Elephants in the cryptocurrency room

Faced with a proliferation of world issues, there is a global demand for “something else”, cryptocurrency technology, can at least in part address…

Cryptocurrencies, Blockchain technology, wallets and countless related apps form an exponentially expanding field. No longer the sole preserve of specialists, hackers and crypto enthusiasts, this effervescent set of technologies is invading mainstream business. It is no longer of interest to just the so-called “Fintech” but also increasing to the world of utilities, for power grid management, to the oil industry or even in areas like advanced agriculture and food processing technologies and businesses. In short, faced with a proliferation of world issues that is expanding no less exponentially, there is a global demand for “something else”; something that cryptocurrency technology, as demonstrated by recent developments, can at least in part address. The questions few are asking though are what this “something else” actually may be and how big it may be.

A global demand for something else

This is the second in a series of posts that will focus on this global demand for “something else.” As the emerging interest from sectors as diverse as power utilities, the oil and gas industry, agriculture, and a growing number of other industrial sectors hint, this is a demand that extends far beyond the mere domain of cryptocurrencies, although clearly cryptocurrency technology has an essential role to play in addressing it. In short, it is a demand for ways of getting rid of a number of “elephants” that have begun rampaging in a number of “rooms”. As GB hopes to show in future posts, all of these “elephants” are interrelated, they form a rapidly growing herd and they are led by what one could call the “mother of all elephants”.

“Elephants-in-the-room” are by definition invisible except to the few who actually dare to look through the veil of beliefs and conventions. So, to date, the resulting demand remains largely unseen, which also means that the business, money-making potential is, well, huge, in direct proportion with the mother of all elephants and her herd of offspring…

In this introductory post we will focus on the elephants in “cryptocurrency room”. In subsequent posts we will cast light on the elephants in the oil and energy rooms, and from there we will look at the global picture for the whole of the industrial world. One could begin with any of the others since they are all interrelated, however, cryptocurrency technology, in fact, is an essential “ingredient” to dealing with the whole herd and focusing first on that particular lot is easier as it does not require too much prior knowledge about the others; that is, the cryptocurrency room is a good entry point…

A loss of fiat

The cryptocurrency matter is obviously “hot” concerning a range of issues badly affecting mainstream currencies and the global financial system. Since the 2008 global financial crisis and its endless saga of sequels, including various forms of quantitative easing, ever growing global debt and sluggish growth at best, growing numbers of specialists and lay users of money have come to doubt that the global fiat currency system, as we currently know it, has much of a future. Some talk of a “reset” without it being clear what form this could specifically take… In other words, the “fiat” is rapidly oozing out of fiat currencies.

Pumping in massively more fiat, aka “quantitative easing”, has not cured the ills. There is a growing suspicion that, qualitatively as well as quantitatively, fiat not only can’t “cure” but also is one of the poisons affecting the whole system. In other words there is an emerging global demand for a “something else” where cryptocurrencies and technologies like the Blockchain have important roles to play to enable secure, reliable transactions, globally, in all domains involving value — accounting, transfers of value, storage of value — a “something else” that could do substantially better than fiat currency systems or even gold, silver and the full spectrum of precious metals.

This same kind of demand for “something else” can also be found in all other domains where transactions of all sorts take place between any kinds of entities forming networks. These entities may be people or things that people use, directly or indirectly — electrons, photons, materials, goods, services… The fields include any domain where one must keep track of exchanges (accounting), organise and settle exchanges, and store “things”, whether these things take on a currency character or not. A good example is the increasingly complex management of power grids when instead of central power stations one has to deal with increasingly finely distributed supply and storage units, such as photovoltaic panels on roofs (PVs), wind turbines, combined heat and power units (CHP), grid connected batteries, mobile batteries in electric vehicles (EVs), etc., where transfers of electrons in all directions and their storage at a wide variety of locations must be tracked in real time (accounting) and managed (means of exchange), often by the millisecond.

Fiat is from the Latin fieri, a passive of facere, to do; cognate of the Greek phyein, to cause to grow. Put in the most generic sense, there is a huge global demand for means to do transactions between anything/anyone and anything/anyone else in secure, safe and resilient ways, that involves the key features of currencies as units of account, exchange, and storage of value.

A matter of scale

The above considerations serve to cast light on the first of our elephants. At GB we do not know of any cryptocurrency technology or combinations or integration of technologies that can scale to fulfil the above demand, not only now or in the near future but also in the longer run, say at the 2030 time horizon. This remains the case even if we set aside the other challenges that we will examine in subsequent posts.

