I Will Never Buy Bitcoin, But Not for the Reason You’d Expect

Let’s be honest. Investors have never particularly cared for the environment. In 2019, two former Exxon scientists testified to Congress: The oil giant had known about its impact on climate change since the early 1960s and buried the truth for decades. The same year, New York State sued the oil company for misleading investors.

image of bitcoin to represent cryptocurrency stocks

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Today, over half of Americans still likely own shares in the firm, either through passive index funds or direct investments. New York would eventually lose its case against Exxon, and the oil company would continue its foot-dragging on green energy, even relative to peers.

Bitcoin (CCC:BTC-USD) now finds itself on that same unhappy ship. The legacy coin still holds 60% of the total market and is universally accepted wherever cryptocurrencies are found. However, despite its new-age feel, Bitcoin’s recent price rises have turned it into the world’s most energy-intensive coin. Its miners now consume more power than the entire country of Argentina — most of it powered by coal-fired plants in just three northern Chinese provinces. All this to complete a series of seemingly pointless computational exercises.

A growing minority of investors have started to vote with their feet — an investment in energy-efficient Cardano (CCC:ADA-USD), Polkadot (CCC:DOT1-USD), Stellar (CCC:XLM-USD) and Cosmos (CCC:ATOM-USD) would have turned $1,000 into over $5,100 in three months, more than doubling Bitcoin’s rise. But more still needs to be done.

And that’s why I’ll never buy Bitcoin. Though the “king of cryptos” may continue rising, investors need to choose whether this “digital gold” is worth its staggering costs to the world.

Bitcoin: A True Energy Hog

To be clear, Bitcoin is a phenomenal cryptocurrency, even if just as a concept. The world’s first cryptocurrency promised to decentralize finance by publishing transaction ledgers and handing power to the people. And to investor delight, the cryptocurrency delivered. Today, Bitcoin’s entire list of every transaction is both public and highly secured. Even Citigroup, a long-time critic, managed to squint hard enough to find 100 pages of nice things to say.

But Bitcoin’s meteoric rise has also masked some profound flaws: At its core, its system is a walking dinosaur. Its 10-minute block time means transactions are achingly slow to process — multiple trips to the store are impossible without third-party validators. And its single blockchain means the currency will slow down even more as its ledger grows longer. Bitcoin’s most devastating problem lies with the intense “proof of work” calculations that the cryptocurrency forces on its miners. To add a block to the end of the blockchain, Bitcoin miners use a Hashcash proof of work function — a costly guess-and-check calculation that takes torrents of computing power to produce.

By and large, the function works well in small settings — the process directly helps validate Bitcoin transactions and keeps the whole system alive. A dozen desktop computers could theoretically operate the entire Bitcoin blockchain, given enough storage space and a reasonable processing load.

The function, however, also has a self-adjusting difficulty level. No matter how much computing power you throw at the system, Bitcoin will adjust its complexity so that miners will collectively get only one “right” answer once every 10 minutes. Much like an overly strict teacher, the test gets scaled so that only one person gets the right result, no matter how many people are taking the test.

Good Intentions Gone Bad

Bitcoin’s inventors couldn’t possibly have foreseen its $1 trillion-plus market capitalization. That’s because any skilled programmer will know the pitfalls of attaching a function to something that could go up infinitely. But that’s exactly what happened with Bitcoin rewards. Doubling Bitcoin prices also means doubling reward values, creating a mad digital gold rush.

Today, adding a single block awards 6.25 Bitcoin to a lucky miner, so Bitcoin at $50,000 now spins off $312,500 worth of reward every 10 minutes, or $16.4 billion per year.

In economic theory, that means crypto miners should collectively spend that much (i.e., $16.4 billion per year) on mining Bitcoin before a cost-benefit analysis tells them to stop. About a third will get used on electricity, while the balance will go toward machinery, real estate, cooling costs and economic profit.

Meanwhile, the net benefit to Bitcoin and its users will remain precisely zero. The extra investment gets dumped into a figurative ocean of ever-harder cryptographic computations.

Bitcoin’s Proof of Work Meets Proof of Stake

That’s starting to change elsewhere. Since 2017, new currencies have pioneered a different “proof-of-stake” system. Coins like these, including Cardano and Polkadot, use a member’s ownership stake rather than complex cryptography problems to determine mining eligibility. Essentially, it replaces energy-intensive mining with a system of trust that uses virtually no energy to maintain.

