How It Works
Bitcoin And Electricity
Bitcoin and it’s electricity consumption has been criticized and reported about frequently since its meteoric rise in value. The reason is that with the increase of Bitcoin users, so did the electricity usage of the worlds biggest cryptocurrency. But has it to do with more users, transactions or is it entirely something else?
Simply put, Bitcoin transactions are bundled into blocks by miners. The miners decide which transactions they add to a block. A block is heavily limited in size (~0-4 Megabytes, 4 million weight units) so miners select out of a pool of pending transactions which ones they want to add. Each transactions pays a transaction fee that can be freely set and miners chose categorically the ones with the highest fees of course. Once in a block, the transactions are officially “sent” or “verified”. The miners work for this block is done. Time to find the next one. Miners can’t just create blocks. They have to find them, hence the name bitcoin mining.
Bitcoin uses a Proof of Work (PoW) consensus algorithm. This is basically a mathematical puzzle that miners must solve in order to find/produce a block. This is of course a very high level description but it is all one has to understand to see the link between electricity consumption and Bitcoin. This puzzle requires a lot of computing power which in turn uses a lot of electricity.
Bitcoin has been designed to have miners find a block approximately every 10 minutes. Now with increasing computing power over time as computers evolve, computers would solve that puzzle faster and faster. To avoid this and keep the time between blocks at around 10 minutes, bitcoin has a parameter called difficulty.
The Bitcoin protocol controls with the difficulty basically how difficult the puzzle is. The Bitcoin protocol does this by checking every 2016 blocks and if the value is below 10, it increases the difficulty, if above it reduces it. This way, it accommodates for more calculation power into infinity.
With this in mind, it is obvious that if more computer power (hashing power) comes into the game, the more the protocol increases the difficulty, hence making it more electricity consuming to find a block.
What happened is that miners ramped up their game and more hashing power is put into the network, pushing the difficulty to enormous heights. In a way, the miners efficiency and brute amount of hashing power they put into the mining business to stay on top of each other, caused bitcoin to increase the difficulty almost continuously, making it more and more difficult to find blocks in order to keep the time between blocks around 10 minutes.
But why do miners want to find a block so bad?
Because of 2 reasons.
- Block reward
Every block that is found and added to the blockchain, the miner gets a reward from the bitcoin protocol. Brand new virgin bitcoins. At the time of writing (January 2022) it is 6.25 Bitcoins to be exact. This is how new bitcoins come into circulation. This amount was once 50 Bitcoins and will eventually go down to 0. On top of the block reward, the miner collects transaction fees. All fees paid from all transactions the miner added to the block, the miner collects the fee (now you know why they like high fee transactions). This can be as high as 3 Bitcoins and as low as 0. At the time of writing, it is obvious that miners are mainly incentivized by the block reward, not the fee. This will change however and will do so probably within the next 8 years, as the block reward is halved roughly every 4 years (every 210.000 blocks) until it reaches 0.00000000 BTC. (By then, the amount of Bitcoins in circulation will remain the same. It will be a little under 21 million bitcoins in total that will have ever existed)
Now we know that a minter gets rewarded 6.25 + transaction fees for each block. At 40,000 USD a Bitcoin, that means a miner that successfully finds a block gets 250,000 USD.
It becomes very clear, why the miners want to find a block and also that they don’t shy away of enormous electricity bills and hardware expense, as long as the business is viable and the cost put into finding 1 block is lower than 250,000 USD + change (transaction fees). Keep in mind, this 250,000 USD is per block. Finding 10 blocks (of average 144 blocks per day, every day) in one day means 2,500,000 USD in payouts. Not a bad business.
In reality, there is only a handful of massive miners out there that compete. This means that in order to find 1 block, many miners work on the puzzle, until one miner solves it and then all abort and start a new block. If miners don’t keep up with the competition, they will soon (very soon) not find a single block. That would push them out of business within a minute (or 10 minutes to be exact).
It is important to understand that this also has a positive side. The more computer power is required to find a block, the less likely a 51% attack becomes which is basically a miner having 51% of all the hash power (computer power) which in turn would allow him to hijack the bitcoin network (longest chain concept). At the time of writing, this is impossible. There just isn’t the hardware to do that.
What is important to understand is that bitcoin does not use more electricity the more transactions there are. Remember what we said about Blocks having a size limit? There is only X amount of transactions able to make it into a block and contrary to some beliefs, the amount of bitcoin you send around has absolute no impact on that but rather the size (in megabytes or/and weight units). Transactions have almost no impact on the electricity consumption but the puzzle solving, proof of work mechanism does. 99% of electricity goes just into that.
Until now, the bitcoin protocol foots the bill for the electricity with its distribution of new, virgin bitcoins but what happens after the next 2 halvings when miners are not rewarded as handsomely by the bitcoin protocol anymore?
Well, the transaction senders (output spenders) foot the bill due to the nature of the limitations the block size as miners must select which transactions they add, and they will definitely prefer the ones that pay more transaction fees. How this will impact the mining business is not something we can predict or understand (yet) but its certain that this amount of consumption cannot go on and be paid by a couple transaction creators as when broken down, it would be enormous. A simple transaction from 1 output to 2 outputs (receiver + change) would need to incur around 85 USD of fees (time of writing) in order to pay for the electricity alone. There is no hardware or profits yet involved. With limited block capacity, there is also competition among transaction spenders as they want to get their transactions validated, hence they must add more fee then others to please the greedy miners, likely catapulting the cost of a bitcoin transaction into the thousands of dollars at peak times.
GlassChain has a comprehensive breakdown for each Bitcoin Address and Wallet about its electricity consumption based on their spending behavior. See how much electricity each address or wallet has incurred, even though it didn’t pay for it directly but used up space in a block. As transactions take up space in blocks, they are eventually the ones that bear the cost.
The way it is calculated is that the daily assumed electricity consumption of the entire bitcoin network is taken and broken down onto all the transaction senders, according to the space they occupied within the blocks in relation to the daily total capacity. This means a small transaction (in size, not value) shares a small cost then a bigger one distributing the cost fairly and according to the polluter pays principle.
This also covers the logic that the entire Bitcoin networks reason of existence is to be able to send value around, hence the senders being the “users” that eventually must pay for the entire Bitcoin mining industry and partially already do.
The values are indicative.