At Expensivity, Bernard Fickser, who has explained how to sell non-fungible tokens (NFTs) now offers “The Truth About Cryptocurrencies: A Clearheaded Guide to the Crypto World.” (January 15, 2022) For your convenience, we are serializing his work, which can be read in whole here. Here’s Part 6 (of 6):

6 Conclusion: Is Crypto a Mature Technology?

So far, this article’s approach to crypto has been a balancing act, weighing pros against cons. Thus, we’ve seen much to commend crypto, but also much to raise doubts about it. In this closing section, I’m going negative. My concluding thesis is this: peer-to-peer distributed blockchain-based cryptocurrencies as they exist now represent an immature technology and miss much of what we would like to see in a full-fledged cryptocurrency.

I’m therefore going to lay out what I take to be deal-killers with today’s crypto as well as what we should ideally like to see in a crypto of the future. Whether such a crypto of the future is indeed possible will be left to a follow-up article.

6.1 Insane Energy Consumption

I mentioned earlier that Elon Musk would accept Bitcoin in payment for Tesla automobiles except that Bitcoin mining consumes too much electricity and is therefore unfriendly to the planet. Stated in these terms, however, Musk’s concern doesn’t even begin to clarify just how bad Bitcoin is as an energy drain.

The most current estimates are that Bitcoin consumes 200 TWH (terawatt-hours) annually. That’s the energy consumption of substantial countries with tens of millions of citizens, such as Poland, Thailand, and Turkey. Not far behind is Ethereum, which consumes over 100 TWh annually. That’s more than smaller European countries like Finland, Belgium, and Austria.

How much does all this energy consumption cost? One way to answer this question is by calculating the average energy cost per Bitcoin transaction. On average, there are roughly 300,000 Bitcoin transactions daily. It’s estimated that each of these transactions costs the peer-to-peer network that processes them north of $100 each. As Forbes notes, “each Bitcoin transaction consumes 1,173 kilowatt hours [kWh] of electricity. That’s the volume of energy that could power the typical American home for six weeks.”

At an average worldwide cost per kWh of $0.14, that comes to more than $164 per Bitcoin transaction. Now granted, Bitcoin miners tend to congregate where electricity costs are lower. In China, the average kWh costs about $0.08. But that still means that before China outlawed cryptocurrencies in September 2021, and even if all miners were located in China, each transaction would still cost around $100. Bitcoin mining has now left China and presumably gone to other countries with low electricity costs.

But even at $100 per Bitcoin transaction, that means $30,000,000 in electricity costs per day to run Bitcoin. Given that Bitcoin blocks take about 10 minutes on average, that means, with 24 x 6 = 144 blocks in a given day, each block entails roughly an expenditure of $30,000,000/144 = $208,333. Given, that 6.25 Bitcoins are created in each block, that means each Bitcoin created these days jointly costs miners over $33,000 just in electricity costs.

Given hardware costs to run dedicated mining computers, it’s probably safe to say that each Bitcoin costs miners more than $40,000. And what happens in 2024 when the number of bitcoins mined in each block is halved to 3.125. All those numbers for the cost per bitcoin will double.

At what point does it become financially infeasible to keep in operation Bitcoin mining, which is necessary for the peer-to-peer network that runs Bitcoin to exist in the first place? Will miners abandon ship? Will the peer-to-peer network grind to a halt? These are real dangers

Ethereum is, of course, not far behind Bitcoin in all these concerns. Ethereum’s energy drain is likewise insane. The leadership of Ethereum sees this and wants to switch over to a more energy efficient proof-of-stake approach to creating and distributing ether.

But for now, like Bitcoin, Ethereum’s consensus mechanism is based on proof of work, and the problem with proof of work in mining of cryptocurrency is that it becomes an arms race in which ever faster processors running in every greater numbers and with ever increasing electricity demands are required to compete against other miners to create new cryptocurrency.

