Navigant Research Blog

The Dynamics of Bitcoin Mining and Energy Consumption, Part I: A Problem in the Here and Now

— June 5, 2018

I’ve written quite a bit about use cases for blockchain, the technology that supports applications like Bitcoin, outside the world of digital currencies. I have spent much less time diving into the impacts of digital currencies themselves. This is because the most exciting and potentially transformative applications for blockchain in the energy world have little to do with them, or with the proof of work consensus algorithm.

The downside of taking a future-focused view, however, is that it tends to gloss over the real challenges faced by utilities and other energy stakeholders today. The rapid rise in the valuation of proof of work-based digital currencies like Bitcoin and Ethereum has created a new, power-hungry digital mining industry that utilities have to confront.

Digital Currency Farms Require Huge Amounts of Power

Take the example of this bitcoin farm in inner Mongolia, which demands 40 MW of electricity per hour and, at the time Digiconomist’s article was written, earns the equivalent of $250,000 per day in bitcoin. At $0.09 per kWh, that’s about $86,000 per day in electricity costs. Even after taking hardware, maintenance, oversight, and facilities costs into account, the farm is turning a substantial profit, and a percentage goes back to the power provider. This farm is one of many around the world that collectively accounts for 65 TWh of electricity consumption annually.

At first glance, this might not seem like a bad deal for power providers. If the deal is structured properly, they get a cut of a profitable and fast-growing business, provided they can support the miner’s power needs. That’s likely why the Chinese government offered them a rate discount as an incentive for setting up shop.

But mining farms aren’t a typical client. The value of digital currencies like bitcoin in real money is highly volatile, which makes continued profits uncertain in the future—and that has serious implications for utilities that are considering developing new capacity to account for a surge of new facilities like the one in Mongolia. If the bubble bursts and mining becomes unsustainable, these farms could disappear as quickly as they sprang up.

A Rock and a Hard Place

Utilities with decades-long planning horizons revolving around rate cases should want little to do with an industry that thrives on short-term volatility, and whose loads could be here today and gone tomorrow. But in the short term, the energy consumption associated with proof of work gives them little choice. Worse yet, not all mining companies bother to speak with utilities directly. Some simply truck in their equipment, plug in, and get to work. They’ve been blamed for rate spikes and other problems in distribution networks around the country.

Examining the Cost of Digital Currencies

Over the next several weeks, look for my blog series on energy consumption associated with bitcoin and other digital currencies and its impacts on utilities and energy systems. The series will build off of work by others in this area—notably the folks over at Digiconomist and the recent paper (no paywall) published by Alex de Vries in the peer-reviewed journal Joule earlier this May.

My intent is to add a systems-level perspective to the conversation that will help build an understanding of the main drivers of mining activity, how it might change in the future, and what utilities can do to make the best of a bad situation that many analysts expect to get worse. The second part of this series will look at the situation from the miner’s perspective, exploring why farms like the one in Mongolia arise, what determines where those facilities pop up, and what causes them to move or shut down.

 

Takeaways from Reversapalooza: One Analyst’s Perspective on Blockchain

— May 15, 2018

I recently returned from Reversapalooza, a 2-day event hosted by Nori and designed to explore the role of blockchain technology in reversing climate change. There were farmers, economists, policymakers, academics, and representatives from many other professions in attendance. In the conversations that ensued, blockchain took a backseat to Nori’s larger mission.

Blockchain is a hot topic at conferences globally and in many sectors, but this event was one of the few large-scale conversations I have participated in where the “hash everything and put it on the blockchain” crowd were a minority. The event gave me the opportunity to reflect on how blockchain is perceived by stakeholders with a wide range of familiarity with the technology. The majority of customers who will be the end users of blockchain-based solutions probably won’t understand the underlying systems, but they still need to be able to engage with the system.

