Peter Kelly-Detwiler: 617.875.6575 | Leighton Wolffe: 781.547.1193 pkd@northbridgeep.com, leighton@northbridgeep.com

Today’s modern economy depends upon a mindboggling array of servers spread across the planet – mining and retrieving data to create value for humanity. Indeed, much of our modern economy is digital. By its very nature, this modern, digital economy is fueled by affordable electricity. In this modern economy, a new form of currency has emerged called cryptocurrency. Based on encryption (encoding) there are literally dozens of these digital currencies, the most famous and popular of these being Bitcoin. Bitcoin – and the energy use required in its creation – is the currency we will focus on in this post.

Bitcoin – increasingly accepted in more locations. Photo credit: PETER PARKS/AFP/Getty Images

While the currency itself is ethereal, Bitcoin and the other cryptocurrencies are anchored in the real world, and they have a voracious and growing appetite for electricity. Hundreds of megawatts of power are used in the global production of Bitcoin today. Nobody knows quite how much, since many of the bitcoin ‘miners’ maintain a very low profile and they are spread across the planet. Bitcoin mining operations – essentially massive and powerful datacenters – are located internationally, and usually concentrated where the cost of electricity is cheapest. That’s because the cost of electricity can make up 90-95% of total ongoing mining costs. These datacenter mines can be found in numerous countries, from the Republic of Georgia to Iceland, to Malaysia and Venezuela. The largest share of the miners are located in China, close to the border with Tibet where cheap hydropower is relatively abundant.

 What is Bitcoin? – Bitcoin is digital money (estimated recently by Reuters to be worth approximately $10 billion globally) that can be used to buy and sell anything, and can be transacted online. A growing number of individuals and companies are using it, including Expedia and Overstock.com. There’s no Fed here, printing money, manipulating interest rates, or managing Quantitative Easing. The currency is created through a process called ‘mining,’ in which the solving of math problems is rewarded with new bitcoins. Energy and computers are like the fuel and the bulldozers, clawing away at a proverbial hillside for gold. These very powerful computers armed with specialized chips are meant to do just one thing: solve math problems using open source software.

If you are new to the concept, it’s a lot to wrap one’s head around, and it has some aspects that make it feel like a real-life video game. It’s also somewhat complex: the notion that one can create currency by virtue of solving complex math problems that seal off blocks of transactions in a decentralized and publicly visible blockchain general ledger. In the global race to solve the next problem, if your solution wins, you get awarded bitcoins.

The Bitcoin network stores every transaction that ever occurred in a giant decentralized network called a blockchain. Each miner has a unique ID/address, or multiple IDs, but nobody knows who the individuals are. The ID is kind of like a Social Security number. Every computer involved in mining bitcoin is networked and works jointly with all the others around the globe. If part of the network goes down, the entire system can partition that piece off and continue to function. Still don’t get it? Perhaps an example or two will help.

How One Buys or Sells in the Blockchain – To buy or sell using bitcoins in the blockchain, you first need a wallet (a kind of electronic bank account) on your computer or cellphone, and that wallet will generate a unique bitcoin address, that should be used only once. Once you have a wallet you are ready to transact, buying or selling something with bitcoin that you bought for dollars, Euros, or some other currency (unless you created bitcoins yourself by mining). Bitcoins are not cheap. On July 19th, one bitcoin was worth roughly $675, though the value fluctuates constantly just like any other currency. So when person A buys something from person B, the transaction is recorded in the blockchain – a public ledger in a global cloud of networked computers. Each bitcoin wallet has a unique and private key (known as a ‘seed’) that is used to authenticate the transaction, prove it came from that specific wallet, and keep the record from being altered after the fact. Multiple transactions are occurring constantly (between 150,000 and 250,000 transactions occur daily), and everybody can see that they occurred – they just don’t know the identity of the participants. And then the cool bitcoin mining part: every 10 minutes, the transactions are irrevocably locked up. They are swept chronologically into a single block of the block chain that is sealed through the Bitcoin mining process.

The Process of ‘Mining’ – Mining is where the currency is created. It’s the process of confirming the blockchain transactions that occurred in the last ten minutes, sweeping them into a list and creating the most recent block that is waiting to be secured. It’s based on consensus and it keeps the block chain intact and inviolable. To all intents and purposes, bitcoin is ‘discovered’ by computers that compete globally with one another to gain credit for sealing off the latest block in the chain.

Mining – no picks and shovels here; just millions of chips in a non-stop race  Photo credit: Andrew Burton/Getty Images)

With the creation of each new block, miners create what is called a ‘hash,’ which takes the information in the most recent block and turns it into a unique sequence of letters and numbers. Each new hash takes its place at the end of the block. One of the inputs to the latest hash is the hash from the previous block. So if somebody came in and tried to tamper with a block already installed in the ever-lengthening chain, that hash would change, as would all the subsequent downstream hashes, and alert everybody in the network that something was amiss. Every time a new hash is created, the miner gets bitcoins. Once 210,000 blocks are created, the value of the award is cut by 50% (one of these reductions just occurred in July, reducing the award level from 25 to 12.5 bitcoins).