Short of some new physics creating abundant free energy (cold fusion? Moray radiant energy?), proof-of-work based cryptocurrencies are a train wreck waiting to happen

6.2 The Incentivization Trap

Not all cryptocurrencies are based on energy-intensive proof of work to run their peer-to-peer networks and thus implement their consensus mechanisms. But all peer-to-peer networks that run cryptocurrencies require incentives to keep operating. Are those incentives enough to guarantee, or at least render probable, the long-term viability of cryptocurrencies?

We just saw that for proof-of-work consensus mechanisms, keeping up incentives could prove problematic as energy demands continue to skyrocket and place ever more burdens on the users running the underlying peer-to-peer network. But what about other types of consensus mechanisms?

All the other consensus mechanisms are in some broad sense proof-of-stake, where one’s involvement in the cryptocurrency, whether in facilitating transactions, owning existing cryptocurrency, or maintaining the blockchain ledger, provides incentives for users to maintain the underlying peer-to-peer network that runs the cryptocurrency. There can also be disincentives, where failure to provide certain services leads to a loss of cryptocurrency.

We’ve already seen that proof-of-stake cryptocurrencies (and I include here proof-of-history as a special case) tend to concentrate wealth among a very few early adopters, leaving most people who are interested in acquiring the cryptocurrency with but a few crumbs (section 5). But even if such crypto could be more equitably distributed, why should we think that the incentivization mechanisms that it uses provide any guarantees that it will endure?

It’s a question of the longevity of a cryptocurrency’s incentives, and it’s a problem that confronts all existing cryptocurrencies. No cryptocurrency can exist unless users/nodes of the peer-to-peer network that supports it keep running its protocols. But why should they keep running it? Perhaps they’re invested in the cryptocurrency. Perhaps, at least for now, they are seeing some reward in helping to run it.

But what guarantee is there that such incentives won’t run out? What if some other cryptocurrency ends up looking more attractive? What’s to prevent a user from jumping ship and embracing that other cryptocurrency? And what if that happens enough times that the peer-to-peer network that is supposed to run the cryptocurrency becomes unstable and begins to falter? Like people dumping a stock in a panic, it’s not far-fetched to think that a sudden loss of confidence in a crypto could lead to its abandonment.

These are not idle or academic concerns. We’ve already seen this worry play out in case after case. There’s even a website called Coinopsy.com (as a play on autopsy) that tracks failed cryptocurrencies (over a thousand, and counting!). Coinopsy defines “dead coins” as follows:

Dead Coins refer to cryptocurrencies that have been abandoned, used as scam, their website is down, has no nodes, has wallet issues, doesn’t have social updates, has low volume or developers have walked away from the project.

Just as ghost towns represent once-thriving communities, so dead coins can represent cryptocurrencies that once were going concerns and then sank into desuetude. It happens. And it happens especially on the web. Anybody who has spent considerable time on the web has witnessed first hand what’s come to known as “link rot.” Links that used to work no longer work because the items on the web that were linked to are suddenly gone. Sometimes you can go to the Web Archive (aka Way Back Machine) and try to recover the items, but often they are just gone for good.

Link rot is a special case of what I call digital dilapidation. The web consists of digital properties. The peer-to-peer networks that run cryptocurrencies are examples of such properties. All properties, whether real or digital, are subject to decay, to the forces of entropy over time. Things, whether real or digital, don’t stay as they are or maintain their functionality without constant supervision and upkeep.

But supervision and upkeep require incentives. People don’t just supervise and keep up things for the fun of it. Right now, cryptocurrencies are a hot topic, and for the hot cryptocurrencies out there (i.e., those in the top 50 or so in market capitalization), it will seem that the interest and incentives to keep them running now will be enough to keep them running indefinitely. But as Coinopsy demonstrates, that’s a misapprehension. This is the incentivization trap, i.e., to think that the incentives that are currently in place to keep a digital property going will be there in the future. There are no guarantees.

So far, the incentivization trap has applied to individual cryptocurrencies that for a time held sway but then were given up by their user base. But what happens if there’s a general loss of confidence in crypto? If the incentivization trap comes to apply widely to many cryptocurrencies, then the users that keep them functioning may bail en masse.

