The dirty secrets of cryptocurrency EXPLAINED

The very nature of cryptocurrencies makes them incredibly hungry for energy. Can they lower their impact without losing their anti-establishment appeal? Olivia Wannan reports.

Bitcoin was the first cryptocurrency, and remains the best-known. Today, there are thousands of alternatives.

As we’ve seen from headlines, speculators who bought into a cryptocurrency during the early days transformed – on paper at least – thousands of dollars into millions. But sudden crashes in the value of major currencies and the recent bankruptcies of major crypto firms mean the fledgling industry is also responsible for wiping out people’s savings.

And as crypto has grown, so has its outsized carbon footprint.

The design of the system – based on blockchain technology – is responsible for both its environmental impact and its consumer flaws.

Essentially, blockchain is a type of database, recording a list of transactions. The transactions could be for anything: It could record the changing ownership of an artwork or a car. For cryptocurrency, it’s money.

Rather than being held in a bank’s data centre, the blockchain database is freely accessible. Everyone in the blockchain network holds a copy of the evergrowing list of transactions.

How it works – and why it’s so energy-hungry

When you sign up to cryptocurrency, you receive a dedicated security code (often known as your ‘‘wallet’’), essentially a secret signature. You’ll need this every time you want to make a transaction.

When you run your secret signature plus the details of the transaction through a cryptographic puzzle (a complicated algorithm), the puzzle spits out a public signature.

It’s a string of numbers and letters. When you send 10 Bitcoin, the puzzle produces a result that bears no resemblance to the one produced when you send 11 Bitcoin. This is a fundamental security element: No-one should be able to take the public signature and work backwards to crack your original secret code.

These transactions are then bundled together into a list – called a block. Each block must be added onto the chain one after another (hence the name blockchain).

To do this, the system again relies on the cryptographic puzzle plus people known as Bitcoin miners.

Mining might make you think of gold mines – where the miners’ task is to find gold. That’s not the same for Bitcoin. The miners’ key job is to process Bitcoin transactions. If they successfully complete this, they receive a small nugget (about 6 brand-new Bitcoin, creating additional currency).

It’s like a gold mine that only offers one nugget every 10 minutes, and every miner works to be the first to complete a maths problem to be awarded the gold.

Work is the operative word. The

Bitcoin designer deliberately made the process resource-intensive, for security reasons. The founder theorised that, by requiring a lot of computer processing, a single hacker would need more computing power than all the other honest miners combined to successfully hijack the system.

Bitcoin miners are in a race to produce a tiny number.

Each miner puts the list of transactions (the block) plus a code of their choosing through the cryptographic puzzle, which of course spits out a number. If that number’s not small enough, they select a new code and try again.

The first one to produce an output number smaller than a set threshold is the winner. The block is then added to the chain, the winner earns the reward, and the competition for the next block begins.

The competitive set-up requires a lot of superfluous work – and all the mining computers repeating this process consume a lot of electricity.

Essentially, Bitcoin sets up a computer processing arms race between good and bad. There’s an elegance to the design that can be enticing. But the resource-intensive processing of blocks protects against a rare problem. After all, why would you try to hack a payment system when you can simply trick people into sending you money or revealing their security details?

That has led critics to ask whether the carbon footprint of all this digital work is worth it.

Buyer beware

Crypto is often associated with high-value fraud.

Consider non-fungible tokens (NFTs) – a unique ‘‘box’’ of code that could be as simple as a link to an image. These digital assets first made headlines for record sales. Nowadays, you’re more likely to read that tokens valued at more than $100 million have been nicked in the last year.

Phishing attacks convince users to accidentally reveal the security details for their cryptocurrency wallets, after which the scammers transfer the digital item to themselves.

The transaction ‘‘will look as if it is valid’’, says Victoria University researcher Jennifer Ferreira.

In addition, NFT technology allows savvy scam artists to create a type of booby-trapped token. If it ends up in your account, the token will execute the function contained in its ‘‘box’’ and transfer the entire contents of your account to its maker.

