Our law firm, Cole-Frieman & Mallon, has been a leader in helping fund managers form private investment funds focused on the digital asset space. We’ve seen the space mature from 2014 when programs were focused on long tokens, to later investment strategies that included long/short, jurisdictional and exchange arbitrage, VC-focused or hybrid, to the more recent focus on staking, yield-farming, long NFTs, etc. What these changing strategies show are two things: (1) the crypto space will continue to incorporate traditional investment management strategies as it iterates to find the most compelling investment scenarios and (2) the future of finance will also include crypto-centric strategies that cannot be achieved through traditional markets. The crypto space is dynamic and advances without the constraints of traditional markets. However, the crypto space, like the rest of the world we live in, requires energy to move forward. The time is now for the crypto industry to focus on how the next generation of blockchains (and infrastructure to support those blockchains) will coexist with a society that is starved for energy-efficient industry. This focus on energy consumption is vital and will have numerous consequences for the space moving forward. And because the crypto industry is so dynamic, led by visionary actors, we expect to see great movements in how the industry thinks about and uses energy in the future.

Bart Mallon

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Overview of Energy Issues Related to Crypto Mining

By Emily Irigoyen & Bart Mallon

In this post, we will explore energy consumption and its relation to cryptocurrency as well as discuss the factors that will shape this relationship moving forward. This article also provides insight into the different influences of various stakeholders in the digital asset space and identifies other important aspects that will guide the development of the industry going forward.

Proof of Work (PoW) versus Proof of Stake (PoS)

Depending on which protocol for validating transactions a particular blockchain uses, the energy intensity of its mining will vary. This is because cryptocurrencies that run on Proof of Work (PoW), such a Bitcoin, require substantial amounts of computer power and energy to mine versus Proof of Stake (PoS) which is more energy efficient. While these aren’t the only protocols that exist in the crypto space, these are the most well-known, and highlight a stark difference in a cryptocurrency’s expected energy consumption.

What are Miners Doing?

There are various groups who oppose crypto adoption because of the perceived negative environmental impacts of crypto mining. While it is true the mining process can be energy-intensive, the practical value of crypto and the diverse ways that mining facilities have been incorporating green practices into their business models, have transformed environmental concerns into a nuanced set of issues that deserve exploration.

When discussing mining’s environmental impact, the notion of high energy consumption and negative environmental externalities are often erroneously conflated. While some cryptocurrency mining operations use substantial amounts of energy, such as Bitcoin, the nature of the energy source used will ultimately determine a miner’s environmental impact. As evidenced by our own interactions with crypto miners, many operations are currently or, in the process of, implementing more sustainable fuel sources. By using renewable energy sources to power their operations, these miners are minimizing their negative environmental impact in comparison to operations based solely on fossil fuels.

Furthermore, while mining facilities abandon China, the hashrate in the United States continues to increase steadily. This phenomenon reflects a recent trend in mining facilities’ international expansion, with a particular focus on US areas that boast cheap renewable energy and pro-crypto politicians, such as Texas. The former grants them a huge reputation boost, as facilities based in renewable energy sources cause significantly less environmental harm than those based in fossil fuels, and the latter allows facility owners to stay secure in the knowledge that state and county regulations will remain lax for the foreseeable future.

Some mining facilities have also taken extra steps to engage in grid balancing, a process by which the facility — in conjunction with their local utility company — can ensure the stability of the power grid. Grid balancing ensures electricity supply meets electricity demand. Large mining facilities can take part in this process by shutting down their operations for small periods of time when the grid is experiencing a surge of demand. This prevents blackouts and can bolster the push for renewable energy, as more balanced grids mean fewer that must rely on increased fossil fuel consumption to respond to demand peaks. Essentially, when large electricity consumers such as crypto miners change their usage as needed, renewable energy can handle more of the grid’s electricity needs.

Is High Energy Use for Mining Any Less Valid Than Other Energy-Intensive Operations?

Almost all business activity consumes energy. In the same way commercial landlords power their warehouses and offices, so too crypto companies use energy to power their mining centers. This perspective contends crypto mining’s energy use is no more inherently wasteful or less legitimate than that of any other business operation. The flaw in this argument is the scale to which crypto mining has grown and will continue to grow, along with its extremely high energy consumption in comparison to other businesses. According to the University of Cambridge Bitcoin Electricity Consumption Index, the global bitcoin network annually consumes approximately 80 terawatt-hours of electricity, which is roughly equal to the annual output of 23 coal-fired power plants. While the scale of this electricity consumption cannot be ignored, it must be understood in the context of crypto mining’s growing reliance and impact on availability of renewables. Cryptocurrency mining could be a driver encouraging adoption of renewable sources until they become the predominant source of electricity generation.

ESG, the SEC and (Potential Future) Institutional Mandates

It’s clear that the demand for ESG investments is increasing and is currently on the forefront of the SEC’s agenda. In response, more institutional investors are committing to ESG investments, which in turn, has or will encourage cryptocurrency miners to follow in this direction.

This desire to offer more sustainable cryptocurrency has manifested in large private sector initiatives that focus on decarbonizing the cryptocurrency industry, such as the Crypto Climate Accord. These forms of risk management have shaped the crypto mining space environmentally and allow us to better predict how crypto mining will evolve in the future. Naturally, as the demand for ESG cryptocurrency increases — as well as the desire to get in front of regulatory uncertainty grows — more mining facilities will green their operations.