6.3 Concerted Government Antagonism

The cyperpunks who gave us crypto had an anarchic streak and saw in crypto a way to bypass government controls in advancing freedom and privacy. So far, they have largely been vindicated. Crypto has been able to get around government interference, even to the point that some politicians and economists are increasingly concerned about crypto’s role in abetting a criminal economy and want to curtail it. The locus classicus exemplifying this concern is Ross Ulbricht‘s Silk Road marketplace, in which Bitcoin was used to buy and sell illict drugs.

But what happens if governments crack down on crypto? We saw this in May of 2021, when China outlawed crypto mining, and then in September 2021, with a vengeance, when China outlawed all cryptocurrencies. As it is, some crypto mining — now totally illegal — still continues in China. As CNBC, in December 2021, reported about a Chinese crypto miner named Ben:

Ben is mining for bitcoin in the Chinese province of Sichuan, hoping every day that he doesn’t get caught by the authorities. 

Like other crypto miners who have gone underground since Beijing cracked down on the industry earlier this year, Ben — who asked only to be identified by his nickname to ensure his safety — is getting creative to evade detection. 

Ben has spread his mining equipment across multiple sites so that no one operation stands out on the country’s electrical grid. He has also gone “behind the meter,” drawing electricity directly from small, local power sources that are not connected to the larger grid, such as dams. He’s taken steps to conceal his geographic digital footprint, as well.

Ben tells CNBC that he is used to “getting around things” when it comes to running a business in China, but the last six months have really raised the stakes. 

“We never know to what extent our government will try to crack down…to wipe us out,” Ben said.

Ask yourself how long operations like Ben’s are sustainable. And what happens if world governments as a whole start cracking down on crypto? When China cracked down on crypto, most mining operations in China jumped ship to other countries (apparently with little if any loss to overall Bitcoin mining). But what if, for crypto mining, there are no other countries, or if they are few and far between?

Proof-of-work based cryptocurrencies like Bitcoin and Ethereum are so energy intensive in their mining operations that they will be hard to hide. Unless you can tap illegally and undetectably into an electricity source to do mining, your mining operation will be on the grid, and the energy distribution on the grid will be open to government scrutiny, with tell-tale patterns of energy consumption diagnostic of crypto mining surely being evident. And once it’s evident, it’s easy to shut down.

Why the increasing government hostility to crypto? Crypto acts like cash, which keeps transactions private and thereby allows users to hide transactions from the government. This makes it easy to use crypto for illegal purposes, including tax evasion. Governments, in the interest of maintaining their power, are thus showing an increasing hostility toward crypto, preferring it to go away and substituting in its place a Central Bank Digital Currency (see section 7.3 of Expensivity’s article “The Creation of Money“). True, some local governments in the US are providing openings for crypto, and some countries, such as El Salvador, are likewise providing openings.[9]

But it’s entirely plausible that governments will increasingly be closing the doors on crypto. Exchanges, for instance, are becoming more and more regulated. Short of outlawing crypto in the US, exchanges like Coinbase could essentially be taken over by the US government, where all its activities are clearly delineated. That would still leave users working with crypto wallets. But even here a government hostile to crypto could do much to rein it in.

A government doesn’t have to go as extreme as China in fully outlawing crypto. It can, instead, put laws in place that merely outlaw crypto privacy (“you can still transact crypto, but we need to know about it”). In a surveillance economy where big tech and big government conspire to track all digital activities, it would presumably be possible to go as granular as tracking keystrokes and finger swipes on smartphone apps to determine whether a crypto transaction has occurred and what it was.

But even if it is possible to stay off the government’s radar in one’s own personal crypto transactions, it may not be possible for the peer-to-peer network that runs the crypto to stay under the radar. These peer-to-peer networks will always be computationally intensive, even if not based on proof of work, and display characteristic digital signatures of the blockchains being processed.