Sophisticated hackers can find vulnerabilities in coded systems to gain access to security details, as occurred when a type of gaming venture capital-style fund was drained of cryptocurrency worth $600m.

Each time, the scammer has gained access to the secret signature, so the blockchain technology will run the transaction as if the owners made it themselves. All that energy-hungry processing couldn’t protect against this problem.

And here’s where the theory behind crypto’s decentralisation bites.

There are few consumer protections. There’s no Paypal Protection Policy. No Mastercard Zero Liability policy. No bank is there to freeze your account, or reimburse you if you can demonstrate you acted honestly and safely.

Without the scammer’s secret signature, no-one can reverse or instigate a transaction to remove the currency or digital asset out of their possession.

Ferreira says that by design, there is no central authority to act as an intermediary. ‘‘This is why a lot of people are losing money.’’

Yet high-profile crypto thefts show people want – even expect – overarching organisations to come to their aid.

Art gallery owner Todd Kramer appealed to the OpenSea marketplace, where people can buy and sell NFTs, after 15 NFTs valued at a total of $2.2m were transferred out of his wallet. He had fallen for a phishing attack.

OpenSea agreed to ‘‘delist’’ those 15 tokens, so thieves wouldn’t be able to sell them on their platform. But the blockchain still lists the scammer as the owner, who may simply turn to another marketplace to flog the stolen items.

It’s an unsatisfying resolution – and hardly a disincentive against theft. And yet proponents are suggesting that the registration of physical assets, including houses, and personal information be switched to decentralised blockchain tech.

Tackling thieves

Larger cryptocurrencies are addressing the lack of consumer protections, Ferreira says.

The leaders of Ethereum, another popular cryptocurrency, stepped in when a hacker drained an investor-run digital venture capital fund of $50m. To return the funds, the system had to reset its blockchain.

Here’s the problem with having copies of your blockchain, one sitting with each miner. Ethereum had to convince every single one to update their file with the reset. Some agreed, but purists refused.

Essentially, the cryptocurrency split into two timelines. There was the original, uncorrected blockchain. This became known as Ethereum Classic.

Today’s dominant Ethereum blockchain carries the correction in its sequence of transactions.

It’s hard enough to get your head around what this means for digital currency. But imagine if a similar ‘‘fork’’ happened within a public blockchain recording property, where some people recognise you own your home while others insist your title was stolen.

To right a wrong, Ethereum acted as a central authority – breaking the central tenet of decentralisation.

‘‘It’s almost putting decentralisation inside a centralised system,’’ Ferreira says. ‘‘The way Bitcoin and Ethereum started out, there wasn’t a way to get your money back if something went wrong.’’

In that way, cryptocurrency is creating a series of alternative financial institutions, rather than getting rid of banking altogether.

At the moment, these crypto-authorities are unregulated – not yet subject to national finance laws, codes of conduct and independent bodies such as the Banking Ombudsman.

That’s why the Financial Markets Authority warns enthusiasts to: ‘‘Only invest what you can afford to lose’’.

Dirty dough

Crypto is also criticised for its impact on the environment. Recently, experts warned Bitcoin is as environmentally costly as beef.

All those servers trying to crack cryptographic puzzles chew through power. And to prevent systems from overheating, they need fans to cool them down.

While around 80% of New Zealand’s electricity comes from low-carbon renewable generation, most countries’ grids rely much more heavily on burning coal and natural gas.

‘‘It’s not just the use of electricity,’’ Ferreira says. ‘‘People buy these massive rigs of hard-disk space and computer processors to do the mining.’’

And when you have Bitcoin’s set-up, it’s not just one computer system doing this work – but every miner’s computer attempting to win the success and transaction fees.

That built-in redundancy means a lot more processing is done, compared to a purchase run through the Eftpos or Mastercard network.

With Bitcoin outsourcing its data processing to miners, it’s not easy to calculate the carbon footprint of the cryptocurrency, though various researchers have attempted the task.

One study estimated the annual carbon footprint of four digital currencies – including Bitcoin and Ethereum – sat somewhere between 3 and 15 million tonnes of carbon dioxide (our coal-burning Huntly power station produces about 3m tonnes each year).

