Blockchain — hero of the energy transition or climate policy enemy number one?

Virtual, decentralized platforms are either a disruptive technology that could potentially accelerate the clean energy transition or send decarbonisation goals hurtling over a cliff by giving rise to energy intensive digital currencies such as bitcoin. So what do we know so far about these two contrasting views? And what role can energy regulators play in maximizing any potential benefits while mitigating risks for the consumer?

Amid the hype and scepticism about bitcoin it is as difficult to forecast the cryptocurrency’s energy intensity as it is to predict how transformative the platform it uses, blockchain, will become. Here’s why.

So far, estimates suggest that the current bitcoin network consumes somewhere between 2 to over 6 gigawatts (GW) of electricity, with the latter being equivalent to the power consumed by more than 4.9 million US households, or more than the rate of consumption of Israel. So febrile are consumption estimates right now that one minute we add these mind-boggling numbers in this blog, only for them to be different the next time we click through the Bitcoin Energy Consumption Index.

However, estimates rely on a vast number of assumptions, and the reality is that we miss hard details on one key component of the algorithm: miners’ operating costs and exact location.

The task of accurately forecasting the network’s future carbon footprint becomes nearly impossible when we take into consideration the following:

· Evolving regulatory schemes in countries like China, which has already imposed restrictions on cryptocurrencies and is considering further measures to curb energy use;

· The network’s architecture, which rewards the most efficient miners and therefore drives innovation and investment, ie the more powerful and efficient systems are, the more likely it is for miners to crack the codes and win the reward;

· The volatility in bitcoin’s value, which drives the demand for computing power and therefore its energy usage;

· The development of other blockchain networks that are significantly less energy intensive such as proof-of-authority (PoA) and proof-of-stake (PoS).

These are just a few of the reasons why it is unrealistic to use the growth rates that we have experienced in the past year and the current bitcoin network’s characteristics to forecast its future energy consumption. But it is an area worth observing, even if we’re short on detail right now.

Why are blockchain platforms so energy intensive?

Essentially, in a decentralized network, you have to replace what was a trusted intermediary (ie, bank) with a computer-driven certification process. The blockchain network used by bitcoin — which relies on something called proof-of work (PoW) — solves this problem by incentivizing “miners” on the network to use computational power (and thus energy) to compete to be able to crack a code and validate a block of transactions.

The difficulty in solving the puzzle is said to ensure the security of the system, but it consumes a lot of electricity which is why a lot of ‘mining’ has been concentrated where electricity is cheap, ie China, where 58% of bitcoin miners are located. Unfortunately, the electricity system in China is still heavily dependent on coal, so not only is the electricity consumption for cryptocurrencies high, it is a highly carbon intensive activity. That said, researchers at Cambridge University have also identified the co-location of mining capacity alongside hydro power stations in Sichuan province, while other operations have started to locate in other low temperature zones with plenty of clean electricity, such as Iceland with its deep pockets of geothermal reserves.

From the Global Cryptocurrency Benchmarking Study 2018 (Cambridge Centre for Alternative Finance)

So what about those who say that blockchain can accelerate the energy transition — how would that work? Advocates of distributed generation say that blockchain makes peer-to-peer trading more accessible, bypassing any need for a formal market or intermediary which can add to transaction costs.

From the perspective of electricity consumers the potential benefits could be significant.

Not only does the blockchain platform promise to reduce costs by eliminating intermediaries and allowing more efficient marketplaces, but it also could allow consumers to source their power directly from low cost and low carbon resources, whether that is a neighbour’s rooftop or a large wind farm many miles away.

Blockchain based systems could provide a platform for market participation in distributed generation, virtual power plants and demand management. One application for a decentralized transaction system, which is what a blockchain provides, could be to support payment services for electric vehicle (EV) charging — a critical piece of infrastructure for the energy transition.

