Crypto-mining in times of energy crisis
September 13, 2022
In 2022, the global energy supply is in the middle of turmoil not seen for nearly half a century. The shock had been brewing some time already, and as of September 2022 has probably not reached its peak, expected for the winter. But it is already possible to tell that the extent of the impacts will be huge, especially in Europe.
How to fundamentally characterize what we witness? This is the partial or total discontinuation in the flow of Russian hydrocarbons to a set of countries in Western Europe and the USA (+ affiliated). Regardless of the complex discussions on whether this disruption has been forced or decided, by which of the parties in present and why, the result is the same. A significant fraction of the global fossil fuel demand is in the situation to need to find alternative sources of supply (and/or to decrease its consumption), whereas a significant global provider of this same energy must find new clients to export to. As a result, some countries at least transitionally pay more than the overall market price for their oil and gas (respectively the corresponding suppliers will earn more), and other countries will pay less (respectively their suppliers earn less). Of course, meanwhile, the overall price of hydrocarbons went up. So, while globally the energy prices might not in absolute be sky high - oil price is absolute below the peak of 2008 - the major effect is still that Western European countries are experiencing a strong squeeze, which will surely trigger a recession for their economies.
Talking of the energy crisis, we also need to put these European circumstances into perspective. This is the "short-term" energy crisis. It matters a lot today, but evidently, due to Planet Earth being finite in its resources, the human race also does face a much more problematic "long-term" energy scarcity.
The timescale and kinetics of this ultimate crisis are of course open for speculation, but its starting effects already pile up with the short-term turmoil. Indeed, if oil and gas were truly abundant and everything was only a matter of supply chains, prices of gasoline would not have remained so high in Western Europe. We will not analyze here the long-term trend and its foreseeable effects, but let us just acknowledge the compounding effect on the current circumstances. It is important to understand it that way because we will see further that much of the impact of the short-term crisis is to make people conscious of the longer-term energetic challenges. Hence there are short-term as well as longer-term decisions - or at least, debates - happening worldwide right now, and therefore impacting businesses.
Let us now examine how crypto-mining is impacted. We can see two sides to it. On the one hand, like for any energy-intensive industry, operative expenses are increasing, which pushes for optimizations and search for the most competitive energy sources. On the other hand, the situation of energy scarcity exacerbates critics of the sustainability of the Proof of Work consensus algorithm, which puts extraordinary pressure on miners to consume exclusively low-carbon electricity. Let us have a look more in detail at both.
For crypto mining as for any industry, energy bills overall are climbing. Industries that are especially energy-intensive are hit the hardest: margins are endangered. That is especially the case of PoW crypto mining with even a vicious effect. If some players are forced out of business, the security of the network tends to deteriorate, which in turn may cause the market price to be under pressure, in itself has the potential to make the situation worse.
However, there are a number of actions that can be undertaken by crypto miners in order to escape such a negative feedback loop.
For a given crypto mining operating company, since electricity is by far the largest OpEx, it logically also is the major expense that is constantly scrutinized. In times of high or volatile energy prices, the sourcing of reliable, cheap energy is even more crucial than usual, so any optimization has to start there - and because electricity is very costly to store, this issue then equates to choosing the best geography to localize the mining equipment.
There, to make things even more complicated, crypto mining has two stringent requirements for its energy sources: (1) its significant CapEx structure makes it still important to operate 24/7, so miners need ideally baseload contracts; (2) for reasons highlighted further on, crypto mining is under special pressure to discard carbonized electricity. So this practically leaves us with nuclear and on-the-flow hydro as eligible sources. As of the end of 2022, places on our planet that offer cheap reliable electricity of this kind are in practice regions where rivers provide hydropower with limited population/industries around to use it.
Let's add to this that the geography should ideally be in a cold climate to obtain the best heat sinks, and with no surprise, we shall obtain the top attractive locations where we observe miners be rushing: Canada, Scandinavia, big dams of South America, and then as well recently developed hydro in Africa or fracking methane wells scattered in Northern America. Anyway, to present a sound business plan in crypto mining reasonably robust to bitcoin price variations, the price of electricity must be so low that today, only electricity that otherwise would be essentially wasted can really fit. This is why, the race is on to capture the low-carbon leftovers in the mentioned, mostly remote places.
While this is by far the most important, once the energy supply is optimized, other optimizations are still available, starting with the performance of the mining equipment (ASICs). New generations of such graphic cards keep being designed and brought to market despite the crypto price fluctuations – and the performance of their fleets of ASICs plays as the next available competitive differentiator between miners.
To demonstrate the importance of this effect, we can observe the evolution of the hash rate on the Bitcoin network. We note that with respect to the bottom that followed the Chinese ban on crypto-mining, the available hash power online has recovered and now almost tripled the bottom. Clearly, this would never have been possible without a massive upgrade in material efficiency, with energy consumption progressing much slower.