And even if an existing peer-to-peer network running a blockchain can remain out of reach of direct government control, it’s unclear that it can avoid government subversion. The NSA, for instance, has immense computational resources. One can imagine the NSA, with its huge computational resources for doing hashing, setting up cubicle after cubicle as nodes on the Bitcoin network (or any other cryptocurrency network like Bitcoin with an open blockchain) and essentially taking over the network by performing most of its computations.

Achieving that level of computation doesn’t have to extend over a long period of time, but just enough to achieve majority control. That’s because the peer-to-peer networks that run crypto’s blockchains are democratic, run by a 51 percent vote. It’s enough therefore to subvert these networks briefly, and then redirect them along a government’s preferred prong of a hard fork.

This may all seem a bit speculative right now in that governments have largely taken an indulgent attitude toward crypto. Even in China, one has to wonder if Ben in the CNBC article above could continue his Bitcoin mining operations if China really decided to crack down. And that’s the issue: what happens when governments put aside their present lackadaisical attitude toward crypto and really decide to crack down?

In that case, crypto as we know it would largely disappear. Existing crypto exhibits a fundamental weakness that makes it easy pickings for governments intent on control. That weakness centers on the peer-to-peer blockchain-based networks that run cryptocurrencies and on whose reasonably smooth operation cryptocurrencies depend for their very existence. These existing crypto networks can, with enough computing power, be readily subverted. And what has more computing power than a government?

The subjugation of crypto to computing power was implicit in Satoshi Nakamoto’s abstract to his Bitcoin whitepaper (recall the reference in it to “majority of CPU power”; see section 3). It’s implicit even in newer blockchain-based, non-proof-of-work cryptocurrencies, such as Solana, which require Byzantine fault tolerances to operate successfully (the core idea of Byzantine fault tolerances being that good actors need to outnumber bad actors for these systems to work). That’s the vulnerability.

6.4 What’s Wanted in Any Future Cryptocurrency?

Since I’m writing a full follow-up article for Expensivity on what a radically decentralized cryptocurrency should look like — one that avoids the problems of blockchain-based cryptocurrencies outlined earlier in this section as well as earlier in this article —I’m going to keep this conclusion brief.

There’s one main problem with existing cryptocurrencies, and that’s that the average user (in contrast to the creator of the cryptocurrency, such as Satoshi, and also its early adopters) can only acquire crypto by either (1) buying it with conventional currency from someone who already owns it or (2) jumping through the hoops set by the protocols that characterize crypto transactions on the blockchain in question long after that crypto is readily available (i.e., as high-hanging rather than low-hanging fruit; creators and early adopters get it as low-hanging fruit).

In neither case, however, can average users take value from their stores of value and directly convert them into crypto, with value being commensurable. Money or effort expended by the average user to obtain existing crypto ends up being an uneven transaction, with the value received often quickly out of sync with the value inputted (because existing crypto is so volatile and admits of no clear valuation).

Consider the contrast with minting gold coin. Back when money was gold coin, an economically viable DIY mint would have been possible. An individual could mine for gold, purify it to acceptable standards, and then, with a suitably engraved coining press, manufacture coins indistinguishable from those of the realm. Such coins would be economically legitimate (even if the government would have preferred to mint the coins themselves).

No such parallel exists for crypto as it is configured now, but I want to suggest that a mature crypto technology would allow for crypto to be minted by the individual without the need for permission from a centralized authority, even if it is a peer-to-peer blockchain-based network that is advertised as “decentralized.” It is decentralized only in the sense that it is non-hierarchical with no single node of control at the top of a hierarchy. But collectively the nodes that make up such a network constitute an authority, even a trusted third party. It is a democratized centralization, rather than a traditional monarchical centralization, but it is a centralization nonetheless.

I want to suggest that a mature crypto technology will dispense with this democratized centralization and be radically decentralized, where the individual user can create cryptocurrency essentially from scratch, in analogy with a DIY mint for gold. The devil, as always, is in the details, and I will lay them out in a follow-up article titled “Is a Digital DIY Mint Possible? The Minimum Infrastructure Needed for Digital Money Creation.” Stay tuned.

Notes

[1] Eugene F. Fama and Kenneth R. French, “Size, Value, and Momentum in International Stock Returns,” Journal of Financial Economics, 105(3) (2012): 457–472.

