Bitcoin and its energy problem - May the bubble burst quickly
Even though the general concept of Bitcoin is finally known to the brought public, the complex field of cryptocurrency and its underlying technology still confuses even higher banking management circles (as I can tell from experience). This article will equip you with the answers to at least three common question, so you can impress your colleagues during the next coffee talk or prevent a family member from selling his/her or their whole property to bet on a bubble.
Most peoples knowledge is fueled by, sometimes fantastic and sometimes terribly wrong, articles that followed the recent price surge from 700$ a year ago to 17,300$ by the day of writing. I base this article on some questions I have recently stumbled on in a LinkedIn group, linking to an excellent article by Jessica Irvine. While giving a good rundown on the current discussion whether "Bitcoin will replace banks," many fundamental technical characteristics, essential to the debate when looking at Bitcoin, where left out of the explanation.
The 21 million Bitcoin cap
Many authors of articles mention a maximum number of 21 million Bitcoin, which leaves us with the questions: When and why?
Let's answer the "why" first: The implementation of the Bitcoin Blockchain is closely tied to Satoshi Nakamoto's goal of "creating money that can not be stolen by banks or the government." The ominous creator of Bitcoin explicitly listed inflation - especially those that can not be planned for because the central bank can suddenly decide to flood a market with money - to be the biggest threat to normal peoples money. For that reason, he/she/they limited the growth of money supply in a foreseeable, plannable way. Every new block created, in a process called "mining" (see below), contains some transactions and a certain amount of new Bitcoins.
The "when" is just a somewhat simple mathematical question. The Bitcoin-System allows for the creation of one new block approximately every 10 Minutes. When started in 2009, each new block added 50 new Bitcoins to the system. Since then, and this will also continue into the future, the amount of new BTC per block gets reduced by 50% about every four years (or more precise: every 210,00 blocks). Following this calculation, we will reach the maximum of slightly below 21 Million Bitcoins in 2140. On the other hand, because of this exponential slow-down, the money supply of Bitcoin will reach 20 Million in 2023 already.
What mining actually is
Many authors compare mining Bitcoin to mining gold, a process that creates Bitcoins - a comparison that can lead to dangerous assumptions like "the minimum value of Bitcoin is its mining costs," a quote from a horribly misleading article I read in an online investment magazine.
Unlike mining gold, where more input leads to more output, Bitcoin mining is, at its core, a lottery with a fixed price pool. Bitcoins are not created by the participants but awarded one to lucky participant every block. With your calculating power, you can buy yourself a ticket to this lottery. Your calculating power compared to the total amount of calculating power determines your winning chances. For example: If you double your calculating power, your chances of winning the prize approximately doubles. However, if every miner in the Bitcoin network also increases their computing power by 100 percent - your winning chance stays the same.
Because of the fixed price pool, doubling everyone's power does not change the number of Bitcoins that the system distributes to the winner. That example also illustrates why the concept of supply and demand does not apply to bitcoin mining. If the gold price decreased, it becomes unprofitable for some gold mines to produce and the gold supply decreases. If the bitcoin price decreases, some people will stop mining, but the output of newly generated Bitcoins will still stay the same.
Bitcoins incredible power consumption
Bitcoin mining is not free. Since the winning chance in this "Bitcoin lottery" is tied to the input calculating power, mining Bitcoin requires both (highly specialized) technical equipment and electricity.
According to Digiconomist, the Bitcoin networks annual energy consumption is already to be 33.2 TWh - that is equal to 10% of the UK or the total energy consumption of Denmark. With the current price rally, bitcoin mining becomes more attractive again. The higher prize pool of mining activities means that the participants (miners) will use more calculating power. This increase happens either by new participants entering the system or existing participants using more computing power to improve their chances of winning. 90 - 95% of the mining costs derive from the power usage. That leads to a straightforward calculation: The Bitcoin system awards 667,800 BTC every year. At the current price of $ 17,300/BTC, this equals $ 11.5 Billion per year. Given the fact that most mining centers are in China, and the average electricity price in China is $ 0.08/kWh, the total annual energy consumption of the Bitcoin network can be expected to surge up to 144TWh. With the current trend of rising Bitcoin prices, this value might get even higher.
What does that mean for the Future of Bitcoin and similar Blockchain applications?
All the points above reveal some significant flaws in Bitcoins architecture that prevents it from scaling.
One of two of Bitcoins most significant problems is that all that computing power goes to waste. It is used to solve calculations, which only exist to make the mining process hard enough, with the goal to just create one block 10 minutes. The actual process of writing new transactions into the Bitcoin-Blockchain could, security aspects aside, be performed by a single computer. However, as long as the price increases at least as fast as the number of new Bitcoins per Block decreases, energy consumption will not diminish and are inherent to the system. The same problem exists for similar alt-coins like Litecoin and cannot be solved easily. Some cryptocurrencies, like GridCoin or FoldingCoin, use the computing power of their system for science. Other modern cryptocurrencies, e.g. Ripple, do create new coins at all but start with a fixed amount that even decreases over time. However, all of these Solutions require more or less a complete change of the underlying system.
Together with the well discussed but easier to fix, problems of low transaction capabilities (3-4 per second) and high average transaction const (spiking at $ 27 this week) Bitcoins future does not look too bright. The vast economic and ecological costs should even make us wish for a quick death of Bitcoin so we can move on to improved, more efficient payment systems.
The same also partially applies to other Blockchain applications. The Etherum Blockchain, which powers many decentralized apps from ICOs to Crypto Kitties, already brought its annual energy consumption up to 11 TWh. Contrary to all the promised of "Decentralisation" and "Democratization", I strongly believe in a future of semi-centralized Blockchains, run within single organizations (comparable to TUIs usage of IBM's blockchain) or consortia like r3. Will there be a future for generalistic Blockchain infrastructure providers like Etherum or Stellar? Most likely, but they better solve their power problem.
