Decentralization Finance (DeFi) and blockchain technology have brought forth innovative solutions for building trust in decentralized networks and optimizing processes across various industries. However, traditional cryptocurrency mining, known as Proof-of-Work (PoW) mechanism, is notorious for its high energy consumption. This generates environmental concerns for exacerbating climate change. Yet, a study by ACI finds that not all DeFi activities demand such intensive energy use. The mining mechanism transition from PoW to Proof-of-Stake (PoS) can significantly reduce energy consumption for the Ethereum ecosystem. Yet, while more energy-efficient, the PoS sparks concerns about centralization, potentially challenging blockchain’s decentralization principle.

Under the PoW mechanism, miners in the Ethereum system compete to solve puzzles for a chance to add blocks to the blockchain and earn rewards. The first one to solve the puzzle will get a reward, which is a certain number of cryptocurrencies. PoW is characterized by security and decentralization. Yet, it demands a large number of computational resources and power to solve the puzzle. This raises environmental concerns and presents an economic barrier to miners, particularly with soaring energy prices globally. Moreover, PoW is said to confront limitations in scalability, a challenge that comes to the fore as the number of Ethereum transactions increases.

In contrast, within the PoS framework, the Ethereum system selects validators to solve the puzzle based on the amount of Ether they own and their willingness to stake it as collateral. This change dramatically reduces the demand for computational power and energy consumption, which enables greater network scalability and environmental sustainability. A study estimated that transiting to PoS reduces ETH’s energy consumption by an astounding 99 per cent. It also facilitates broader participation in the Ethereum network, as the entry barriers concerning hardware investments and energy costs are significantly lower, compared to the PoW paradigm.

However, despite energy efficiency, PoS is criticized for its potential to lead to increased centralization of network control. This is because the system allocates more power to entities holding a larger stake in the network, which could potentially undermine the decentralization principle that underlies cryptocurrencies.

The transition from PoW to PoS and the debates surrounding the two mechanisms offer significant policy implications. Policy discussions regarding cryptocurrency mining should consider both sustainability and decentralization and strike a balance in between. Adopting energy-efficient mining without sacrificing decentralization is crucial for climate action. Regulatory measures can provide incentives for using greener alternatives, and stringent environmental standards for mining activities. For example, they can steer mining sites towards regions with cleaner energy sources. Conversely, they can discourage cryptocurrency mining in areas heavily reliant on fossil fuels, thereby lowering the carbon footprint of mining activities. Furthermore, regulatory authorities can introduce carbon pricing mechanisms to account for the environmental costs of mining activities. Such measures should go hand in hand with the promotion and development of renewable energy sources, in order to encourage miners to reduce their reliance on fossil fuels.

Despite the potential for policy recommendations, the decentralized nature of blockchain systems and their worldwide presence imply substantial enforcement challenges. Therefore, an international collaborative effort in the regulatory landscape of cryptocurrency is crucial. This global approach is necessary to ensure the effectiveness of these policies and to mitigate the environmental impact of cryptocurrency mining, highlighting the need for a coordinated response to the complex challenges at the intersection of technology, sustainability, and regulation.

By HUANG, Yijia

Researchers: WOITSCHIG, Patrick, UDDIN, Gazi Salah, XIE, Taojun and HÄRDLE, Wolfgang Karl