[2] William Poundstone, Fortune’s Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street (New York: Hill and Wang, 2005). This book is for a general audience and describes how to wager in order to maximize your expected rate of return based on the total you have to wager (wager too much, and you can lose everything, even in a winning game, by getting unlucky; wager too little, and your rate of return will grow too slowly).

[3] Ben Mezrich, Bringing Down the House: The Inside Story of Six M.I.T. Students Who Took Vegas for Millions (New York: Free Press, 2002). This book shows how beating the casino can actually happen, as well as some of the risks. The risks include not merely getting caught, but also getting caught up in the whole gambling culture, which all the participants ultimately found destructive to themselves.

[4] Jackson Palmer, in his interview with Kal Penn for the Amazon Prime docuseries This Giant Beast That Is The Global Economy (season 1, episode 7), describes how he put Dogecoin out to the public and then simply sat back, never to cash in on the venture.

[5] For more on that pre-Bitcoin history, see Duke University professor Harvey Campbell’s lecture notes on the history of digital money.

[6] Cryptographers James Ellis and Clifford Cocks, both at the British version of the American National Security Agency (i.e., the General Communications Headquarters), had in fact originally invented the Diffie-Hellman as well as the RSA schemes several years earlier, but because their work was classified, it only reached public awareness once it was independently reinvented by Diffie et al.

[7] See Antony Lewis, The Basics of Bitcoins and Blockchains: An Introduction to Cryptocurrencies and the Technology that Powers Them (Coral Gables, Florida: Mango Publishing, 2018), s.v. “Cross Border Payments.” Lewis was a traditional banker who got excited about cryptocurrencies and switched his entire emphasis there when he understood the ease and flexibility brought on by crypto. He is especially clear in this book about the advantages of crypto over conventional banking in handling remittances.

[8] Campbell R. Harvey, Ashwin Ramachandran, and Joey Santoro, DeFi and the Future of Finance (New York: Wiley, 2021).

[9] Despite the big hopes that Bitcoin would be a boon for the Salvadoran economy, signs in late January 2022 suggest otherwise: “Months after El Salvador announced that it would accept bitcoin as legal tender, the country has found itself on the verge of economic collapse yet again… It turns out that forcing your nation’s banks and stores to accept a currency large swaths of the population are unfamiliar with and don’t trust is a good way to tank your economy.”

The whole series in order:

Part 1: Some brute facts about Bitcoin and other cryptos Crypto is transforming money and finance. Like the computer, you don’t need to use one but you’re wise to know the basics. Start here. Crypto functions much like cash, avoiding or minimizing the increasing ability of government or other big institutions to snoop on who you give money to.

Part 2: If you want to stick a toe in Bitcoin’s world … read this first. This short guide offers a quick introduction to the two biggies, Bitcoin and Ethereum. Whether you are investing or just using the system, you need to be very cautious with passwords. It’s not your street corner bank.

Part 3: As money slowly transitions from matter to information… Let’s look at a brief history of cryptocurrencies — which is not quite what we might think. The mysterious Satoshi Nakamoto, founder of Bitcoin, did not invent new concepts in computer science or cryptography; he put them together in a way that worked.

Part 4: How and Why Cryptocurrencies are Revolutionizing Money The trouble is, cryptos are an immature technology at present and that fact may doom many of the current ones. Bernard Fickser looks at the “hard forks” where things went badly wrong. There are problems that decentralization and minimizing the need for trust can’t solve.

Part 5: Is cryptocurrency selling out to centralization? Crypto wealth is radically centralized in the hands of a few, compared to more conventional forms of money. A bit like the politician who goes to Washington to change things and leaves it unchanged — but has become a millionaire in the meantime…

and

Part 6: Why cryptocurrencies like Bitcoin are not ready for prime time Bernard Fickser at Expensivity — friendly to cryptos in principle — offers an unsparing look at the current problems. Unsolved problems include insane energy consumption, dead coins, and the potential of government subversion, if not suppression.