‘Environmental disaster’: BIS warns on cryptocurrencies
Bank of central banks highlights huge electricity and processing requirements
The Bank for International Settlements, known as the bank for central banks, issued new research this weekend on the cryptocurrencies boom. It has a few concerns with the idea of digital money becoming actual money:
•‘Environmental disaster’.
•Scalability woes.
•‘Unstable value’.
•Oh and it may “bring the internet to a halt”.
The BIS has been sceptical for some time on cryptocurrencies, echoing many major players in the financial industry which have serious qualms with advocates’ aim of bringing digital currencies into the mainstream as a key medium for exchange.
In its new report this weekend, the BIS has pointed to some of its over-arching concerns that lead it to conclude that “decentralised cryptocurrencies suffer from a range of shortcomings.”
fastFT rounds up some of the key points below.
Electricity
A key element of many cryptocurrencies, including bitcoin, is that so-called miners compete to complete complex mathematical calculations to get the right to add a ‘block’ to the blockchain. The addition of the block stores information about a transaction, and the winning miner is rewarded for its work.
Miners need to run superfast computers in order to perform these calculations. This requires electricity. A lot of it.
. . . a key potential limitation in terms of efficiency is the enormous cost of generating decentralised trust. One would expect miners to compete to add new blocks to the ledger through the proof-of-work until their anticipated profits fall to zero.
Individual facilities operated by miners can host computing power equivalent to that of millions of personal computers. At the time of writing, the total electricity use of bitcoin mining equalled that of mid-sized economies such as Switzerland, and other cryptocurrencies also use ample electricity. Put in the simplest terms, the quest for decentralised trust has quickly become an environmental disaster.
Scaling
It would take vast computer storage for major cryptocurrencies to keep up with the speed of transaction-processing systems that are currently in place, according to the BIS. That presents a major problem in scaling-up cryptos.
At the most basic level, to live up to their promise of decentralised trust cryptocurrencies require each and every user to download and verify the history of all transactions ever made, including amount paid, payer, payee and other details. With every transaction adding a few hundred bytes, the ledger grows substantially over time.
For example, at the time of writing, the bitcoin blockchain was growing at around 50 GB per year and stood at roughly 170 GB. Thus, to keep the ledger’s size and the time needed to verify all transactions (which increases with block size) manageable, cryptocurrencies have hard limits on the throughput of transactions.
A thought experiment illustrates the inadequacy of cryptocurrencies as an everyday means of payment. To process the number of digital retail transactions currently handled by selected national retail payment systems, even under optimistic assumptions, the size of the ledger would swell well beyond the storage capacity of a typical smartphone in a matter of days, beyond that of a typical personal computer in a matter of weeks and beyond that of servers in a matter of months.
That thing about the internet . . .
But the issue goes well beyond storage capacity, and extends to processing capacity: only supercomputers could keep up with verification of the incoming transactions.
The associated communication volumes could bring the internet to a halt, as millions of users exchanged files on the order of magnitude of a terabyte.
Stability
The second key issue with cryptocurrencies is their unstable value. This arises from the absence of a central issuer with a mandate to guarantee the currency’s stability.
Well run central banks succeed in stabilising the domestic value of their sovereign currency by adjusting the supply of the means of payment in line with transaction demand. They do so at high frequency, in particular during times of market stress but also during normal times.
This contrasts with a cryptocurrency, where generating some confidence in its value requires that supply be pre-determined by a protocol. This prevents it from being supplied elastically. Therefore, any fluctuation in demand translates into changes in valuation. This means that cryptocurrencies’ valuations are extremely volatile.
And the inherent instability is unlikely to be fully overcome by better protocols or financial engineering, as exemplified by the experience of the Dai cryptocurrency.