Even today, some legacy currencies like Ethereum (CCC:ETH-USD) are looking to upgrade to proof-of-stake methods. Rather than have miners fight it out over challenging math problems, Ethereum would pick a random winner to add a piece to the chain.

But not Bitcoin. The legacy cryptocurrency seems stuck in its old ways — famously forking itself multiple times rather than yield to community members agitating for shorter block times. And even if No. 2 competitor Ethereum manages to move to a proof-of-stake system, don’t expect Bitcoin to make the jump so smoothly. BTC miners hold a substantial portion of the cryptocurrency, giving them extra reason to preserve any current system that benefits them.

Who Loses in the Bitcoin Game?

Years ago, investors might have looked the other way. Low Bitcoin prices kept a cap on mining profits, reducing investment into unnecessary investment. Proof-of-stake currencies were still years away. I too was an earlier investor in Ethereum, a coin that once had a far smaller energy footprint.

But Bitcoin’s problems have started to become harder to ignore. Though some outfits claim that much of Bitcoin’s energy usage comes from renewables, much still comes from coal and other fossil fuels. And even if Bitcoin went entirely to renewable energy, its dependence on cryptography saps investment and energy from other potential projects. Every terawatt spent on mining, after all, represents a unit of human productivity that could have helped someone elsewhere.

Meanwhile, the losers are Bitcoin holders themselves. None of the extra computing power from Bitcoin’s high prices goes toward faster block times or lowering the $12 average transaction fee. Instead, the effort gets wasted solving ever-harder cryptographical computations. It’s having a thousand artists paint your portrait, only to burn 999 of the mostly finished pieces.

Cardano and Polkadot Show a Way Out

Investors are starting to see alternatives crop up. Today, Polkadot, a cryptocurrency co-founded by Dr. Gavin Wood of Ethereum fame, uses a system where trusted validators do the “mining.” Rather than solve pointlessly challenging puzzles, participants focus their attention on validating proofs. Meanwhile, the system maintains trust through a network of community members who nominate and monitor these validators. Further, Polkadot uses a system of “parachains,” multiple blockchains that run in parallel. Doing so distributes the workload and makes the cryptocurrency infinitely scalable, at least in theory.

Meanwhile, Cardano, founded by another Ethereum alumni, Charles Hoskinson, uses a similar method. The cryptocurrency uses the Ouroboros protocol, a scalable proof-of-stake model introduced in 2017 that divides its blockchain into multiple segments. Trusted slot leaders who work for small ADA rewards control these segments.

Both systems might still run into scaling problems; as Bitcoin found, success in small, theoretical applications doesn’t necessarily translate to performance as a trillion-dollar currency out in the real world. But it’s still the right step forward.

What’s Next for Bitcoin?

It’s blissfully easy to ignore the environmental impacts of any investment. A $10,000 investment in an S&P 500 ETF still sends $100 to energy companies, whether investors like it or not.

Wall Street also makes it hard to go green. The S&P 500 Fossil Fuel Reserves Free ETF (NYSEARCA:SPYX) has a fee rate almost three times higher than the regular S&P 500 index and doesn’t penalize other energy hogs like aluminum or steel manufacturers. And that’s only the tip of the ESG iceberg – good corporate citizenship covers everything from reasonable worker wages to women’s representation on boards. No company can claim perfection.

When the 2018 cryptocurrency “bubble” burst, investors jumped back into Bitcoin as a safe haven, pushing the coin from a 36% market dominance back to over 72%. Today, Bitcoin remains blockchain’s “North Star,” according to the same glowing Citi report.

Today is different. Investors now have a choice in where they put money next. Because unlike companies, which have thousands of pros and cons, cryptocurrencies have fewer shades of grey. They’re either energy hogs or they’re not. They help society or push black-market trades. They can run NFTs or are incapable of doing so.

Crypto investors can no longer hide behind a fig leaf of ignorance. Though Bitcoin may still change the world (and make you rich in the meantime), we can no longer ignore its devastating environmental costs.

So, I’m not buying Bitcoin. What say you?

On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.

Article printed from InvestorPlace Media, https://investorplace.com/2021/03/i-will-never-buy-bitcoin-energy-consumption-bitcoin-mining-btc/.

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