Currently, the main barrier that miners face is ensuring that both regulators and the public at large take note of their ESG initiatives and sustainability protocols. Since environmental critiques of the crypto mining industry have been incorporated so heavily into the national narrative surrounding cryptocurrency, many mining and general crypto users have been working together to publicize information that highlights their evolving green initiatives and the many benefits that crypto mining can provide. This has taken the form of both sustainable initiatives and intense lobbying, which brings us to our next point.

Issues That Will Influence This Discussion Going Forward

While the future of the crypto industry will be influenced by everything we discussed above. We also predict the following will increasingly affect the development of the industry in the coming years:

• Lobbying the Government for Less Regulation & More Renewable Energy. As shown by the recent stalling of the 2021 Infrastructure Bill because of the crypto tax provision, lobbying pressure in the cryptocurrency community in unified and persistent. In the future, we can expect a larger lobbying contingent, and we can expect Representatives and Senators fighting for interests that affect their states. This is especially true in states like Texas where politicians are particularly friendly to crypto miners and business, boasting both lax state regulations and large renewable energy capacity to attract miners fleeing from Chinese regulatory scrutiny. Despite potential movement on the federal level, some states are going to fight hard to ensure bitcoin mining continues to flourish in their states so that they can continue to reap the current (and future) tax revenue.
  
  Lobbying for more and cheaper renewable energy in the US will also benefit the crypto market and has already started to manifest itself in the new Infrastructure Bill. The new bill proposes a $73 billion government investment to rebuild the electric grid, build thousands of miles of new power lines, and expand renewable energy. As the US naturally moves to a cleaner power grid, it’s expected crypto miners will gradually follow.

• International Crackdowns Affecting Bitcoin Value and Mining Hubs. Previously a major hub for bitcoin mining, China’s latest crackdowns on bitcoin mining and cryptocurrency exchanges have created space for other countries to become bigger players in the bitcoin arena. This explains why countries like the US have had an increasing number of bitcoin miners move their operations in their jurisdiction. While China justifies their harsher regulation in the name of their 2060 carbon neutrality plans, their regulatory scrutiny has also pushed many bitcoin miners towards countries with less renewable energy capacity, such as neighboring Kazakhstan, a former Soviet republic that is primarily dependent on coal and gas. This demonstrates how China’s actions may be hampering Bitcoin’s transition to cleaner energy sources, thus creating a larger carbon emissions problem. While some former Chinese miners that are now based elsewhere internationally are implementing greener operations in their new locations, it’s unclear whether these miners are outnumbered by miners who were forced out of China into countries with even less access to renewables. Also, it seems that China’s actions weren’t solely based on their national environmental plan, but also aimed to weaken Bitcoin in general so that the digital Yuan, their national digital currency, can run without competition. This greenwashing tactic has worked — China’s actions have brought Bitcoin’s value down substantially while also allowing them to claim their regulations are in response to their environmental concerns. This instance further demonstrates the impact stringent regulations in key mining countries can have on the crypto markets.

• Elon Musk’s Comments on Cryptocurrency. On July 21, at the B-Word conference hosted by the Crypto Council for Innovation, Musk claimed that Tesla will once again receive Bitcoin as tender once it is clear Bitcoin’s mining operations and exchange are powered by 50% or more of renewable energy and is steadily growing its renewable energy sources. This announcement correlated to a rise in the price of bitcoin and comes after Musk’s original statement in May on Twitter that said Tesla would suspend vehicle purchases using Bitcoin citing environmental concerns. This statement dropped the value of bitcoin within minutes and demonstrates the power Elon Musk and the Tesla brand have on the perceived worth of cryptocurrency. If a tweet by Elon Musk can cause immediate volatility to crypto prices, investors and crypto advocates alike should take note of his future remarks.

• Cryptocurrencies Moving Towards More Energy-Efficient Protocols. As Ethereum transitions from the consensus mechanism of Proof of Work (PoW) to Proof of Stake (PoS), it is expected that more digital assets will move towards “greener” protocols. Ethereum has already noted the benefits of their new protocol, such as its increased energy-efficiency, which signals to us that other protocol developers in the crypto space will also be mindful of energy consumption when creating their consensus mechanisms.

Conclusion

Because energy is such a broad topic in the crypto space, and encompasses so many parts, it is difficult to neatly address all of the factors that shape energy’s role in the crypto movement. Obviously, the people leading crypto are part of a generation that is focused on the environmental impact of their behaviors. This form of self-imposed environmental regulation, combined with the external pressure from other stakeholders concerned about crypto’s energy use, will not only affect the value and sustainability of cryptocurrency in the long term, but also potentially inform broader discussions of renewable energy capacity generally.

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Emily Irigoyen is an EDICT intern at Cole-Frieman & Mallon LLP. She is currently a senior at Vanderbilt University majoring in environmental sociology and will be attending Harvard Law School after graduation.

Bart Mallon is a founding partner of Cole-Frieman & Mallon LLP. Cole-Frieman & Mallon has been instrumental in structuring the launches of some of the first digital currency-focused hedge funds. For more information on this topic, please contact Mr. Mallon directly at 415-868-5345.