Blockchain Attracts People, but It Can Also Alienate Them

Blockchain generates a huge amount of interest even outside of tech-savvy circles. I have yet to speak with someone who has heard about blockchain and doesn’t care to learn more about it. It is very tempting for early innovators to put blockchain front and center to capitalize on that interest.

However, once you get people in the door, you need to be prepared to explain in simple terms what blockchain brings to the table and why you’re talking about it in the first place. The technology is complex and difficult to visualize. Without proper care, it can begin to sound suspiciously like wizardry.

Demonstrations Help Clarify Blockchain

Nori worked hard at Reversapalooza to create interactive exercises that demystified some aspects of the customer experience with blockchain-based systems. One gave folks in the room hands-on experience with trading mock carbon removal credits (CRCs), and a second used 10 copies of the Seattle Times, some simple addition, and a 5-dollar bill to illustrate the fundamental steps involved in building a blockchain.

Results were mixed, but any explanation of blockchain must strike a difficult balance between oversimplification and a black hole of technical details. Overall, attendees left the conference knowing more about blockchain than they did when they came into the room.

Blockchain Should Never Be in the Driver’s Seat

I dream of the day when blockchain becomes a means to an end for companies like Nori, and panels devoted to its specifics are no longer necessary. When was the last time you attended a conference with a panel on database mechanics?

Today, companies that use blockchain but neglect to explain it risk appearing like they don’t know what they’re doing. They can’t afford to push it completely into the background. But startups and established players alike must recognize that blockchain, by itself, is not a value proposition. Succeeding in this space requires a clear mission and purpose—a goal where blockchain makes sense as the means to an end.

What Did Reversapalooza Do Right?

Reversapalooza succeeded because Nori kept blockchain in the backseat (or at least in the passenger seat). The event was about reversing climate change and the many processes—behavioral, economic, geological, and scientific—that are necessary to achieve that goal. Within that context, attendees could see the value of a trusted, decentralized ledger that could track CRCs and compare it against the carbon offset markets and other mechanisms that currently exist.

 

Can SegWit Save Proof of Work?

— May 10, 2018

If you’ve been following news surrounding digital currencies and blockchain, you’ve probably seen the criticisms of the inefficiencies in Bitcoin’s underlying blockchain architecture. Bitcoin relies on a computationally intensive consensus algorithm, proof of work (POW), to digitally establish the security and trust provided by central institutions in traditional networks. The system is designed to be transparent, so anyone in the network can independently verify the validity of a transaction and ensure their counterparty isn’t trying to generate currency out of thin air or spend the same coin twice.

So far, POW has done its job. As of early 2018, more than 310 million transactions have been made on the Bitcoin blockchain alone without issue. But using math rather than institutions to back a currency requires time, money, and a lot of energy. These shortcomings call into question whether POW has a future in use cases—including many in the electricity industry—that require a faster, more efficient blockchain architecture.

In February 2018, the Bitcoin community announced long-awaited changes to the digital currency’s core protocols that are aimed squarely at these inefficiencies. But segregated witness (SegWit) isn’t likely to save POW. Industries outside of the cryptocurrency world will need a new design altogether.

When Proof of Work Doesn’t Work                                                               

POW is essentially a mathematical race that requires a lot of time and energy to complete; this limits the speed at which Bitcoin transactions can be confirmed to between 3 and 7 transactions per second (TPS). Ethereum, which also uses POW, manages about 15 TPS. This makes both networks highly sensitive to network congestion. Throughput capacity acts like a bottleneck in the system, and can cause a pileup if the number of transactions exceeds the rate at which they can be confirmed.

When network congestion occurs, users have to choose between offering a higher percentage of their transaction as a fee to validators, who are incentivized to confirm high value transactions first, or waiting even longer to be sure their transaction is finalized. The figures below display that Bitcoin transaction fees jumped to $55 per transaction in December 2017, while average wait times reached almost 20 hours.

