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Bitcoin

Episode 174 – Fanning the Flames: Proof of Work Consensus Algorithm

Glenbrook’s Neel Saunshi and Yvette Bohanan return to explain the Proof of Work consensus algorithm. Listen in as they discuss what it is, how it works, and the environmental impact from the associated energy consumption.

 

Yvette Bohanan:

Hi, everyone. Welcome to Payments On Fire. I’m the Yvette Bohanan, one of the partners here at Glenbrook, and along with George Peabody, we co-host our podcast series, Payments On Fire, on a regular basis. Today is a quick episode, called Fanning The Flames, where we take a particular topic of interest that’s happening in the news, or where we’re getting a lot of questions in our education workshops, or people calling us. And we try to focus on it, highlight it, and break it down and explain it in 10 minutes or so.

 

Yvette Bohanan:

So, with me today is a colleague, Neel Saunshi, at Glenbrook. He is one of our experts in the digital currency space and digital payment systems, and so we are delighted to be talking with him. So welcome, Neel.

 

Neel Saunshi:

Thank you. I’m happy to be here.

 

Yvette Bohanan:

And, we are going to talk about the evolution of the proof of work consensus algorithm. So, let’s start by just breaking down, in a few sentences. What is, for those that aren’t talking about this on a day in and day out basis, what are we talking about when we say proof of work consensus algorithm?

 

Neel Saunshi:

Yeah. So proof of work, it was the first type of consensus blockchain mechanism that came out onto the market back in 2007. Most notably, it’s called Bitcoin. So the way this actually works is the fact that it converts. Mechanism is supposed to convert real world energy to solve these mathematical problems on a system called the blockchain, and then in doing so, the miners or the people that validate these transactions and use the energy, get rewarded by getting a few Bitcoin. So this process is called proof of work.

 

Yvette Bohanan:

And they do all this work because they have to add a block to the chain?

 

Neel Saunshi:

Exactly.

 

Yvette Bohanan:

So, that validation basically, is getting agreement of which block to add.

 

Neel Saunshi:

Exactly.

 

Yvette Bohanan:

Okay. Got it.

 

Neel Saunshi:

So in doing so, they, the miners earn rewards and most commonly they earn Bitcoin.

 

Yvette Bohanan:

Okay. So it’s a self-propagating sort of environment, and it has been getting a bad rap since Bitcoin came onto the scene, 13 or so years ago, because it’s kind of an energy hub.

 

Neel Saunshi:

Yeah.

 

Yvette Bohanan:

So, that’s really one of the criticisms of a proof of work, is there’s investment. And that investment in that conversion that you’re talking about, sucks energy off of somebody’s energy grid somewhere, in order to perform this task of mining and getting consensus. And we get this question at least once every workshop, where we’re talking about digital currency systems. People saying, “Isn’t this horrible for the environment?”

 

Yvette Bohanan:

So, that’s what brings us here today, and the evolution of this algorithm. The New York State Senate just passed a Bitcoin mining moratorium bill. Now, it’s not law yet, but it’s passed the Senate and it passed with a 36 to 27 vote. So it passed with a decent margin. What is this all about?

 

Neel Saunshi:

So, this has to do with the whole ESG concerns we’ve been seeing around the world. We all know carbon emissions are through the roof. We need to curb carbon emissions, and it’s very important. So this whole idea behind Bitcoin becoming so energy intensive in today’s world, I mean, it was only a matter of time before something like this was introduced on the market. So this bill, essentially, is trying to curb the environmental impact, by making sure that new miners who are trying to mine Bitcoin, do not mine using carbon based fuel systems.

 

Yvette Bohanan:

Okay.

 

Neel Saunshi:

So, there’s a two year ban for those new miners that end up doing so. So this is kind of rewriting the whole licensing around how you can mine, but then who should be mining as well.

 

Yvette Bohanan:

And we know that the state of New York famously came out very early on with their Bitcoin permit.

 

Neel Saunshi:

Oh, yeah. Their BitLicense. Yeah.

 

Yvette Bohanan:

BitLicense, for things like Bitcoin. So we basically see them evolving and saying, “It’s not good enough to be licensed in what you’re doing, but we also are now looking at how you’re doing it.” That’s kind of out there on the tip of the spear, if you will.

 

Neel Saunshi:

Yeah.

 

Yvette Bohanan:

So, they’re taking a bold stand, and good for you, state of New York for doing this, because you’re bringing a lot of awareness, a call to action. How big is the problem? How do we size this in our brains? How much energy is being consumed? Who’s been doing this historically. What does it look like?

