As current blockchain technology faces accusations of inefficiency and unsustainability, new technologies are finding ways to counter them.
Crypto Blockchain is a highly debated topic. Blockchain is used by many cryptographic networks (such as Bitcoin and Ethereum) to enable various transactions. In this context, a transaction is a cryptographically signed instruction from a network participant to update the state of the network. The simplest transaction is the transfer of cryptographic value called coins from one account to another. Blockchain can be described as a time series concatenation of blocks. These blocks contain various data. For example, information about the transaction itself, the date of creation, and other information required for creation and transaction. These blocks are linked together to create what is known as a blockchain.1
Proprietary blockchain technology
Creating such a blockchain requires so-called “miners”. These miners are users of their respective blockchains who create new blocks and extend the chain. Only legitimate transactions should be part of the chain. To create a new block, miners have to solve a cryptographic problem. In other words, we need to find the corresponding key (the so-called hash value) to connect the new block to the blockchain. To create an incentive for miners to work, the first miners to solve the problem will receive a payment in their respective cryptocurrencies. Many miners are working in parallel to solve the problem, so only the winner who “worked” the hardest or fastest can update the blockchain with a transaction. This unique consensus mechanism is called ‘Proof of Work’ (PoW).2
Disadvantages of “Proof of Work”
The Proof of Work mechanism has one major drawback. It’s energy consumption. Energy consumption is huge, as high processing power is required to perform mining as quickly as possible. Studies show that Bitcoin alone consumes over 100TWh annually.3 This is twice the annual electricity consumption in Switzerland.Four A significant increase in energy consumption has been measured, especially when it comes to Ethereum.Five
Another point is efficiency. In the PoW mechanism, many miners are working on adding the same block to the chain at the same time, and only one of these miners’ work results are available. Therefore, the number of miners can be used to add more blocks in a shorter period of time. This increases the speed of adding new blocks and makes mining more efficient. PoW has come under a lot of criticism, especially in the age of climate change, and the voices for the necessary change are getting louder these days.
“Proof of Stake” instead of “Proof of Work”
Apart from Proof of Work, “Proof of Stake” (PoS) provides another mechanism for adding blocks to the blockchain. In this approach, validators, not miners, are responsible for extending the chain. This mechanism uses an algorithm to determine the validator and add the next block. To participate in the Proof of Stake network, validators must have a stake of a specific coin on the network. Imagine a validator depositing a certain amount of tokens in some kind of lottery drum. The algorithm then randomly selects the next validator from these deposited tokens.6 Therefore, each token staked into the network represents a chance of being selected. This means that the higher the number of bets, the more likely the verification will be chosen. To deter fraud, the system penalizes improper transaction validations by seizing and destroying all or part of the stake of cheating validators.7 PoS mechanism has some advantages over PoW mechanism. Since miners no longer need to compete with each other and validations are assigned directly to validators, less computing power is required and energy consumption is reduced. This increases the efficiency with which new blocks are connected to their respective blockchains.
Due to the energy-intensive ramifications of “proof of work,” one of the largest decentralized blockchain networks, “Ethereum,” announced on September 15 that it will be moving its consensus mechanism from “proof of work” to “proof of stake.” ”.8 The update, called “The Merge”, aims to reduce high computing power. Ether Price in Anticipation of The Merge9 (Ethereum network cryptocurrency) increased compared to BitcoinTen (which hadn’t made a similar change) in the previous week — although the price of Ether against Bitcoin has corrected somewhat in the days following the merger. Further changes are planned by the Ethereum network to enhance it. According to Ethereum co-founder Vitaly Buterin, four stages are yet to come: “The Surge,” “The Verge,” “The Purge,” and “The Splurge.”11
The PoW process has negatively impacted sustainability and may continue to come under political scrutiny.
Due to existing climate change and climate targets set, the White House has announced that a significant reduction in energy in the crypto industry is the goal after a report on the climate impact of the crypto industry. If the goal is not met, the PoW process may be banned.12
PoS is not without criticism either. This is a factor related to securities law under the US Securities and Exchange Commission (SEC) framework for analyzing digital assets. In fact, within two hours of The Merge, Ethereum was already showing signs of centralization, with only two entities confirming nearly half of all blocks verified in that period. After testifying before Congress on The Merge day, his SEC Chairman Gary Gensler reiterated his view that staking in PoS could be considered a security.
The issue of PoW vs. PoS is getting more and more attention in Europe as well. Therefore, a draft of the Crypto Asset Market Act (MiCA) earlier this year included regulations to limit proof of work. ESMA’s Vice-President has even called for a ban on the system due to sustainability considerations. However, the latest draft does not contain any rules regarding PoW limits.
It remains to be seen how the change from PoW to PoS will evolve. In this context, attention should also be paid to the consequences of switching to Ethereum and the political developments drawn from it in order to create the most sustainable crypto industry possible. However, if PoW is banned, as the White House believes, it will have a major impact on the blockchain industry as a whole, except for those networks that have upgraded their consensus mechanisms to more sustainable practices. But one thing is certain: sooner or later, blockchain technology will have to change to meet climate-friendly efficiency requirements.
1 The foundation of the digital future
2 Proof of Work (POW)
3 DIGITALES GELD NACHHALTIGER MACHEN (PDF)
4 Research: Digitales Geld nachhaltiger machen – dem quantifizierten Energieverbrauch von Bitcoin auf der Spur
5 Ethereum Energy Consumption Index
6 Proof of Stake (POS)
7 Proof of Stake (POS)
9 nasdaq.com – cryptocurrency market activity
10 nasdaq.com – bitcoin
11 Vitaly Buterin’s speech at the Ethereum Community Conference in Paris on July 21, 2022
12 Factsheet: The Climate and Energy Impact of Crypto Assets in the United States
Chanté Eliaszadeh (Associate, White & Case, London) and Helena Voege (Legal Trainee, White & Case, Frankfurt) contributed to the development of this publication.