The Need for Powerful Computers – The challenge is this: it is relatively easy to create a new hash from a bunch of data. But in order to create scarcity and avoid inflation – to keep everybody from doing it and rendering Bitcoin valueless – the network makes the creation of winning hashes deliberately hard, requiring what is known as ‘proof of work.’ There are certain protocols: A hash has to have a certain number of leading zeros. It also has to have all of the transaction data that is included in the block. It also includes a random piece of data known as a ’nonce’ in the recipe (see what I mean by video game qualities?). The computer grabs the nonce and creates a random hash. If the outcome doesn’t conform to the format protocols, the computer repeats the process. Again and again.  As do all the other miners around the world until somebody creates the hash with the required characteristics.

Part of the challenge is that in creating random hashes, the chance of arriving at a number with the necessary amount of leading zeros is extremely low. So you have to try millions and millions of times, and ‘win’ before some other competitor does. Speed is therefore incredibly important. The process can take place on specialized computers that can run in the tera-hash range, which is a trillion inputs every second (The first tera-hash rig was shipped in early 2014 – companies such as Antminer manufacture sophisticated and dedicated mining equipment, including specialized chips.). In the old days, individuals could compete. However, mining today generally occurs in dedicated datacenters that may consume tens of megawatts of power.

The creation of new hashes is made more difficult on purpose, to deal with the fact that an increasing number of miners join the global game with their faster machines. After every 2,016 blocks are created, a new level of difficulty is added. This is based on a formula that calculates a new value so that it would have taken two full weeks for 2,016 blocks to have been created at this new level of difficulty (one block is created every ten minutes). The more miners that engage in the hunt, the higher this level of difficulty must be in order to slow the bitcoin creation process. Which drives the incentive to engage ever more faster and more powerful machines. In fact Reuters recently reported an estimate that the computer network dedicated to Bitcoin is 43,000 times more powerful than that of the world’s top 500 supercomputers combined. This in turn means more and more electricity consumption.

To provide one example, one mine in western Sichuan, China, near Tibet, was reportedly aiming for 12 petahashes (12 quadrillion hashes per second – and the industry is eyeing exa-hash scale capabilities, 1,000x faster) using cheap hydropower – and pulling in an estimated daily haul of $30,000 net of costs.

The Electricity–Intensive Nature of the Enterprise – Not surprisingly, power densities in bitcoin mining centers tend to be significantly higher than traditional datacenters – this is about concentrating the most computer processing power in the least amount of space. As a consequence, a tremendous amount of electricity is used for bitcoin mining, although nobody knows exactly how much. Some estimates suggest that by 2020, BitCoin mining could conceivably burn through 14,000 megawatts (MW) of power (about equal to half of New England’s generating capacity, or –put another way – equal to Denmark’s consumption). In this case, if no changes are made to the system, the viability of the currency itself might be challenged because the seignorage (defined as the difference between the face value of money and what it cost to make it) could be minimal or negative. In other words, the marginal electricity costs could outstrip the value of the newly minted bitcoin.

The figure of 14,000 MW is the worst-case estimate, based on current and relatively inefficient technologies at work. A more optimistic estimate from the same source is 417 megawatts (for context, a gas fired combined cycle power plant generates about 500 – 600 MW). This lower figure might occur if the less efficient machines are replaced by better equipment as the value of bitcoins is cut over time (however, even that optimistic analysis suggests that creation of one bitcoin would require 5,500 kilowatt-hours – half the annual electric consumption of an average U.S. household).

Some Data Points Relative to Electricity Consumption – Information on the decentralized and low-profile industry is tough to come by. However, based on a few (and admittedly random) data points, it’s clear that the low estimate may be well off the mark. One compelling data point is that the Washington State Chelan Power District – with its low cost power rates of 3.4 cents per kilowatt-hour – saw 34 bitcoin miner requests for access to power totaling 220 MW of capacity in 2014 (that compares to a normal one to three megawatts of new load applications for that utility in a normal year).

Meanwhile, an industrial scale miner – KnC – built 30 MWs of facilities in Sweden, with another 20 MW announced in late 2014 (the company recently filed for bankruptcy).

For its part, BitFury – one of the larger and best-funded mining hardware companies – announced construction of a $100 million, 100 MW data mining center to add to its existing 20 MW datacenter in Georgia. Bit Fury also has two datacenters pursuing the creation of bitcoins in Iceland’s cheap electricity market, and it is not alone there. DigitalBTC Bitmine, and Cloudhashing also have multi-megawatt bitcoin mining operations in Iceland.

