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Proof of Work Flaws: Ethereum Lays Out Proof of Stake Philosophy

Reading Time: 6 minutes by on January 7, 2017 Bitcoin, Commentary, Ethereum, News, Tech
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From December 4, the bitcoin price was $749.99 and increased to a high of $1120.51 on January 6, settling around $880 at the time of writing. This continuous increase of the price of ‘digital gold’ has been attracting people around the globe to mine Bitcoin. Since mining provides an opportunity for people to create income, they are incentivized to facilitate the powering of hungry machines in order to obtain bitcoin.

Bitcoin’s Proof of Work seen as ‘Unsustainable’

In the long run, this is not sustainable. This is one argument made by John Lilic in a LinkedIn blog post. With Ethereum slowly moving toward Proof of Stake, co-founder Vitalik Buterin also outlined the philosophy of Proof of Stake that is an imminent change for the network.

Growing number of miners brings our attention to the total amount of energy required to sustain the Bitcoin network, which has been steadily increasing over the years. According to the Key world Energy statistics published by the International Energy Agency, the Bitcoin network currently requires more energy than a number of countries. The diagram below illustrates that if Bitcoin were to be a country where it would rank.    

Source: Digiconomist

The high level of energy consumption of the bitcoin network signifies how unsustainable and inefficient that bitcoin is for the economy. To gain a clearer picture of amount energy consumed by the Bitcoin network, Digieconomist compared bitcoin to the Visa payment method, although it is stated that a proportion of energy required for Visa is not included (such as offices). Also, there exists measurement errors involved in the estimation of the amount of power required to sustain the Bitcoin network.

Nevertheless, it has been argued that people perceive Bitcoin to be more energy efficient due to the smaller size of the network compared to Visa. Whilst the total visa transactions consume energy equal to that of 50,000 US households. Bitcoin consumes energy equal to a staggering of just over one million households, which is 20 times the amount of Visa payments. Visa process 24,000 transactions per second, while Bitcoin processes seven transactions per second. From the comparison of the payment methods, it is evident that Bitcoin is very energy intensive per transaction and therefore if we could imagine bitcoin payments becoming mainstream like that of Visa payments, it is argued it could be extremely inefficient and unsustainable.

However, Bitcoin maximalists argue that much of the energy consumed by big banks and payment systems like Visa are not accounted for. There is no workforce traveling for Bitcoin, no energy expended to investigate chargebacks or fraud and no power required to maintain a large physical network of banks and offices. Also, let us not forget the energy involved in the production, distribution and destruction of fiat money.

The main costs that the miners need to consider is the electricity used to mine bitcoin and in order for the miner to make a profit, their aim would be to gain access to the cheapest possible source of energy. In this case, the cheapest option for miners is increasing the demand for coal power. Which requires computers to run continuously and therefore constituting to “baseload” demand. Such a surge into bitcoin mining has the potential to contribute to an environmental disaster, especially if bitcoin is to become an integral part of our financial system. Additionally, increases in the electricity demand will impact the process of decarbonising the energy system, and in turn, may slow down the pace of phasing out fossil fuels.

“The average US households uses 10 to 1000 kwh in electricity each year, about the same as would be required to generate four bitcoin worth under $1,000.”

Suppose a typical household have $6,000 in cash at hand and in their savings account and around $15,000 in credit card balances. Even if a typical household converted a tiny part of their financial transactions to bitcoin, there would be a huge increase in the energy use.   

The arguments above are made by John Lilic an Ethereum developer, as well as posting on his blog the counter arguments from Bitcoin maximalists, who highlight the sheer significance and relevance of bitcoin adoption and that is the one best monetary advances to date “since the monetary supply theory observed by Copernicus or need of gold standard given by Sir Isaac Newton.”

Another counterargument added relates to fiat currency creation and distribution costs. For example, banks printing money, minting coins and the renting of bank building branches, all involves costs. Lilac explains that the latter argument is insignificant since given consumer preferences have altered to favoring mobile banking, over the next decade a substantial number of branches are anticipated to close.