Blockchain offers distributed assets an easier way to trade — a peer-to-peer trading. L03 Energy launched the Brooklyn Microgrid last year, which enables local users to trade clean energy (largely from rooftop solar and batteries) with one another. The startup has already attracted investments from Siemens and Centrica Innovations. However, to accelerate the energy transition, a much greater scale is required.

The Rocky Mountain Institute’s Energy Web Foundation now has support from many of the world’s major utility and energy companies around the world, such as Centrica, Duke Energy, Eon, Engie, Exelon, Sempra Energy, Shell and Statoil, to explore blockchain’s potential in the electricity sector and create less energy intensive options that could “accelerate — not hinder — environmental and energy goals”.

This week GTM has put out a report, Blockchain in Energy 2018, listing nine categories of projects already deployed and announced over the past couple of years — many of those are on the consumer side.

From the perspective of the electric utilities benefits are less clear than they are for the consumer.

The more customers can buy and sell electricity without involving the utility, the smaller the role of the utility becomes. That said, some possible uses of blockchain technology by utilities include:

· Trade without involving a market operator or administrator;

· Track renewable energy credits (RECs) and reduce the cost of making sure RECs aren’t double-counted;

· Operate a marketplace for distributed energy resources and transition towards a business model in which the utility becomes a service provider rather than a power generator.

In future, we think that utilities may no longer be the natural owners for generating assets, but they will be very active participants and in many cases leaders in the delivery market, which will provide flexibility services to achieve high shares of renewables. It is possible that those markets could be built on blockchain-based platforms, particularly where centralized markets are politically challenging to implement.

It is precisely this disintermediation of the utility that makes the potential for a distributed grid and transactional technologies so exciting. However, this business model introduces a significant risk to utilities and their customers.

As the market for distributed generation expands, utilities face the risk of ending up with stranded assets on their books — obsolete or uneconomic assets on which the utility cannot recover the full cost of its investment and therefore must record a loss on its financial statements. While many renewable energy advocates strongly believe that shareholders should take the hit given management’s poor investment decisions, that would only cause the sector to become riskier from the investors’ perspective. In exchange, investors would demand higher returns, ultimately resulting in higher financing costs for the utility, which in turn, could slow down the energy transition.

In electricity markets the higher cost of capital would be passed on to customers, either directly through regulated rates, or indirectly through the investment choices of market participants. Even in a decentralized system there is a key role for utilities to be had in the delivery of electricity, so financing costs and the financial stability of utilities are crucial to realizing a low carbon energy system at low cost.

So what is the role for policymakers and regulators in this brave new decentralized world?

If we can learn something from the past century it is that innovation and adaptation have led to significant reductions in electricity costs and improved system flexibility, particularly where policymakers and regulators have allowed markets and regulation to adapt alongside technologies.

In a world where energy policy objectives are focused on grid reliability and in providing access to affordable and sustainable energy, regulators and policymakers should embrace innovation, encourage the analysis and evaluation of new technologies, while always acting in the best interests of consumers. There are big challenges for policymakers and regulators to address though.

In the near term, regulators face the challenge of rapidly growing demand from bitcoin mining, which could drive up costs and carbon emissions from the power sector. More fundamentally, blockchain-based platforms could provide an alternative to traditional utilities, leaving regulators to deal with reduced utility revenues and potentially stranded assets. Last — but not least — blockchain technologies could open up entirely new possibilities for market structures that lower costs for consumers.

Regulators will have to carefully balance potential benefits of blockchain technologies against the risks that they could raise costs and slow the transition to clean energy. But only time will tell whether blockchain technologies will have an incremental or transformational effect on the energy transition.

With input from Brendan Pierpont, an Energy Finance consultant at CPI, and Laura Sanchez, an analyst at the same organisation.

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Climate Policy Initiative Energy Finance

CPI Energy Finance is a team of analysts based in San Francisco and London that evaluates policies and financing mechanisms that enable and accelerate the energy transition