How Much Power Today? An Educated Guess of 600 Megawatts – Today, the largest mining pools are in Chinese, located close to sources of cheap hydropower from Tibet. Nobody knows exactly how much electricity the Chinese facilities draw, but according to a Business Insider ranking in August of 2015, Chinese miners comprised 60% of the total global Bitcoin ‘hashpower.”

In a recent conversation, a senior executive at one of the mining firms (who did not wish to be identified) suggested a more conservative number, on the order of 600 MW globally. He bases this estimate on the hash rate (number of calculations being performed) and today’s average energy efficiency in performing the hash calculations, a number that is constantly improving.

Could Growth of Bitcoin Eventually Be Constrained by Electricity Supply? – So how much energy will the Bitcoin network use and how fast will that demand grow? Two datapoints suggest rapidly increasing energy use.

 First, the growth potential is enormous. As noted previously, the number of bitcoin transactions is estimated to range from 150,000-250,000 per day – up to 90 million annual transactions. In the scheme of things, that number is miniscule in the context of an estimated 389 billion global annual non-cash transactions. So there’s potentially plenty of room for expansion.

Second, the way hashing is currently structured, the creation of each additional unit of currency is mathematically more difficult, thereby requiring more computing power and energy than the previous iteration.

These two facts would seem to imply that crypto-currencies could have huge room to grow if they grabbed just a fraction of global economic transactions, with a potentially large strain on future power supplies.

However, other factors might suggest otherwise. The executive interviewed for this piece noted that efficient new mining chips soon to enter the market will be three times faster than today’s chips. He also observed that the industry margins are consistently tight, which will keep the focus on energy efficiency. The industry simply will not be able to grow if the economics (either the value of bitcoins or energy efficiencies, or both) do not continue to improve. By his estimate, the industry currently spends approximately $250 million annually on electricity. With other costs (such as capital costs), he suggests that the current annual price tag to run the network is somewhere between $400 and 500 million. Compared to revenue of approximately $525 million (1.4 million bitcoins created over the same period at an average price of roughly $375), the margins are not enormous. Continued growth without gains in efficiency is therefore unlikely.

With Impressive Transactional Efficiencies, Cryptocurrencies Are Here to Stay – The industry exec suggests that one way to look at the future viability of Bitcoin is to compare societal value created versus resources consumed.  He observes that one way to look at this is with a comparison to the economics of PayPal. In 2015, the total cumulative value of estimated Bitcoin transactions equaled just over $60 billion, with a total system network cost of roughly half a billion dollars. By contrast, PayPal reported the following in its latest quarterly report: $2bn in expenses (17,000 employees) for 1.4 billion transactions representing $81 billion in payments. Among other things, Paypal needs a lot of resources for fraud protection, which is something the blockchain addresses by its inherent nature. From the perspective of the value of payments relative to costs, Bitcoin is much more efficient.  It’s not a perfect comparison, but it certainly highlights the inherent efficiencies of a network that relies less on humans and more on electrons and machines.

At the end of the day, although they are ethereal, Bitcoin and other cryptocurrencies are still tethered to the hard reality of the physical world, relying for their creation on actual computers that consume real kilowatt-hours. While Bitcoin mining is still small in terms of its demand on electricity resources, the cryptocurrency energy requirements will likely soon grow into the thousands of megawatts. These mining operations will continue to be situated near sources of cheap electricity, even as the industry strives to improve efficiencies in order to stay profitable. For many reasons, it’s a trend worth watching.

Correction: BitCoin miner BitFury was contacted by the author in June but did not want to release information beyond what was publicly available (press releases totaling 160 MW of BitFury data centers). A subsequent conversation with a representative of the company on July 22nd (after the posting date) indicated that – although BitFury won’t publicly say how much capacity is dedicated to data centers – the amount is not equal to the total of the known facilities; the 100 MW Georgia center is still under construction and the total is not cumulative.  We can therefore posit that the current total amount is in the 60 MW range and growing to 100+), getting us to about 400 MW if BitFury is roughly a 6th of the market and other miners enjoy the same efficiencies (which they don’t). The originally posted content below was based on those erroneous numbers, and has therefore been removed from the original body of the text.

BitFury, the third largest miner, represents around 16-17% of the market. We may be able to assume that – assuming similar efficiencies (probably a bad assumption, since BitFury prides itself on having some of the most efficient operations in the industry) BitFury represents roughly 1/7 of the entire industry’s power consumption. Since BitFury is know to have at least 160 MW of datacenters (it built one 20 MW center within a few weeks!), a rough extrapolation suggests that today the global draw of Bitcoin exceeds 1,000 MW.”