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.

 

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.

 

How Energy Transformation Investors Are Supporting New Utility Customer Solutions

— May 10, 2018

I recently highlighted how innovative utility customer solutions can have both customer benefits and utility value. Such customer-focused solutions in both the residential and commercial and industrial (C&I) sector are the focus of my new Utility Customer Solutions Research Service.

The Southern Company pilot effort I blogged about last month exhibits the kind of customer-focused thinking needed by vertically regulated utilities, retail energy choice brokers, energy service providers, and technology disruptors. But not all types of new behind-the-customer solutions can come from rate-based, approved pilot projects in the vertically regulated US. For these solutions to begin to scale, forward-thinking investment funds will play a key role in supporting solutions-based technology platform companies with the capital they need to take advantage of the distributed energy solutions being created by the Energy Cloud transformation.

Investment Activity Key to Transformation

By way of example, several of Southern Company’s recent technology investments and investment exits directly support the new residential utility customer solutions framework in my recent report as well as my C&I-focused Energy as a Service report. The following investment funds are playing key roles in this evolution:

  • Energy Impact Partners (EIP) is a utility investor partnership supported by Xcel Energy, National Grid, Southern Company, AGL Energy, and Alliant Energy, among others.
  • Constellation Technology Ventures (CTV), a subsidiary of Exelon, seeks to invest in energy technology companies at various stages of development to deploy the company’s products via Exelon’s commercial platform.
  • Shell Ventures seeks technology to help residential customers better manage their personal energy use and commercial opportunities to bring power to remote communities. The company invests in renewable power generation, distributed energy solutions, and energy storage solutions.

Key investment/divestiture examples from these three investors include:

  • EIP’s joint investment with Amazon’s Alexa Fund in ecobee, an integrated home energy/smart home company with smart thermostat, smart lighting, and smart sensor technology. This investment supports Navigant Research’s take that technology like ecobee’s, coupled with smart home technology like Alexa, will revolutionize the way people interact with their homes. It also will extend the role a smart home platform can play to support efficient home energy use.
  • CTV’s investment in Sparkfund, a company focused on a subscription-based energy efficiency technology deployment business model to deploy lighting, HVAC, building controls, and energy storage at C&I facilities. Sparkfund’s approach highlights the C&I customer’s need for energy as a service solutions without CAPEX.
  • Shell Ventures’ investment in Sense, a smart home-focused home energy disaggregation platform that enables customer smartphone visibility at the plug and device level. These types of platforms are poised to add depth to utility partners looking to engage with their customers with new, cutting-edge technologies for the home.

Tipping the Scales

Transformative change takes time and the scales never seem like they will tip until they do. Navigant Research believes that the scales will tip when utilities, energy services, technology providers, and investors focus first on the customer and what customer problems these new technologies can solve. EIP, CTV, and Shell Ventures are providing the support necessary to bring these solutions to the marketplace.

 

Swinging the Blockchain Hammer – Event Horizon 2018: Part 2

— May 8, 2018

In my second post following the Event Horizon 2018 event, I discuss blockchain startups’ business models. I see too many startups following the peer-to-peer energy trading model, rather than pursuing business models that address utilities’ current needs.

A Hammer without a Nail Is Just Scrap Metal

Innovation in the technology industry is unrivaled. “Necessity is the mother of invention” may be the credo for utilities’ innovation efforts, but the technology industry is different: it must stay ahead of the curve through endless cycles of R&D. The output of this research has given birth to many fantastic products that have revolutionized the way we live—no one really knew they needed an iPod or smartphone until the products were brought to market.

Conversely, many fantastic technologies—from Betamax VCRs to Google Glass—fall ignominiously by the wayside. They are the proverbial hammers that failed to find a nail. Despite the hype, right now blockchain is a hammer searching for a nail. The rash of startups developing energy-focused blockchain solutions are each hoping their solution will be the one that transforms the industry. However, there is likely not enough room for all of them.

Peer-to-Peer Energy Trading Is (Probably) Not the Right Nail

However, I have concerns that the business models pursued by many startups are not optimizing the pursuit of those elusive nails. After many conversations with people across the industry and listening to several startup pitches, I am worried that too much investment is flowing into the wrong business models. Right now, the majority of energy-focused blockchain startups include some element of peer-to-peer energy trading. While I remain positive about the future of transactive energy markets, there are still significant barriers to adoption.

So why are there so many TE-related startups? The cynic in me believes that too many of the people behind these startups are following the money and copying the business models of previously successful initial coin offerings (ICOs). Rather than spending time with a utility to identify existing business needs, it’s far easier to raise a few million dollars by launching an ICO with a white paper that promises Uber-style industry disruption and bitcoin-like token inflation.

ICO Follow-the-Leader Will Consign Many Startups to the Scrapheap

There is a saying often, but incorrectly, attributed to Einstein: “The definition of insanity is doing the same thing over and over again, but expecting different results.” Unfortunately, blockchain startups seem to value short-term ICO success, not the value of their business models: too many are recycling the business models of their peers to raise seed capital rather than identifying the business pain points that blockchain can address. This is not just unoriginal; it is fraught with danger.

Potential new entrants will do well to note the following observations before deciding on their business models:

  • We do not need any more peer-to-peer blockchain startups. More than enough currently exist for the world’s transactive energy requirements.
  • A peer-to-peer trading platform does not address any current, pressing issue with utility industry business processes.
  • The energy industry is not the taxi industry. Regulators will not permit Uber-style disruption. No startup can simply release an app and instantly sideline industry incumbents.
  • Regulatory approval for peer-to-peer energy trading could easily take longer than it takes a startup to spend all its seed capital.
  • No peer-to-peer energy trading model will create cryptocurrency billionaires. Startups should think twice about using any form of token. I am unconvinced regulators will permit the energy system to be priced in anything other than fiat currency.
  • True peer-to-peer energy trading is a physical impossibility; some form of centralized control and pricing must be done to maintain electricity networks.
 

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