 

Neel Saunshi:

Yeah. So actually let’s start with how Bitcoin started off in the early days. Back in 2007, when Bitcoin was created, it could be mined on a computer, right? So everyone who had a computer, could just mine this and earn their coins. And the energy cost was almost minimal to nothing. But what happened is, as more and more users got onto the network, people started realizing the cost was increasing. The cost of the infrastructure to mine these transactions, but also the cost to use the energy as well, because there was a lot of heat being produced. And so, it cost a lot more to mine Bitcoin than people originally thought. So back in 2017, we actually had a bunch of miners based out of China. They owned 50% of the network and there were using coal powered plants to mine Bitcoin.

 

Yvette Bohanan:

Coal, not necessarily the cleanest, most renewable thing out there. Right? So, okay.

 

Neel Saunshi:

Exactly. And you can imagine with ESG mandates, this was not looking good for China at all.

 

Yvette Bohanan:

Right. So today, what are we seeing in terms of consumption, if we kind of fast forward 13 years?

 

Neel Saunshi:

Yeah. So today we see a lot of miners are actually in the US and Europe, and South America as well. And we’re noticing that Bitcoin mining within the US, actually, is beginning to grow. So there was a study done by Cambridge where they found out, the US Bitcoin energy consumption, as of today actually consumes a 0.54% of the total US electricity bill.

 

Yvette Bohanan:

So, roughly a half a percent of our total available power is going to Bitcoin mining.

 

Neel Saunshi:

Electricity, yes.

 

Yvette Bohanan:

Okay. And then if we expand that out on a global scale, how much of the global energy production available resource is being consumed?

 

Neel Saunshi:

0.55%.

 

Yvette Bohanan:

Okay. So, a half a percent of the US available resource and about a half a percent of the global resource. And just to put that in perspective, how’s that compared to a country? What country would be consuming 0.55% of global energy production.

 

Neel Saunshi:

You can think of Sweden. Sweden’s a good metric to base it off of.

 

Yvette Bohanan:

Okay. So one type of Bitcoin, one type of cryptocurrency, Bitcoin, and there’s tens of thousands of those out there right now. Right? And there’s a couple hundred stable coins, we know that. And, a few pilots of central bank, digital currency, but wow. That’s a lot of energy. So, that got everybody’s attention in New York at least.

 

Yvette Bohanan:

And what do you think will happen? What’s the outcome here? If we have a take on this bill passing in New York and the Senate there, what are the implications? Which way could this go? Because, regulation always cuts both ways. Right? So let’s think about this.

 

Neel Saunshi:

So, let’s talk about the Bitcoin miners. So for the Bitcoin miners that are being compliant with this new rule, and are reassigning their permits, and making sure they’re energy compliant, they’re actually going to be able to stay within New York and mine Bitcoin. Now this was great because the state of New York has around 80% of its energy coming from hydroelectricity, which is fantastic, right. It meets the ESG standards and it’s great for everyone, and it’s cheap as well.

 

Neel Saunshi:

So, it’s great for the miners that are already there and in practice, but for new miners that are interested in getting in on this space, it’s terrible. Because, they need to be more compliant, which means their risks go through the roof, which means their costs go through the roof as well. So they can’t set up a new facility in New York anymore. We should end up seeing a lot of exodus coming from New York, into other states like Texas, where they have their own energy grid, and the cost for the energy is actually minimal, comparative to New York. So we’ll see an exodus from new miners. Old miners will stay, which may consolidate the mining network around Bitcoin, making it actually, not as decentralized as people assume.

 

Neel Saunshi:

Now, on the regulation side, it’s a little different because this new bill that was introduced by the Senate, if it becomes passed by the governor or signed by the governor, we should see other states doing the same thing. They’re going to use this bill as a precedent to draft other bills in the future. So, we may see other states coming out with bills from their Senate. We may even see a more federally level bill coming from Congress around proof of work mining, and other proof of work mechanisms out there.

 

Yvette Bohanan:

So, sometimes we often see state regulations kind of inspire federal, if there’s enough critical mass getting behind them at the state level. So yeah, that’s definitely a possibility, too. But at least we’re actually talking about it. And, we’re starting to see, how you’re doing this, kind of come into play, in terms of energy consumption, ESG, which is climate. Everybody’s really concerned about this right now. So good for state of New York. I applaud them. I applaud them getting out there in front of this and trying to do something, but time will tell how the industry reacts.

 

Yvette Bohanan:

So we’ll be keeping an eye on this and what other states start to do, like California. Often, it’s California and New York that starts to think about these things first, and come out with some laws. So, we’ll see.

 

Neel Saunshi:

We’ll see.

 

Yvette Bohanan:

All right. So Neel, thanks so much. It’s been a pleasure as always, chatting with you. Thanks everyone for listening. If you have a podcast topic or a Fanning The Flames short topic that you would like to suggest, please feel free to email us at paymentsonfire@glenbrook.com. We read and take all your suggestions very seriously. So, let us know what you’d like us to be talking about. Until then, thanks everybody. Take care and do good work.

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