Bitcoin Average Transaction Fee (Last 6 Months)

(Source: Bitinfocharts.com)

Bitcoin Average Transaction Confirmation Time (Last 6 Months)

(Source: Blockchain.info)

SegWit to the Rescue?

SegWit has complex technical details. The new protocol changes how information is structured in the blockchain database and allows more transactions to fit into a block, reducing the likelihood of congestion in the network. While congestion is still possible and fees could still spike, SegWit should help buffer against the magnitude of swings (such as those in 2017) and create more stability in the system.

So far, SegWit seems to be helping to keep fees low. However, while it makes the system more stable on average, it doesn’t prevent congestion from happening—it only raises the threshold where it becomes a problem. And SegWit doesn’t address other concerns with POW, like its massive energy consumption.

POW blockchains can support other applications, as Ethereum’s range of decentralized applications shows. However, any business models that require rapid transaction confirmation or rely on low value transactions would be wise to consider a permissioned blockchain architecture or similar design that prioritizes throughput capacity over maximizing decentralization.

Many of the most transformative applications for blockchain rely on low volume transactions, and they will require an architecture that keeps such exchanges reliable and profitable. SegWit is a good stopgap, but POW-based blockchain architectures will have to do better if they hope to have value outside of the world of digital currencies.

 

US State Legislatures Are Pivoting to Blockchain—Will Energy Follow?

— March 1, 2018

Blockchain’s high profile in the news, particularly the billions of dollars pouring into Initial Coin Offering fundraisers (ICOs) and yet more cryptocurrency heists, is pressuring governments and policymakers globally to develop new laws and standards to guide the developing technology.

Policy changes are happening at all levels of government. China has banned ICOs and cryptocurrency exchanges but remains interested in commercializing the underlying technology. South Korea wants to ban cryptocurrency trading altogether. Even in regions where no new laws have passed, existing legislation designed to regulate centralized systems of energy supply or data privacy are barriers to blockchain development and scalability in many parts of the world.

Stakeholder consortia and other groups in the energy sector that see value in the architectures that support cryptocurrencies are working hard to convince utility commissions and local governments to adopt more blockchain-friendly policies. Some worry that too much regulation too soon could scare away developer talent and potentially lucrative new blockchain-based businesses.

In the US, States Are Moving First on Blockchain Regulations

While the US lags behind Europe and Asia Pacific in the number of energy-related blockchain projects, it is making some promising progress in the regulatory space. At least eight states are already tackling issues surrounding legal treatment of blockchain signatures and blockchain data. A few examples:

  • In California, Assembly Bill 2658 would formally recognize blockchain signatures and records as legal electronic records, paving the way for smart contracts
  • In Florida, House Bill 1357 ensures that blockchain smart contracts are treated with the same legal weight afforded to traditional contracts
  • In Arizona, House Bill 2417 adds blockchain databases to the list of electronic records with recognized legal status and enforceability
  • In Wyoming, the House approved two bills in 2018 that set standards for when digital currencies can be exempted from securities regulations (House Bill 70) and modifies regulations on financial transactions that would exempt digital currencies and allow exchanges to operate legally in the state (House Bill 19).

Progress Is Being Made in Unusual Places

What’s particularly interesting about the above list is the range (geographical and political) of states jostling for position in the market. The next question for the energy sector is how, or if, state-level regulations will translate into real change in these states’ energy markets. Utilities have been understandably bearish on blockchain so far, even in traditionally experimental states like New York and California.

Some of the states experimenting with blockchain regulations are usual suspects when it comes to energy market experimentation, but others are not. Will public utility commissions and regulatory authorities in the latter group take cues from their state governments, or will real progress require more pressure from the bottom up? Either way, the pressure will come.

States are often called laboratories of democracy, and they have the potential to become laboratories for blockchain as well. A range of approaches and experiments is the best way to develop best practices and determine a path forward for a rapidly evolving technology. Check out Navigant Research’s upcoming Utility Blockchain Applications report for more insight into blockchain’s growing role in the energy sector.

 

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