The Ethereum Merge's Climate & Energy Implications May Be Only the Beginning for the Crypto-Asset Industry
Load management is a hot topic these days, as grid managers struggle to satisfy growing energy demand in the face of steadily intensifying seasonal weather patterns. According to the U.S. Energy Information Administration, global net electric consumption has risen to over 23,000 terawatt-hours (TWh) annually in recent years. The prospect of shaving off even a sliver of that rising demand should raise eyebrows. In one massive move scheduled to occur this week, Ethereum—the world's second-largest cryptocurrency platform—stands to potentially eliminate a whopping 0.3%.
Energy use in the crypto-asset industry stems primarily from the consensus mechanisms used to mine and verify digital assets. The most well-known and commonly used mechanism is the Proof of Work protocol that underpins the two largest cryptocurrency platforms: Bitcoin and, until "the Merge" occurs, Ethereum. The Merge, anticipated by mid-September 2022, refers to Ethereum's long-awaited transition from the more energy-intensive Proof of Work to an alternative blockchain consensus algorithm referred to as Proof of Stake. Proof of Work requires tremendous energy expenditure as miners compete to solve complex equations to create new blocks that are then entered into the blockchain. Proof of Stake instead requires miners to deposit cryptocurrency as collateral for the right to validate transactions on the network. With Proof of Stake, the race to solve mathematical problems is replaced by an algorithm that appoints validators at random; transactions must be verified by a sufficient number of validators to be approved.
Ethereum predicts that moving to Proof of Stake will decrease its overall energy consumption by 99.95%—wiping out virtually all of its electricity demand in a matter of minutes. Eliminating almost all of Ethereum's estimated 80 TWh of annual energy consumption equates to an anticipated reduction of over 0.3% of global electric demand annually—as if the country of Finland dropped off the map. It's impossible to ignore the implications of adopting less energy-intensive consensus mechanisms to reduce the crypto-asset industry's increasingly massive energy demand, and digital asset enthusiasts aren't the only ones taking notice.
The Biden Administration Aims for Responsible Development of the Crypto Industry
In March of 2022, President Biden signed Executive Order 14067 on Ensuring Responsible Development of Digital Assets, which included a mandate for the White House Office of Science and Technology Policy (OSTP) to examine the climate and energy implications of these emerging technologies. On September 8, 2022, OSTP issued a report examining these concerns in detail. The energy impacts of the crypto-asset industry have generated almost as much interest as the industry's financial and technological promise, and OSTP provides an eye-popping analysis of the sector's global and domestic energy impacts. For example, in the United States, crypto-asset operations consume around the same amount of electricity usage as all residential lighting. Globally, they use as much electricity as all conventional data centers combined.
Many in the crypto-asset industry have tried to reduce their energy impact via the same load-reduction tools employed by traditional data centers, including on-site renewable generation, batteries, and energy efficiency measures. But the White House report makes clear that the crypto-asset industry has an even greater role to play in ensuring a net-zero, clean energy future. The report outlines the potential negative energy impacts of crypto-sector operations in the United States: higher greenhouse gas emissions, increased rates for consumers, and reduced grid reliability. Importantly, it also calls for significant energy data disclosures to various federal agencies, including the Energy Information Administration. The crypto-asset industry—and the energy industry that supports it—should be prepared to provide these disclosures in the near future.
The report also makes clear that mining operations on crypto-asset networks using the energy-intensive Proof of Work protocol will likely face marked scrutiny and pressure from the federal government to reduce their impacts. All crypto-sector stakeholders will want to pay close attention to actions taken by the Department of Energy (DoE), the Federal Energy Regulatory Commission (FERC), and other regional and state energy agencies as they begin implementing these recommendations.
Reducing Greenhouse Gas Emissions Associated with Digital Asset Technologies
The OSTP report recommends developing environmental performance standards for digital asset technologies, such as requirements for decreased energy intensity, water usage, and noise generation. Most importantly, these environmental performance standards may require carbon-free energy usage for crypto-asset mining. Essentially, the report recommends that the federal government push the crypto-asset industry to pursue carbon-free energy sources via a common regulatory tool used by many states to assert downward pressure on the greenhouse gas emissions of their regulated utilities: Compliance with a renewable portfolio standard that strengthens over time. Such a standard for the crypto-asset industry would ensure that mining operations use or buy carbon-free electricity that matches or eventually exceeds the additional electricity load associated with their facilities.
Proof of Work devotees, beware: The report goes even further and suggests that both the Administration and Congress should consider limiting—or eliminating altogether—the use of high-energy-intensity consensus mechanisms for crypto-asset mining. In other words, the federal government may ban Proof of Work-based mining operations in the United States entirely. In light of this proposal, the Ethereum Merge may be more than just a progressive shift, it may be prescient for the direction of the industry as a whole.
Ensuring Energy Reliability Despite the Crypto-Asset Industry's Added Strains
The report also calls on the DoE, in coordination with FERC and other energy regulatory bodies, to conduct "reliability assessments" of current and projected crypto-asset mining operations to determine their impact on power system reliability and adequacy. The report recommends that, if necessary, regulators follow up by developing reliability standards and emergency operations procedures to ensure grid reliability amidst the growth of crypto-asset mining. Reducing the strain on the grid will accordingly lead to reduced energy costs for all consumers. Utilities and rural cooperatives across the country who have faced significant and variable load increases in their service territories as a result of crypto-asset mining operations temporarily or permanently locating in their service territories will be keenly interested in any such "reliability assessments."
The OSTP report is just one facet of the Administration's consideration of how to regulate the rapidly developing digital asset space. For more information about another important action taken by the federal government that focuses on the intersection of climate and the financial industry, please see our blog on the CFTC's recent request for public comment on a wide range of climate-related financial risks. With the CFTC increasingly monitoring digital assets, any CFTC rule on climate will likely significantly impact the crypto-asset industry.