Cryptocurrencies, obviously, are technologies run on the Internet. This year, 2017, the population of Internet users is reaching 50% of global population (http://www.internetworldstats.com/stats.htm). In round numbers let’s say 3.8 billion people (3.8G). At the 2030 time horizon and with UN population growth expectations, we can conservatively consider a 7G Internet user population. However, we must also consider “things”, in the Internet of Things sense (IoT), that is, not only the things most lay people tend to think of, such as smart phones, cars or electronics appliances of all kinds that are increasingly connected, but also a whole host of other things concerning power grids, gas reticulation, oil and fuels pipelines, water reticulation, sewage systems, and in fact all production and supply chains, including recycling. To this we must also add all the networking required to deal with the rapidly mounting sets of ecological issues, locally and globally, such as floods, droughts, fires, crop diseases, deforestation, water tables and stream pollution, sea pollution, air pollution, and more.

Scaling is a specific domain of engineering. Here we must conservatively consider that the scaling requirement for cryptocurrency technology taken in the broadest sense of the word is at least in the order of 70 billion points of use globally (70G) at the 2030 time horizon. This is the demand as we identify it. As far as we can see, the current cryptocurrency state of the art cannot meet that demand.[1] There is a market vacuum. By scaling, GB means cryptocurrency technology able to be interoperable between anything and anything else, in real time, with very low latency, globally at many billion nodes levels and able to go well over 70G nodes beyond the 2030 time horizon. How to go towards this kind of service with current Blockchain technology? This is the first of our elephants as this specific demand, in our view, remains largely unseen.

A matter of power

A number of other elephants follow suit behind the scale and fiat elephants. It is well known that Bitcoins require ever increasing amounts of computing power as transactions numbers and use progress. Besides the clear lack of scalability, the resulting impact is that Bitcoin-based transactions are increasingly slower and slower and that the number of transactions that can be processed by unit of time remains lower than what e.g. Visa provides. In short, there is a trade-off between the transaction security provided by the present Blockchain technology versus speed and flexibility of transactions. The matter is the object of considerable debate and development work (e.g. concerning SegWit and MASF matters resulting in the recent fork and advent of Bitcoin cash).

A number of more recent cryptocurrency developments endeavour to bring transaction times and computing power use down. However, and just as importantly, what many if not most parties involved in cryptocurrencies appear to neglect is that, as a consequence of the increasing computing power they require, present cryptocurrencies also require a rapidly increasing amount of electrical power. This is our next elephant. The cryptocurrency power demand, presently can’t scale to meet our identified global demand for “something else”…

For example, O’Dwyer and Malone (2014) assess that the energy use of mining Bitcoins is already comparable to the electricity consumption of Ireland (i.e. about 3GW).[2] Scaling to the global monetary mass would require in the order of 25% of present total global installed power.[3] Currently, according to Alex de Vries a Bitcoin transaction takes up some 192kWh, enough to power 6.5 US households for one day.[4] Ethereum is less demanding but its power requirements are already substantial.[5] Alex de Vries’ site puts the energy use of a single Ether transaction at 54kWh, i.e. the power demand of 1.8 US households for one day. All of this is far too high to scale to global demand for something else.

We have noted earlier the consensus issues concerning scaling to the global demand. These translate into energy demand. Proof of Work (PoW) used by Bitcoin is more energy demanding than Proof of Stake (PoS). Dash, for example, uses both PoW and PoS. Other consensus methods are more efficient energy wise, but they introduce their own problems.

The energy requirements are also related to the ability or not to make micropayments (e.g. payments costing less than the energy used to make them). For example, Iota is a cryptocurrency specifically adapted for the Internet-of-Things that does not involve a Blockchain. It is designed to enable micropayments.[6] Although energy requirement are not specifically mentioned, implicitly the approach may lead to efficiency improvements. Another example is R3 Corda, a distributed ledger platform designed to manage financial agreements between regulated financial institutions. Instead of accepting the “Bitcoin bundle” as is, R3 sought to go back to fundamentals, single out and understand banks’ requirements and fashion a solution addressing those specific requirements.[7] A third example is the EOS.IO software. It “introduces a new Blockchain architecture designed to enable vertical and horizontal scaling of decentralized applications…” “by creating an operating system-like construct upon which applications can be built”. EOSIO claims that its software can scale “to millions of transactions per second, eliminate user fees, and allow for quick and easy deployment of decentralized applications.” [8] EOS appears to be a move in the right direction. However, the White Paper claims latencies down to the “few seconds” and support of “millions of users” while what we are considering is tens of billions of users and much lower latencies for at least parts of the energy and communications applications involved in networks of points of use.

In other words, it appears safe to say that the Blockchain and cryptocurrencies are still young, far from mature technologies encountering distinct sustainability issues. They are evolving rapidly but still remain far from the requirements of the large potential global market that we have recognised. Presently, this situation tends to confine current cryptocurrencies to a market of specialists and enthusiasts who are prepared to bear the risks attached to them.

