to destroy the planet in the pursuit of personal wealth.

Why is the future of bitcoin uncertain?

Bitcoin rewards miners for confirming that transactions are legitimate and for signing the block with a proof of work. This reward halves roughly every 4 years. It started at 50 coins per block, today it is at 12.5 coins per block. If you look at bitcoinblockhalf.com the estimated date this will happen is the 3rd of June 2020. Depending on what is happening with the value of bitcoin and the current mining technology arms race, at some point it will no longer be profitable to mine bitcoin. When this happens bitcoin will shift from a system where miners make their money from the rewards and instead will have to charge transaction fees to the users of bitcoin in order to continue to run. No one really knows what will happen at this tipping point, but I can imagine it will cause a lot of panic and uncertainty which will make a volatile situation worse and potentially cause its own destruction.

What should we do to avoid destroying the planet?

We should all stop putting financial value in “proof of work” consensus protocols. A distributed democratised currency can exist without proof of work. The main issue is that the current alternatives also aren’t that great.

Have a quick read about proof of work, proof of stake and proof of burn.

The common issue with introducing any new currency is how to assign it to people. With all the cryptocurrencies to date, it’s been a case of the early adopters becoming rich. This isn’t really a fair way to setup a new currency that is supposed to be democratised.

In order for a new currency to work, it needs to be exchanged for traditional currencies in some way. This directly opposes the idea of a democratised currency system unless you arbitrarily assign currency to early adopters or miners like with bitcoin.

What if we take a different approach and put the money that is burnt in electricity and resources to good use? What if we assign all the coins to a single global charitable body on day one? Then in order to exchange money for coins, you give your money to the charity who invests it in planting trees, protecting the ocean, preserving bio diversity etc. Then similar to bitcoin, miners are rewarded for running the software that keeps the network running, but only small fees per transaction that they sign-off on. These transaction fees wouldn’t be paid by the users, but would be introduced to the system as new coins. This would enable the system to grow once the initial coins have all been purchased. Ideally several decades into the future at that point traditional currency may cease to exist.

Summary

As great as mathematics is, it can sometimes cause unexpected negative side effects. In this case, the wasteful nature of cryptocurrencies. We are a pretty smart species. We just launched a car into space for goodness sake! I’m sure if we all put our heads together, we can come up with a solution that has positive side effects while still achieving the goals that bitcoin set out to achieve.

Dean North

Dean North

Dean founded Bespoke Software Development Company - Atlas Computer Systems Limited and is our technical consultant (aka technical wizard).

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