Why does bitcoin use so much energy? An outsider explains

Why does bitcoin use so much energy? Is it unavoidable? What does it all mean!? As someone who knew little about Bitcoin, I decided to investigate. With the help of my old friend Dhruv Bhansal of Unchained Capital, and another Friend—actually, Sarah Friend—I got to the bottom of why and how cryptocurrencies like bitcoin use energy. Together, the two of them helped me clear up at least a few common misconceptions that I had come across in my readings.

The conclusions I came to were three. First, people often roll bitcoin and other cryptocurrencies into the same pile when it comes to their energy drain. That is wrong. Each cryptocurrency can have a totally different architecture when it comes to its energy usage. 

Second, although it is true that the bitcoin financial system uses a great deal of energy, that’s ok. It is precisely bitcoin’s energy usage that underwrites its security, efficiency, and ubiquity as a currency. In fact, understanding the energy usage of bitcoin is key to understanding bitcoin in general.

Third, I had read criticisms that bitcoin comes with an extremely high energy cost per transaction. That metric turns out to be largely misleading. Just as computing the costs of paper transactions involves tallying the costs of felling a forest to print the money, computing the costs of bitcoin transactions is more complicated than it first seems. 

But, before I get into all this, let’s go back to the beginning. What is a cryptocurrency, anyways?

Chaining up energy

Sarah Friend is a software engineer and artist. She formerly worked as a software developer at the cryptocurrency technology firm ConsenSys, and now works on a project called Circles UBI, developing a currency called Circles.

The underlying concept that Friend uses to think about cryptocurrencies and their energy usage is that of the “blockchain”. A blockchain is a linked set of self-contained digital records called blocks. Each block contains the records of some subset of tokens out of all those in circulation, including their transactions and ownership. This makes the overall blockchain nothing but a giant digital ledger. 

In Friend’s words, the blockchain formally encodes the information of “Who did what, when?” and “Who has what?” There are different blockchains for each currency; one for bitcoin, one for Ether, the second most valuable cryptocurrency by total holdings, another one for Circle, and so on. 

For any given currency, the blockchain exists and is stored on the nodes of a peer-to-peer network. A protocol specific to that blockchain determines how the nodes communicate, process and request new transactions, and so on. The protocol also determines how to create a new block and add it to the end of the chain. When that happens, a new set of transactions is considered to have been formally processed.

For the bitcoin blockchain, creating a new block not only completes a set of transactions, but also rewards the creator with a small set of new tokens. For this reason, the act of processing transactions or creating a new block is generally termed “mining”. 

“Mining is a metaphor that is used for the process by which new blocks are added to the chain,” said Friend. “There are different ways that can be done.”

To mine the bitcoin blockchain, a user on the bitcoin network repeatedly guesses the solution to a cryptographic problem. This solution depends on the solutions associated with all previous blocks. When they find a new solution, the protocol allows them to append a new block onto the end of the chain, containing a new set of transactions. The system is designed so that all other nodes can rapidly verify the new cryptographic solution, adding the block to the end of their own chains, and rapidly establishing consensus on the new state of the ledger. 

The brute force computations involved in mining are what make bitcoin use so much energy.

However, it is important to note that blockchains—including the bitcoin protocol, if it were substantially updated—can be designed such that mining (and transaction processing) require little energy. There is no universal rule that all blocks must be computationally hard to produce. That trait is a design choice specific to the bitcoin protocol.

“With bitcoin in particular, I think it’s completely fair to say it’s inefficient,” said Friend. “There are blockchains that use far, far less energy.”

However, Friend is quick to acknowledge the arguments for bitcoin’s design, which give it, for example, excellent resiliency to bad actors. Other experts argue that bitcoin is actually highly efficient, when seen in the full context of what its energy usage provides. 

Eyeing efficiency

Dhruv Bansal, co-founder of Unchained Capital, believes in the superiority of bitcoin to other cryptocurrencies—at least, in its current implementation. Much of that superiority, he believes, has directly to do with its energy characteristics.

“All these [other cryptocurrencies] that seem more awesome come with a cost,” Bansal said. “Engineering isn’t fantasyland, right? Everything comes with trade offs.”

Bansal points to three ways in which bitcoin’s energy usage reflect an outstanding cryptocurrency design.

First, blocks that can be successfully validated are hard to produce. They cost a good deal of energy. Bad actors are therefore prevented from easily creating fake blocks and spamming the network. Denial of service attacks are prevented.

The second way to understand bitcoin’s energy usage is in how it regulates the bitcoin monetary supply. As more miners mine, the network adjusts the difficulty of the cryptographic problem to make it harder to solve, costing more energy. In particular, the difficulty is adjusted so that the rate of creation of a new block stays constant, at roughly one every ten minutes. Since each new block results in the award of additional tokens, fixing the flow of new blocks regulates the bitcoin monetary supply, controlling pesky things like inflation.

But also, fixing the flow of new blocks enables healthy transaction settling, Bansal says. After all, bitcoin is a financial network, and one of its core purposes is to efficiently settle transactions filed between different parties.