The other big consequence of the energy crisis is the increasing questioning against the sustainability of Proof of Work consensus mechanisms. It is of course a fact that PoW consumes large amounts of electricity. While the question of whether this energy consumption has effectively a large environmental impact is a topic of debate - one that we may examine separately. But for sure, this aspect of crypto is increasingly taken as an angle to attack it in general. A growing audience of people who hardly understand consensus mechanisms in DLTs and/or energy topics come to believe that bitcoin is especially bad for the planet, and that is clearly a topic that the industry must address or cope with. In the worst case, if it does not, then political consequences may even follow, with various regulatory steps taken in order to de facto limit or forbid crypto mining activities.
Consequently, PoW operators have to take action.
There is one radical way to go, exemplified by Ethereum: a pivot toward other kinds of consensus algorithms. This is mostly "Proof of Stake", one mechanism that is not based on solving a cryptographic puzzle but on some kind of lottery that the probability to win is proportional to the staked amount of tokens. Of course, then the question of energy consumption is mostly solved; but the long path that Ethereum is completing only these days shows how complicated a practical implementation of PoS – let alone critics of the governance of such a mechanism, where rich people become richer. For now, everyone shall just reckon that Proof of Work remains the safest and most straightforward mechanism in existence.
For Bitcoin, any push to switch to PoS is highly likely to be rejected or to cause a hard fork of the chain (this situation is poised to happen on Ethereum as well!), with one resulting chain remaining the historical PoW Bitcoin. Hence we may assume that Bitcoin will remain PoW-based. With this assumption, the next area of action is to push toward low-carbon sources of energy.
It is becoming unacceptable to the public and to governments to allow for "unsustainable" activities. On top of this, cryptocurrencies' adoption is still relatively low, they are for now hardly identified as a critical, public-interest sector. This is why the "sustainability pressure" on them is at an absolute maximum. To avoid being too easy a target for environmental concerns, bitcoin miners have no choice but to use exclusively carbon-free sources of electricity. As highlighted above, this then narrows down to using nuclear and hydro, because they are the only sources that can provide decarbonized baseload; and then in effect hydro is the one source of energy for which there is the majority of opportunities because hydro installations can still be found in areas with limited demand, whereas nuclear facilities are usually built close enough to where there is a big demand to serve.
We can just say that in this respect, the current energy crisis is hastening the fundamental trends in the crypto mining industry.
Before concluding, we may wonder: how may an energy crisis and a recession in Europe impact Bitcoin's price in the short and mid-term? Indeed, such price changes will directly impact the profitability of crypto mining.
This is a hard projection to make of course, but we can still lay down a few principles and mechanisms that we can expect to play: - A recession, even in a limited part of the world, is still a slowdown in activity, the price of assets gets depressed as free cash gets scarce and confidence in investments is low. All the rest being equal, that is therefore a bad signal for Bitcoin and other risky assets.
- This recession in these kinds of countries that are already crippled by extremely high levels of public debt, may however trigger some level of money printing because states have currently no margin to pay for economy stimulation policies. The erosion of the Euro already shows some such expectations of the markets in this direction. The downward spiral of western currencies in constant purchase power has the potential to push up alternative assets like gold and cryptocurrencies.
- If energy price goes up, then energy-intensive asset prices should also go up. That is true of aluminum currently, which needs vast amounts of electricity in its refining process. CO2-intensive products like cement, concrete, and real estate might be pricier in the long term for the reason that emissions will need to be limited in one way or another. In this sense, Bitcoin and other PoW coins are more expensive to produce, hence their price floor becomes higher (i.e. the price at which a miner will agree to sell new coins should be higher).
- Also, there is a political aspect to the situation. When the war starts, no one knows the extent it can take, and how it can evolve. The only sure thing is that the world has become much more uncertain, and especially in the countries directly touched, alternative monetary systems get traction.
From these considerations, in the short term, the outlook is worrisome for the economy at large and risky assets in particular, but in the mid-term, there might be opportunities for crypto assets in general and bitcoin in particular.
As a sum up, in the current circumstances of energy squeeze, especially in Europe, crypto mining activities are aggressively competing to secure the cheapest low-carbon left-over electricity available on the planet.
Some other optimizations are to be leveraged as well, in terms of equipment productivity per energy consumed, and efficient cooling technologies. Furthermore, the industry is under pressure to operate in a sustainable fashion. Since PoW will remain the consensus mechanism for Bitcoin in the foreseeable future, this drives crypto miners to typically turn to hydro over-capacities still existing in "frontier" regions of the planet. The energy crisis shall have a mixed impact on cryptos in general; whereas the ensuing economic downturn will be detrimental, the price floor increases and the uncertainty on fiat currencies can make cryptos appear as an interesting alternative.
Still, if to retain one lesson: the players who are unable to tap into cheap sources of electricity will be forced out of business; some would say this is the "sane" process of liberal capitalism, but as usual, that will above all be the signal that the bottom is near.
Head of Operations
A 15-year veteran of the Energy-Blockchain nexus, Alexandre has extensive knowledge of both. He got the chance to dive into blockchain technology after joining Ernst & Young in 2016 as an operations consultant and take part in building the DLT expertise of the Paris EY digital lab.
He led the Swiss national standardization initiative to define distributed execution platform principles for the power generation sector. He applied himself to the various aspects of DLT, including governance, mining, decentralized systems architecture, on-chain data management, digital assets economics, tokenization, etc.
September 13 ― Alexandre Juncker