As the current blockchain technology faces accusations of inefficiency and unsustainability, new technology is finding its way to counter it.
Crypto-block chains are a hotly debated topic. Blockchain is used by many crypto networks (such as Bitcoin and Ethereum) to enable various transactions. In this context, transactions are cryptographically signed on instructions from network participants to update the state of the network. The simplest transaction is the transfer of crypto value, known as coins, from one account to another. A blockchain can be described as a time sequence of blocks. These blocks contain different data. For example, information about the transaction itself, the date of creation, and other information needed for creation and transactions. These blocks are linked together, creating what is known as a blockchain.1
Original Blockchain Technology
To create such a blockchain, so-called “miners” are required. These miners are the relevant blockchain users who extend the chain by creating new blocks. It is essential to ensure that only legitimate transactions become part of the chain. To create a new block, miners have to solve a cryptographic problem, i.e. 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 miner to solve the problem receives a payment in the respective cryptocurrency. Since many miners are working in parallel to solve the problem, only the winner that “works” the hardest or fastest is the one who updates the blockchain with the transaction. This original consensus mechanism is called Proof of Work (PoW).2
Disadvantages of Proof of Work
Proving the mechanism of action has a major drawback: power consumption. Due to the high processing power needed to perform the mining as quickly as possible, the power consumption is enormous. Studies have found that Bitcoin alone consumes more than 100 TWh per year.3 This is equivalent to twice the annual electricity use in Switzerland.4 Specifically with respect to Ethereum, a massive increase in energy consumption has been measured.5
Another point is efficiency. In the PoW mechanism, multiple miners work simultaneously to add the same mass to the chain and only the result of the work of one of these miners can be used. Thus, the number of miners can be used to add more blocks in a shorter period of time. This will increase the speed of adding new blocks and make mining more efficient. Especially in times of climate change, PoW has faced a great deal of criticism, and voices for necessary change have been growing in recent times.
“Proof of Stake” instead of “Proof of Work”
Aside from Proof of Work, Proof of Stake (PoS) provides another mechanism for adding blocks to the blockchain. In this approach, auditors rather than miners are responsible for chain expansion. This mechanism uses an algorithm that specifies the checker to add the next block. In order to participate in the proof of the equity network, the validators must have a certain share of the coins on the network. Imagine that validators deposited a certain amount of codes into some kind of lottery cylinder. Then the algorithm randomly chooses the next validator from among these deposited tokens.6 Thus, every token on the network presents an opportunity for selection. This means that the more bets you have, the more likely you are to choose validation. To deter misconduct, the system penalizes incorrect validation of transactions by seizing all or part of the share of the misbehaving validator.7 PoS mechanism has certain advantages over PoW mechanism. Due to the fact that miners no longer have to compete with each other, but instead set validators to check directly, less computer processing power is required, which in turn reduces power consumption. This increases the efficiency with which new blocks are linked to the respective blockchain.
Due to the energy-intensive negative impact associated with Proof of Work, one of the largest decentralized blockchain networks, Ethereum, changed its consensus mechanism from Proof of Work to Proof of Stake on September 15.8 This update called “Merge” aims to reduce high computing power. In anticipation of The Merge, the price of Ether9 (Ethereum cryptocurrency) increased relative to Bitcoin10 (which did not make a similar change) in the previous weeks – although the price of Ether relative to Bitcoin corrected somewhat in the days following the merger. In addition, the Ethereum network is planning further changes to increase its efficiency. According to Ethereum founder Vitaly Buterin, four more steps remain: “The Surge,” “The Verge,” “The Purge,” and “The Splurge.”11
Since the proof-of-work process has had a negative impact on sustainability, it is likely to remain under political scrutiny.
The White House, following a report on the impact of climate on the crypto industry, announced that due to current climate change and specific climate goals, drastically reducing energy in the crypto industry is a goal. If goals are not achieved, the proof-of-work process can be blocked.12
The selling points are not without cash, either. It is generally considered less decentralized—a factor that implicates securities laws under the U.S. Securities and Exchange Commission (SEC) framework for digital asset analysis. Indeed, within two hours after the merger, Ethereum had already shown signs of increased centralization, with only two entities approving roughly half of all validated blocks in that period. After testifying before Congress on the day of the merger, Securities and Exchange Commission (SEC) Chairman Gary Gensler reiterated the view that staking under PoS can be considered security.
In Europe, too, the issue of proof of work versus entry points is attracting more attention. Accordingly, the Markets in Crypto Assets (MiCA) bill, at the beginning of this year, still contained regulations on the Proof of Work restriction. The Vice President of ESMA has called for the system to be banned due to sustainability considerations. However, the latest draft no longer contains any rules on restricting Proof of Work.
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 changing Ethereum and the political developments that will be drawn from it in order to create a crypto industry that is as sustainable as possible. However, if there is a Proof-of-Work ban, as the White House envisioned, this will greatly impact the entire blockchain industry, with the exception of those networks that have developed their consensus mechanism into more sustainable practices. However, one thing is certain: sooner or later blockchain technology will have to change in order to meet climate-friendly efficiency requirements.
1 The foundation of our digital future
2 Proof of Work (POW)
3 DIGITALES GELD NACHHALTIGER MACHINE (PDF)
4 Study: Digitales Geld nachhaltiger Machen – dem quantifizierten Energieverbrauch von Bitcoin auf der Spur
5 Ethereum Energy Consumption Indicator
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 Fact Sheet: Climate and Energy Impacts on Crypto Assets in the US
Chanté Eliaszadeh (Participant, White & Case, London) and Helena Voigy (Legal Intern, White & Case, Frankfurt) contributed to the development of this publication.
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