Cryptocurrencies like Bitcoin were meant to be used as digital cash. Instead, they’ve become popular as speculative investments.
As well as being resource-intensive and inherently wasteful, cryptocurrencies are also incredibly volatile. Prices for the largest cryptocurrencies, Bitcoin and Ethereum, have both dropped by over 55 percent in six months, leading some to suggest that regulation is needed to contain the turmoil.
Some are blaming sliding prices on one specific contagion, a collapsing “stablecoin” called TerraUSD which is supposed to be pegged to the US dollar. But the current cryptocurrency market crash is more likely a combination of lots of factors.
For years, interest rates have been close to zero, making bank bonds and treasury bills look boring as investments, while cryptocurrencies and digital non-fungible tokens (or NFTs) linked to artwork, look appealing.
However, the US Federal Reserve and the Bank of England recently increased interest rates by the largest amount since 2000. Continuing COVID controls and Russia’s invasion of Ukraine have also sobered up the markets.
Bitcoin was designed to be indifferent towards governments and banks, but investors generally aren’t. They’re cutting sources of risk from their portfolios and dumping crypto.
Crypto’s loss, climate’s gain?
The most polluting “proof-of-work” cryptocurrencies, like Bitcoin, Ethereum, and Dogecoin, together use around 300 terawatt-hours (TW/h) of mainly fossil-fueled electricity each year.
Bitcoin has an annual carbon footprint of around 114 million tonnes. That’s roughly comparable to 380,000 space rocket launches, or the annual carbon footprint of the Czech Republic.
Proof-of-work mining can be thought of as a controlled way of wasting energy. The process involves specialist computers repeatedly taking random shots at guessing a long string of digits. The amount of computing power dedicated to this effort is referred to as the network’s hash rate.
If the hash rate drops for any reason, because of power cuts or price dips, for example, the difficulty of the guessing game is automatically adjusted to ensure the network can find a new winner every ten minutes. Each winner then gets a go at verifying transactions occurring on the network and is awarded 6.25 newly minted bitcoins.
Whether the guessing game is profitable or not depends on how much the mining outfit has paid to set up their computers and for the energy to run them.
Most of the world’s proof-of-work mining machines use electricity generated by coal-fired power stations. The higher the cryptocurrency price, the more cash mining outfits are prepared to waste on this electricity, until the costs of winning outweigh the rewards.
With the Bitcoin price falling, the financial incentive to waste energy for mining Bitcoin should be lower. In theory, that’s good for the climate.
But, surprisingly, the network’s hash rate (and carbon footprint) remains very close to its all-time high, averaging around 200 quintillion hashes per second.
The scale of this continued interest means Bitcoin mining at current prices is probably still profitable. But for how long?
Tipping points and death spirals
Bitcoin’s value has temporarily dropped below the estimated cost of production several times before without significant long-term damage to the hash rate. But should the market stagnate for long enough, proof-of-work cryptocurrencies will start to see an increasing number of miners capitulate.
Miners with the highest costs are likely to sell off their bitcoin holdings as profitability drops, creating even more selling pressure in the market. Short-term capitulation among smaller mining outfits with high …….