How does transaction processing work? When a new block is mined by a node on the network, the node sends it out. Other notes then verify the solution, independently reaching consensus that the new block is valid, and appending it to the end of their copy of the blockchain. Since the rate of block creation is constant, the nodes are prevented from being overloaded with new blocks. The increasing energy of a block, in other words, enables each node to function properly, settling new transactions in a reasonable time, even as more miners try to mine.

A third way of understanding bitcoin’s energy usage is also key. Because the blocks of the bitcoin blockchain eventually require so much energy to produce, as more miners mine, the blockchain becomes difficult to forge. 

Imagine that a hacker was trying to attack the blockchain. One approach they might think to take would be to replace an end segment of the blockchain with one with a small modification, forging the segment, such that a “forged” block routes an early transaction to themselves, instead of the proper recipient. In principle, doing this would not be complicated. They would merely need to do all the mining needed to recreate each of the blocks in the segment, building it up one by one. But there’s a problem. “This wouldn’t work,” said Bansal.

The energy costs of mining new blocks has grown so high that going back and forging a substantial portion of the chain has become inconceivable. By the time a forger reproduced their segment of interest, so many new blocks would have been mined and added onto the original segment, that the new segment would be outdated. “There isn’t an entity on the planet today who can afford the energy it would take,” Bansal said.

For all these reasons, the energy characteristics of bitcoin can be seen as exactly those which allow it to efficiently function. 

For those who subscribe to this view, bitcoin is not energy inefficient. Rather, attention should be focused on its overall energy consumption. And by Bansal’s thinking, this consumption is entirely reasonable.

“The question really becomes what energy budget is fair to support a distributed money supply that no one can censor, that no one can inflate, that no one can manipulate, and that is completely fair and open,” he said. “If you want those advantages, you kind of need to accept these things.” 

Transactional calculus

One claim that is sometimes levelled against bitcoin is that its transactions take an obscene amount of energy compared to a traditional financial network, like Visa or PayPal. Both Friend and Bansal feel that this statement, while true in a limited sense, is ultimately misleading.

On the one hand, in a crude way, you can indeed estimate a high energy cost per transaction. Certain estimates have put it as high as a month’s worth of household electricity. For a transaction of only a tiny fraction of a bitcoin, worth just a few dollars, that would seem exorbitant. 

Indeed, the net amount of energy used by the network compared to the total number of transactions has become larger and larger with with time. More precisely, the number of transactions has stayed fixed, while the overall energy usage has risen.

To see why, consider the the bitcoin protocol. It’s easy to see that the protocol only allows so many transactions to take place. The protocol limits each block’s maximum file size, meaning that each block can only contain so many transactions. It also limits the rate of creation of new blocks. Thus, the maximum rate of new transactions is limited.

But as the value of bitcoin has risen, the network has increased the difficulty of mining. That has led to the expenditure of more and more energy, and therefore a higher ratio of energy cost per transaction.

On the other hand, the total energy usage of the bitcoin network will one day come down. The bitcoin protocol is designed to award fewer and fewer tokens with time. In response, miners are expected to eventually start to drop out of the market, as they receive too few coins to be worth the investment of mining. Eventually, a smaller pool of miners will compete for the same blocks. When this happens, the network will automatically reduce the difficulty of mining, to keep the rate of block production the same—one of the protocol’s central rules.

The punchline of all this is that the energy usage of the bitcoin network is mutable. Friend uses an airline analogy to describe it. It’s like trying to make sense of the energy cost per passenger on a flight, she says. 

When more passengers take a flight, then the energy cost of each passenger may be said to go down. However, when more passengers take more flights, then that would be expected to drive the airline to schedule additional flights, leading to increases in its net energy spend. Similarly, if fewer passengers take a flight, the energy cost per passenger can be said to go up. However, the overall energy use of the airline will come down, eventually. 

The airline analogy shows that it is hard to assess energy cost per passenger without taking into account the overall energy costs of the airline. The former metric can seem insensible compared to the latter. For bitcoin, energy cost per transaction and total energy cost are similarly related.

“It’s not a direct relationship,” Friend said. “And just simply doing the math of the energy cost per transaction doesn’t capture the indirectness of the different factors, and how they might change over time.”

Bansal points out that formally speaking, it is not the transactions that cost energy, at all. A miner could hypothetically choose to mine a block merely for the reward of new tokens. They could choose not to select any of the pending transactions and still solve the cryptographic problem all the same, processing a new, valid block. 

In practice, this would be unlikely to happen, because each transaction included in a block allows a miner to charge a small transaction fee. Nevertheless, the principle is undeniable. “Transactions don’t cost energy. Blocks do,” Bansal said.

In his view, the energy costs of mining a new block should be assigned to the overall blockchain.

It is the blockchain that costs a great deal of energy, then, and not the transactions. But maybe the blockchain should. After all, its design gives it a remarkable functionality and integrity. It has enabled computers to generate over a trillion dollars in value. And it doesn’t look like it will stop growing anytime soon.