In fact this specific energy requirement elephant is closely related to another one that is much bigger. We are focusing here on the power demand of the Internet. The Internet and more broadly Information and Communication Technology infrastructures (ICT) taken as a whole are recognised as an energy “guzzler”, at already twice the energy use level of air traffic,[9] something that is not sustainable in ICT’s current state.[10] Furthermore, Andrae and Edlers (2015) estimate that, at the 2030 time horizon and in the absence of significant efficiency improvements, the ICT share of global electricity usage can be expected to be in the order of 21% and even reach up to 51%, a level that obviously is not viable.[11] Something has to change. Here too we encounter a global demand for “something else” that largely remains unseen. The longer such demands remain unheeded, the more damage from the corresponding elephants.

Both fiat currencies and cryptocurrencies depend on an Internet that is by now close to its “use by date” because of the unviable large amounts of energy that it increasingly requires, and, in addition, cryptocurrencies are affected by this challenge even more directly because of the nature of the Blockchain technology. This means that, at present, not only none of the cryptocurrencies that we are aware of is able to scale to the level of this global demand because of the software challenges inherent in the Blockchain technologies, but also because of their unsustainable energy requirements and furthermore because the Internet they are overlaid on is not viable thermodynamically in the longer-term. GB is forced to conclude that while cryptocurrencies may look attractive for now, most are not sustainable in the medium term and even less in the longer-run, even from the most optimistic points of view. We will see in subsequent posts that factoring in as yet unseen challenges coming from the oil sector, the prospects for current cryptocurrencies are even more problematic.

Let’s hasten to stress than in saying so GB does not intend to downplay the merits of cryptocurrencies and related technologies. We have highlighted the huge demand for them. Instead we seek to cast light on the challenges they face and the directions in which they must move.

A matter of value

There are more elephants in the cryptocurrency room. Besides structural weaknesses of their own, most present cryptocurrencies also suffer from the same weaknesses as fiat currencies, that is, they float in an abstract space and are not anchored in, nor backed with, any tangible physical process that would be directly related to economic activity and the build up of actual value (the “created-out-of-thin-air” syndrome). In short, they are not yet fully meeting the scope of requirements for a currency: to be a reliable means of exchange, a means of account, and a store of value — they are particularly vulnerable as stores of value, especially in the longer run.

To understand them better, the above issues must be set against the physics of value creation and storage. All economic activities require energy and thus some form of installed power (measured in Watt and its multiples). Energy has a unique status. It is the sole resource that cannot be substituted with anything else and that is required in order to access all other resources and to produce anything. For example, if one is short of water one can desalinate seawater. However, this requires energy — no energy, no water. Also one can substitute coal with oil and oil with natural gas, or solar sources, but one cannot operate anything nor live without the energy these carry. It ensues that ultimately energy is the sole, fundamental anchor of value. This specific status of energy in relation to economic value and currencies is ignored by most economists and cryptocurrency developers alike.

Figure 1 — Gold is proxy for energy

The link between energy and value is well illustrated on Figure 1. It shows the stable long-term relationship between gold and oil (orange flat line) versus the evolution of oil prices when measured in US dollars (blue curve). A gram or ounce of gold in 1860 and now are exactly the same. A barrel of sweet crude in 1860 and now contain the same amount of gross energy. Meanwhile the value of the dollar relative to oil and gold has fluctuated wildly since the dollar was unpegged from gold in 1971. Gold is a scarce and stable metal. Its mining requires a substantial amount of energy. As depletion progresses gold becomes scarcer. Oil follows a similar trajectory. Take another example. Wheat is bioenergy used to feed humans. A bushel of wheat at the beginning of the 2nd century AD was traded at about the same weight of silver as now. In other words, historically, gold, silver (and other precious metals), measured by weight, have acted as practical and effective proxies for energy concerning value storage, means of exchange and as a fixed standard of value.

More fundamentally, the work of Prof. Tim Garret highlights the strong link between the growth of installed power and wealth accumulation (capital) globally. Garrett shows that until about 2010, there has been a constant relationship of 9.7 ± 0.3 mW per inflation-adjusted 1990 US dollar of wealth creation.[12] In the most practical sense value is anchored in thermodynamics.

Figure 2 — Value and thermodynamic decline

The link between value and energy is illustrated further in the two diagrams on Figure 2. For decades, wealth creation assessed in terms of GDP per head has grown fairly smoothly when considered in dollar terms for both the US (green curve on left diagram) and the world (blue curve on right diagram). The picture looks considerably different when GDP/head is evaluated with a fixed, tangible standard of value, grams of fine gold (yellow curve of the left hand diagram) or net energy per barrel (red curves on both diagrams). Considered with a fixed, tangible, “measuring stick” wealth creation in the US and the remainder of the world has been on a chaotic thermodynamic decline since the early 1970s.