An extremely important point made in Lilic’s blog post is if marginal costs of electricity outweigh the value of a newly mined bitcoin seigniorage will become minimal or negative:

“In any case, if no changes are made to the system, the viability of the currency itself might be challenged because the seigniorage (defined as the difference between the face value of money and what it cost to make it) could be minimal or negative. In other words, the marginal electricity costs could outstrip the value of the newly minted Bitcoin.”

Lilic also notes that Ethereum will be looking into the “alternatives systems such as proof-of-stake which has been successfully implemented by other cryptocurrencies.”

Ethereum Lays Out Proof of Stake Philosophy

Buterin also explains his reasons on why Proof of Work may not be an optimal protocol  in his post “A Proof of Stake Design Philosophy.” Buterin refers to a point made by Dominic William, who explains that Proof of Work’s security is introduced from block rewards, which lacks two of the three E’s (Entry cost, existence cost, exit penalty) and makes up for this by maximizing existence costs.

Miners are only motivated from the risk of losing their future block rewards and Proof of Work functions on the idea that immenseness power incentivised by the prospects of huge rewards.

Additionally, Buterin argues Proof of Work experiences difficulties recovering from an attack, when an initial attack that takes place may be able to defended. However, on the second occasion of an attack on Proof of Work, you are a risk of multiple of attacks without being able to render the attacker. Thus, a massive mining network will earn attacks are inconceivable.

Vitalik Buterin explains since their costs are involved in the running onto the network in order to attack smaller sized firms less than X will be discouraged to spend X amount to attack each and every day.

“I reject this logic because (i) it kills trees, and (ii) it fails to realize the cypherpunk spirit cost of attack and cost of defense are at 1:1 ratio, so there is no defender’s advantage.”

Proof of Stake is argued to solve this issue as it does not rely on the rewards for security but instead on the penalties. Those that deposit money at stake are rewarded for holding the currencies safely, securing and maintaining nodes. However, the heavy costs of reverting transactions are introduced from the penalties that are hundreds to thousands of times larger than the anticipated rewards in the short term.

“The one sentence philosophy of proof of stake is thus not security comes from burning energy, but rather security comes from putting up economic value at loss.”

While Proof of Work is economically sound, Buterin states that an optimal protocol is not all about economics, as people may be incentivised by extra protocol motives. Lilic alludes in his post that the economic incentives may be too strong in Bitcoin. For instance, Chinese media outlet Daqing News reported during April 2016 a number of instances where Chinese bitcoin miners have gone as far as stealing from a variety of local electricity supplies, including oil plants. The Yushulin Oilfield Power management Branch discovered the over-consumption of power in two well and reported this instance to the local police.

The police were able to locate a house where bitcoin equipment was seized due to the illegal extraction of electricity from the production plant in order to obtain. Thereafter, the Oilfield Security unit pinned down that the electricity had been stolen from oil fields consequently in 1,200 machines units involved in bitcoin mining from twelve locales which were detained. 

Bitcoin’s Energy Cost per Transaction is Declining

There are many possible solutions for Bitcoin’s to energy intensity, including:

  • Bitcoin could potentially switch to such a consensus algorithm, which would significantly improve sustainability. The only downside is that there are many different versions of Proof of Stake, and none of these have fully proven themselves yet.
  • Lightning Network – an update to the network where transfers can take place instantly on micropayment channels off-chain and only the final settlement is processed by the blockchain. Enables scalability, efficient micropayments, and near-instantaneous transactions. SegWit would go some way toward this change by laying the foundation required for the Lighting Network.

While there are many measurement errors present with a simple comparison of energy intensity of Bitcoin and VISA, there is no doubt that Bitcoin mining is highly energy intensive, highlighting the need to move down a path of sustainability. However, the argument is made that Bitcoin’s energy cost per transaction is declining, where Marc Bevand debunks the arguments made by John Lilic and others in a blog post, as Bevand highlights:

“…there is no barrier preventing the per-transaction energy cost from settling much lower, such as $0.10 or $0.01 or less… The adequate amount of energy spent securing the network needs only be proportional to the Bitcoin market cap, not to the transaction rate.”

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