Other researchers determined that Bitcoin alone was responsible for around 22m tonnes of carbon dioxide.

Others have been quick to point out that banks hardly have petite carbon footprints. One cited a report from an environmental group concluding that eight major US banks – including Bank of America and Citigroup – have a combined footprint of 668m tonnes.

But these financial giants handle more than just transactions. They provide credit and savings accounts, mortgages and personal loans. The 83m tonne average accounts for each bank’s branches, vehicles and corporate headquarters – which dwarfs Bitcoin’s presence. Bank staff undertake customer and account management, advertising and even sponsor sports teams.

A fairer comparison might be to global payment providers like Visa. The company processes more than 650 million transactions across the world on an average day. On a busy day, the Bitcoin network might process 400,000.

Visa reported that its total carbon footprint was about 325,000 tonnes – or about one-ninth of Huntly’s annual output. It’s pledged to bring that down to net-zero by 2040 and has switched to renewable electricity for its offices and data centres.

Blocks in the road

It’s not just the environment that pays for Bitcoin’s transaction style. Consumers suffer.

Bitcoin doesn’t process transactions in a first-in-firstserved order. The system doesn’t have pre-determined transaction fees either. Instead, users choose the rate at which they’re willing to pay.

Bitcoin miners will crunch the transactions of the 2000 or so people offering to pay the highest success fee at the time. Those ‘‘bidding’’ lower transaction fees will have to wait until demand dies down.

When we’re used to free automatic bank payments and Eftpos, Visa and Mastercard charges (typically) built into prices, crypto’s transaction fees can feel comparatively expensive.

If everyday banking switched into crypto, a busy system could see you choosing between missing a mortgage or rent payment or skyhigh transaction fees on the afternoon the payment is due.

And if you’re converting from one cryptocurrency to another, you’ll have to take another gamble. The value – famously – can rise and plummet over 24 hours.

Green shift

The budding crypto financial industry hasn’t completely ignored its outsized carbon footprint. For one thing, US President Joe Biden put the crypto industry on notice in September, citing a lack of consumer protections and the large environmental impact.

China banned Bitcoin trading and mining.

Entire currencies have been launched, hoping to allay environmental concerns.

Take Solarcoin. The currency is offered for free to owners of solar farms, in the hope a speculated increase in value could drive solar installation – though it is currently valued at less than one cent.

To minimise energy usage, it’s gone down a different road to Bitcoin. Instead of allowing everyone to be a miner, and creating a lot of redundant computing work, SolarCoin allows only authorised miners to process transactions.

On the plus side, SolarCoin is far less energy-hungry and its founders estimate it uses ‘‘less energy than a single home’’. On the other hand, it’s abandoned the decentralisation dogma, essentially making it a new (unregulated) central bank. The power isn’t shared by all participants.

Larger cryptocurrencies are introducing reforms.

To minimise energy usage and carbon emissions, Ethereum switched from a Bitcoin-style system with lots of people trying to solve the same puzzle to one where just one miner gets selected to do the transaction processing.

To be in the running for this work, miners now need to put a chunk of their cash on the line, at least 32 Ether (the coin on which Ethereum is based). That’s a stake of about $75,000 or more, which would be forfeited if you were discovered to be fraudulent.

The more money you stake, the higher your chances of being chosen to mine the next block.

Ethereum estimated the shift reduced its energy consumption by 99.95%. It should also speed up transaction times and make them cheaper, the founders said.

But it’s hardly the democratic system crypto-purists envisioned. The most cashed-up people on the Ethereum network will dominate the transaction work, earning more fees and boosting their share.

Our Government is also investigating cryptocurrencies. The finance and expenditure select committee – a group of cross-party MPs chaired by Labour’s Barbara Edmonds – has been tasked with the topic.

Edmonds told Stuff last year that the committee hasn’t yet come to a stance on cryptocurrency. There was no deadline for reporting back to Parliament. ‘‘However, it is my hope that we would present our observations by . . . early 2023.’’