As we will explore in subsequent posts, since around 2012 the industrial world has entered the terminal, acute phase of this 45 years decline. In consequence, the currency situation that has been brewing since the early 1970s is now becoming critical. This is the most challenging of the yet unseen elephants. This situation leads us to consider that all present fiat-related, floating stores of value are at high risk. The same applies also to all present cryptocurrencies, and also to gold and other precious metals (since as we will see the energy basis for their ongoing supply and transactions is no longer guaranteed in the longer urn). None meet the challenges presented by the thermodynamics of the world we live in, in terms of accounting for, exchanging and storing value reliably.

Most people involved in cryptocurrency developments or commenting on them miss this link between energy and value, and the challenges it presents. For example, Daniel Jeffries, in his Hakernoon.com posts highlights well a couple of vital features of the emerging cryptocurrency world. First, in Why Everyone Missed the Most Important Invention in the Last 500 Years (23 June 2017), he singles out the importance of triple-entry accounting in that it remove most of the weaknesses of double entry accounting concerning the possibility of fraud and the merit of the Blockchain in implementing triple-entry accounting in a wholly distributed manner that give everyone the ability to ascertain the existence of a “thing” in a network of transactions and stores — that thing being any thing that need to be tracked, value, vote, or anything else.

In a subsequent post, Why Everyone Missed the Most Mind- Blowing Feature of Cryptocurrency (31 July 2017), he further singles out an even more important matter, one that all cryptocurrencies so far do miss and that closely overlaps with what the present post deals with:

“The true power of cryptocurrencies is the power to print and distribute money without a central power… Satoshi understood the first part of the maxim, the power to print money. What he missed was the power to distribute that money… The second part is actually the most crucial part of the puzzle. Missing it created a critical flaw in the Bitcoin ecosystem. Instead of distributing the money far and wide, it traded central bankers for an un-elected group of miners… What if you could design a system that would completely alter the economic landscape of the world forever? The key is how you distribute the money at the moment of creation… And the first group to recognize this opportunity and put it into action will change the world.”

In GB’s view, Jeffries is right in both the matter of triple-entry accounting and that of what current cryptocurrencies do miss concerning the distribution of money within the social fabric. The chief matter is in the “how” to achieve the latter. Here in turn, Jeffries misses a further vital feature, the inherent, inescapable link between energy and value. The matter of the how concerning energy accessing and distribution is where energy precisely comes in. By “accessing” here we mean accessing from a primary energy source, such as the direct solar influx, indirect solar sources like wind or biomass, or even crude oil or natural gas (e.g. in industrial settings). The fundamental challenge cryptocurrencies must now address to achieve the aim of “printing and distributing money without a central power” is to link money creation and distribution with the very act of accessing energy in fully distributed manner right at the point-of-use, at end-users’ levels where they live and work and wherever they go in between. And yes, we agree that doing this can “completely alter the economic landscape of the world forever”. If GB can mention this, is obviously because we have figured out how to do this. However, please bear with us. We need to go through a few more matters before we can come back to this exciting point.

Tangible past versus bets on an increasingly uncertain future

The strong link between value, energy flows and thermodynamic power illustrates also the most fundamental difference between gold and other precious metals on the one hand and fiat currencies and cryptocurrencies on the other hand.

Being based on debt, fiat currencies are de facto bets on the future — each financial transaction using a fiat currency (by cash, credit card, cheque, or any other means) is a bet that the economies that use that currency will remain able to service their debts in the future thanks to the ongoing development of economic activity that is required to ensure said debt servicing. As noted earlier, such bets are increasingly uncertain and flimsy. In subsequent posts we will see that those bets are most unlikely to still hold at the 2030 time horizon. Without a strong, tangible assurance concerning the actual value of fiat currencies through space and time, the entire financial systems built on them are falling into limbo. They fall all the more rapidly that more and more fiat currencies get “pumped” into those systems, shadok-like. Cryptocurrencies do not address these issues either.[13]

The value of gold, of other precious metal, or barrels of oil or any such stores of value, on the other hand, is based on and refers to past work, measured with the Joule and its multiples, exerted to produce and supply goods and services. This is fundamentally the tangible feature that differentiates them from fiat currencies and why so many people worldwide continue to rely on them — past tangible work versus increasingly flimsy bets on an increasingly obscured future.

So to sum up this second post, in order for them to be viable, it is imperative that cryptocurrencies be anchored in, and backed with, sustainable installed power and related energy flows, that they do so at the very points of energy accessing and use at the end-users’ level, in ways that scale to the global demand, that are overlaid onto an Internet that would be thermodynamically viable, and that are immune to the vagaries of the global financial system, not just in the short-term but also in the longer-run. This may seem a most intractable challenge. We are more than confident that it can be dealt with swiftly, and highly profitably, but in our view, not along the routes presently followed.

To be continued…