As current blockchain technology faces accusations of inefficiency and unsustainability, a new technology is finding its way to counter them.
Blockchain
Crypto blockchains are a hotly debated topic. Blockchain is used by many cryptographic networks (e.g. Bitcoin and Ethereum) to enable various transactions. In this context, transactions are cryptographically signed instructions from network participants to update the network’s state. The simplest transaction is to transfer the cryptographic value, known as coins, from one account to another. A blockchain can be described as a chronological linking of blocks. These blocks contain different data. For example, information about the transaction itself, creation date and other information that is necessary for the creation and transaction. These blocks are linked together, creating what is known as the blockchain.
Original Blockchain technology
To create such a blockchain, so-called ‘miners’ are required. These miners are users of the respective blockchain that expand the chain by creating new blocks. It is necessary to ensure that only legitimate transactions become part of the chain. To create a new block, the miners must 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 the miners to work, the first miner to solve the problem receives a payment in the respective cryptocurrency. Since many miners work in parallel to solve the problem, only the winner who has “worked” the hardest or fastest gets to update the blockchain with the transaction. This original consensus mechanism is called ‘Proof of Work’ (PoW).
Disadvantages of “Proof of Work”
The proof-of-work mechanism has a huge drawback: Energy consumption. Due to the high processing power needed to complete the mining operation as quickly as possible, the energy consumption is enormous. Studies have found that bitcoin alone uses more than 100TWh per year. This corresponds to twice the annual electricity consumption in Switzerland. Especially with regard to Ethereum, a huge increase in energy consumption has been measured.
Another point is efficiency. In the PoW mechanism, many miners work simultaneously to add the same block to the chain, and only the work result of one of these miners can be exploited. 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 will make mining more efficient. Especially in times of climate change, PoW has faced a lot of criticism, and the voices for a necessary change have been getting louder recently.
‘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 rather than miners are responsible for expanding the chain. This mechanism uses an algorithm that determines the validator to add the next block. To participate in a proof of stake network, the validators must have a certain stake of coins on the network. Imagine that the validators insert a certain amount of tokens into a kind of lottery drum. The algorithm then randomly selects the next validator from among these deposited tokens. Thus, each token staked on the network represents a chance to be selected. This means that the higher the number of bets, the higher the probability that validation will be selected. To deter inappropriate behavior, the system penalizes improper transaction validations by seizing and destroying all or part of the malfunctioning validator’s stake. The PoS mechanism has certain advantages over the PoW mechanism. Due to the fact that miners no longer need to compete with each other, but validators are assigned their validation directly, less computing power is needed, which in turn reduces energy consumption. This increases the efficiency with which new blocks are attached to the respective blockchain.
The “merger” of Ethereum
Due to the energy-consuming negative impact associated with “proof of work”, one of the largest decentralized blockchain networks “Ethereum” has changed its consensus mechanism from “proof of work” to “proof of stake” on September 15. This update, called “The Merge”, aims to reduce the high computing power. In anticipation of The Merge, the price of Ether (the cryptocurrency of the Ethereum network) increased relative to Bitcoin (which did not make a similar change) in the previous weeks – although the price of Ether relative to Bitcoin has corrected somewhat in the days following The Merge. In addition, further changes are planned by the Ethereum network to further increase its own efficiency. According to Ethereum co-founder Vitaly Buterin, there are still four stages to come: ‘The Surge’, ‘The Verge’, ‘The Purge’ and ‘The Splurge’.
Political discourse
Since the PoW process has had a negative impact on sustainability, it is and is likely to remain under political scrutiny.
The White House announced, following a report on the climate impact of the crypto industry, that due to the existing climate changes and the set climate goals, a drastic reduction of energy in the crypto industry is a goal. If the targets are not met, the PoW process may be banned.
PoS is not without its critics either. It is generally considered less decentralized – a factor that implicates securities laws under the US Securities and Exchange Commission’s (SEC) framework for analyzing digital assets. In fact, within two hours of The Merge, Ethereum was already showing signs of increasing centralization, with just two entities approving nearly half of all blocks validated during that period. After testifying before Congress on the day of The Merge, SEC Chairman Gary Gensler reiterated the view that stakes under PoS can be considered a security.
In Europe too, the question of PoW vs. PoS more and more attention. Accordingly, the draft Markets in Crypto Assets Act (MiCA), at the beginning of this year, still contained regulations on limiting proof of work. The deputy head of ESMA even called for a ban on this system for reasons of sustainability. However, the latest draft no longer contains any rules on limiting PoW.
It remains to be seen how the change from PoW to PoS will develop. In this context, attention should also be paid to the consequences of the Ethereum transition and the political developments that will be drawn from it in order to create a crypto industry that is as sustainable as possible. Nevertheless, should there be a ban on PoW, as the White House intends, this will significantly affect the entire blockchain industry, except for those networks that have upgraded their consensus mechanism to more sustainable practices. One thing is certain, however: Blockchain technology will have to change sooner or later to meet the demands of climate-friendly efficiency.
