Explainer: What is cryptocurrency mining and how does it hurt the environment?

Although the market has swooned from its all-time-high of US$2.9 trillion at the end of 2021, cryptocurrency is now worth US$1.1 trillion – five times the size of the gaming market.

Virtual currency's huge size and volatility has started to trouble regulators, who cracked down after the collapse of one of the largest cryptocurrency exchanges, FTX, in 2022. It has also started to worry climate advocates, because of its enormous electricity consumption.

The United States government is trying to persuade Congress to pass a 30 per cent tax on the electricity used in cryptocurrency mining in the upcoming federal budget to minimise the industry’s burgeoning climate impact. It will be known as the Digital Asset Mining Energy (DAME) tax.

What is cryptocurrency mining? 

Cryptocurrency mining is the competitive process that verifies and adds new transactions to the blockchain, which is a digital transaction record.

As cryptocurrency is a decentralised network that lacks any central governing authority, cryptocurrency uses the proof-of-work method to verify the accuracy of new transactions.

Proof-of-work is a form of cryptographic proof in which one party proves to a verifier that a certain amount of a specific computational effort has been expended.

The miner who completes the highest volume of transactions is rewarded with some amount of currency and/or transaction fees.

If a miner is able to successfully add a block to the blockchain, they will receive 6.25 bitcoins as a reward. Although the reward amount is cut in half roughly every four years, or every 210,000 blocks, cryptocurrency mining still yields fairly lucrative rewards.

The two most popular cryptocurrencies in circulation today are Bitcoin and Ethereum.

As of March, Bitcoin traded at around US$24,300, making 6.25 bitcoins worth a staggering US$152,000.

How does cryptocurrency mining harm the environment?

The proof-of-work concept in cryptomining incentivises miners to ramp up their operations as quickly as possible, often irrespective of the energy source, so as to outdo their competitors.

As more bitcoin miners join the mining network, the difficulty of the computational problem increases, and the amount of electricity needed to win the race increases exponentially too.

Bitcoin, the world’s most widely-traded cryptocurrency, consumes 101 terawatt-hours of electricity annually, comparable to the power consumption of Kazahstan with a population size of 19 million.

Producing that energy emits some 56 megatons of carbon dioxide into the atmosphere each year. This is comparable to the emissions of Peru, making crypto a significant air polluter.

Using the social cost of carbon, a common metric to gauge the financial damage caused by the greenhouse gas, the researchers who looked at the number of bitcoins mined daily between 2016 and 2021, calculated the climate cost of Bitcoin.

On average, they found that for each dollar in bitcoin value created, the process resulted in 35 cents in global climate damage – or 35 per cent of its market value. In contrast, the climate damage caused by beef accounts for 33 per cent of its market value, while damages from gasoline produced from crude oil were 41 per cent.

On the other hand, the cryptocurrency ethereum implemented a major network upgrade in 2022 that completely changes how the blockchain verifies transactions, mints new coins and secures its network. Called proof-of-stake, this system has reduced ethereum’s energy consumption by more than 99 per cent.

A proof-of-stake network like Ethereum secures itself via staked cryptocurrency. Instead of expending computing energy to solve a puzzle, the nodes validating new transactions stake their own value as collateral. These nodes then run efficiently and honestly to avoid losing that collateral.

Deng Xin, associate professor of banking and finance at Singapore's Nanyang Technological University, said that in response to growing environmental concerns, the blockchain community has been actively integrating ecological considerations and embracing more sustainable consensus mechanisms such as Ethereum.

Cryptocurrency mining also produces electronic waste. As the equipment used for cryptomining is highly specialised, the hardware becomes obsolete within just a year and a half before it becomes e-waste, says Alex de Vries, a digital currencies researcher at the Vrije Universiteit Amsterdam in the Netherlands.

A single Bitcoin transaction creates about 275 grams of e-waste, which equates to 1.68 iPhone 12 devices, according to Digiconomist, a site that examines the unintended consequences of digital trends.

What are countries in Asia doing to mitigate cryptocurrency's climate impact? 

Deng said that the introduction of the DAME tax in the US is likely to prompt the departure of Bitcoin miners, driving them to seek more favourable jurisdictions given their sensitivity to cost.

A likely destination for America's Bitcoin miners could be Asia, which is leading the way in cryptocurrency regulations.

Attitudes towards the regulation of cryptocurrency vary greatly across Asia. In the most extreme of cases, developing Asian countries such as China and Bangladesh have banned cryptocurrency altogether.

Some countries, such as Kazakhstan, have adopted punitive measures similar to those implemented by the US. To discourage energy overconsumption, the central government implemented a 1 tenge (0.002 US cents) electricity rate surcharge, about a 4 per cent increase in total energy costs, on registered crypto miners last month. To further regulate the demand for power, state-owned Kazakhstan Electricity Grid Operating Company routinely restricts energy supply to cryptomining companies.

Ben Charoenwong, assistant professor in finance at the National University of Singapore Business School, says that countries in Asia — which are mostly emerging economies — may have a harder time adopting such punitive measures because of enforcement issues.

"I have heard plenty of anecdotes of miners simply tapping into electric poles, effectively stealing the electricity. These miners, unlike those in America, will not worry about energy prices. Likewise, going after them for taxes would also be difficult," he said.

As such, other countries like Uzbekistan have adopted a carrot-and-stick approach.

The Central Asian country has legalised crypto-mining powered by solar energy, and has implemented a new federal income tax exemption that will benefit miners who install solar panels.

At the same time, the government in Uzebekistan has also levied steeper electricity rates on miners who choose not to make the switch to renewable energy, while imposing surcharges during the busiest hours of the day. Miners using non-rewewable energy are also required to foot double the electricity tariff of those using solar energy.

Meanwhile, countries with a surplus of renewable energy such as Japan, have said that they will divert excess renewable energy across the grid to distributed data centres that power cryptocurrency mining operations, curtailing energy wastage.

"Encouraging miners' participation in carbon offsetting programs could also provide another avenue for mitigating their environmental effects," said Deng.

"Countries can also allow cryptocurrency miners to issue green bonds to help miners transition from using energy from unsustainable sources to more sustainable sources," said Charoenwong.

On the other end of the spectrum, cryptocurrency mining is currently not being regulated in land-scarce Asian countries like Singapore. This is because the local conditions are not favourable for cryptocurrency mining.

"[Singapore's] relatively high land, labour and electricity costs, coupled with our hot tropical climate, make it expensive to operate cryptocurrency mining," said environment minister Grace Fu in  parliament in 2021.

What does the future hold for crypto-mining?

Charoenwong concluded that all proof-of-work cryptocurrencies such as Bitcoin are at risk of future developments, such as technological transitions arising from pressures exerted by environmental groups and support from the open-source communities behind these decentralised cryptocurrencies to make the switch.

Hence, the energy discussion may become moot one day, just like how it was wiped out with Ethereum's migration from proof-of-work to proof-of-stake.

"So in some sense, the issue of mining may 'solve itself' just from the incentive of actors in the own economies to develop new solutions even without much government intervention," he said.

A caveat, however, is that this transition is likely to take time given that the majority of Bitcoin miners, who collectively mine 900 new bitcoins per day (worth over US$20 million), still prefer the existing proof-of-work concept. "As such, to the extent that the cryptocurrency activity generates a negative externality to the public, we should consider taxes or other schemes to correct the externality," he said.

Source: Eco-Business