The Inevitability of Escalating Energy Usage for Popular Proof-of-Work Cryptocurrencies: Dimensions of Cryptocurrency Risk

Introduction

Few financial market innovations offer potential opportunities to enhance transaction efficiency, as do the blockchain and cryptocurrencies. With the ability to record transactions or records in blocks over time and then link these blocks together in a chain that prevents subsequent modification, the blockchain allows inalterable records to be stored, often in the cloud. The potential to immortalize transactions, medical records, the ownership and transactions in real estate, or even ownership of a seat to performance or on a flight offers tremendous efficiencies and reductions in transaction costs. At the same time, it can also protect from cybercriminals’ attempts to modify records. This paper addresses the various risks associated with this new technology. I focus on one such blockchain, the Proof-of-Work Bitcoin, to highlight significant unanticipated risks from its use. I also demonstrate that an alternative method of tamper-proofing a blockchain, called Proof-of-Stake, lessens Bitcoin’s dramatic environmental risks.

Economists insist that there is no free lunch. Along with the significant reward in streamlining and reducing transaction costs come risks arising from the unique aspects of cryptocurrency mining demand and supply relationships, challenges relating to global warming, risks to inexperienced investors, and the ever-present cybersecurity risks. Digital currencies also reduce the ability of central banks to conduct monetary policy and challenge regulatory authorities to promulgate rules to protect the economy and consumers. Finally, if cryptocurrencies are to live up to their potential to serve as a substitute for traditional monies, an entire industry that touts its libertarian roots must offer confidence that users of their currencies are not exposed to wild gyrations in currency value. While regulators and central banks have long since learned how to manage traditional currencies to maintain their relative value and consumers’ confidence, the rapid development of cryptocurrencies has defied regulatory overview. I explore these various risks, demonstrate how they frustrate the efficiency they promise, and describe mechanisms to permit cryptocurrencies based on the blockchain to live up to their immense potential.