Not so cryptic take on crypto — II
Diving into energy usage and bitcoin concentration
Last week, FalconX introduced a new series expounding on misconceptions, institutionalization, and technological advancements encountered in crypto every day. I highlighted that bitcoin volatility adds to technological advancement and that central bank digital currencies will coexist with bitcoin, not replace it. This article tackles two major controversial points in this article: bitcoin is not the ESG disaster that everyone thinks it is, and that bitcoin is not as concentrated as top-level statistics often tout.
A quick summary:
- Bitcoin’s electricity usage is on par with the traditional banking system, and 40% of hashing power consumption comes from renewable sources.
- Statistics quoted like 95% of bitcoin are controlled by 2.5% of accounts need to be unpacked as they misrepresent the word “control.”
Bitcoin is an ESG disaster
It’s hard to argue with the massive amount of power consumption that bitcoin mining consumes. Per Bank of America’s report, bitcoin is responsible for 0.4% of the global energy consumption and is on par with the Netherlands and is greater than Chile and Greece. The case mounted usually involves references that this excess electricity is either wasteful or taking resources away from other, more important uses.
Today, the estimated energy costs associated with the traditional banking system, evaluated by the electricity used by branches, servers, and ATMs worldwide, is between 100 TWh and 140 TWh. 40% of the United States’ electricity in 2020 derived from fossil fuels with renewables only accounting for 20%. For a majority of U.S. traditional banking systems, many of these branches rely on electric grids located close to cities and easily accessible. In comparison, Bitcoin operates as a decentralized network of nodes maintaining the upkeep of the network. Due to its decentralized nature, miners are incentivized to find the cheapest sources of electricity, a majority of them coming from renewable energy and locations far from metropolitan systems such as Keflavik, Iceland with a population of roughly 16K.
The University of Cambridge’s Bitcoin Consumption Index page has a variety of visualizations, but perhaps the most interesting is the fact that “the amount of electricity consumed every year by always-on but inactive home devices in the USA alone could power the bitcoin network for 1.6 years”. So, bitcoin consumes as much electricity as the banking system but less than wasted electricity from always-on-but-not-used devices. If bitcoin is wasteful, we should be unplugging our household devices when they are not used.
Cambridge also released their 3rd Global Cryptoasset Benchmarking Study in September 2020 and cited that almost 40% of the hashing energy consumption comes from renewable sources, and 62% of miners reported that hydroelectric power is their primary source of electricity.
While bitcoin’s energy consumption has an extensive global footprint, the top-line number needs to be taken within context. Throughout geographical regions, hydroelectricity is the top energy source for bitcoin mining. Although net-new renewable energy growth took a hit in 2020 due to Covid, the IEA projects about 15% growth in new renewable energy in 2021. 56% of new renewable energy plants have lower electricity costs than the cheapest new coal plants. Given that energy costs are the second largest expenditure for mining companies (after hardware), one could assume that as renewable energy cost decreases, these companies will continue to increase their consumption of renewable energy.
Whales Dominate Crypto
Bank of America stated that 95% of bitcoin is controlled by 2.4% of accounts. The source mentioned, Bitinfocharts.com, also has a page with top wallet addresses and asserts that about 42% of the current circulating supply of bitcoin is held by whales, those with greater than 1,000 BTC as defined by Business insider. In addition, many of the largest bitcoin wallets are owned by centralized hubs, like exchanges that co-mingle customer assets. BitInfoCharts.com has also identified major wallets from exchanges, and according to their list of top 100 wallets, 965,361 bitcoins are held in wallets identified to exchanges. Their list does not include other large aggregators like Coinbase, which according to their recently filed S-1 (data as of 12/31), has $90 billion in crypto assets custodied on their platform. Research firm Messari estimates that bitcoin makes up 70% of the total assets custodied at Coinbase. Fund manager Grayscale, the largest in the crypto space, also has approximately 654,850 bitcoins tied up in their products.
With a bit of back of the napkin math, estimating bitcoins held at Coinbase on 12/31, plus Grayscale, and adding in the 965,361 as identified exchange wallets by BitInfoCharts.com, one can garner that these three sources of data represent about 20% of the total circulating supply of bitcoin. While the argument will be that large holders of bitcoin may be included in this number (which is true), these are honeypots of bitcoin assembled by an immense number of individuals that are trusting centralized counterparties for safety. Large holders exist, but Coinbase, Grayscale, and other aggregators’ primary purpose is to simplify access for institutions and retail consumers alike. Further backing up this notion, Glassnode estimates that the top 2% ownership’s upper bound would be closer to 71.5% percent and estimates that the actual distribution to be more evenly distributed when accounting for custodians, lost coins, wrapped BTC, and exchange supply.
While bitcoin holdings are not as concentrated as one may think, the amount of large holders is increasing, alluding to the institutional wave that the crypto market is experiencing. Over the past few months, there has been a significant increase in the number of accounts with a concentrated supply of bitcoin.Glassnode noted that institutional wallets (those with >1000 BTC) grew more in January this year than all of 2021. Fortune 500 balance sheets, exchange-traded products, traditional hedge funds, and other institutional investors with large pools of capital are entering the space at rapid speed and increasing these concentration pools. Large holders will continue to compete with new institutions, and while this will further concentrate bitcoin’s supply to institutions, it will broaden the scope of concentrated risk among top holders.
What’s next?
The institutional wave is here. Coinbase’s IPO tomorrow brings considerable credibility to the crypto space. The Coinbase IPO, coupled with the numerous Fortune 500 companies putting bitcoin on their balance sheet, generates a lot of interest and intrigue for cryptocurrency. While new institutional entrants are unpacking what bitcoin is and whether they consider it an investable asset, it’s essential to look at the digital asset space through a lens that understands that cryptocurrency doesn’t fit in the traditional modeling framework; it’s new, generationally disruptive, and exciting. Our next article in this series will focus on how vastly different the digital asset space looks today than just one short year ago when Covid began.
David Martin is an experienced finance and fintech professional, starting his traditional finance career focused on trading, quant modeling, and managing portfolio risk. Since 2017, David has centered on his passion for financial technology, founding AlphaStream Analytics, a hedge fund risk management platform, and was the CIO at Blockforce Capital — a quantitative, multi-strategy hedge fund focused on managing volatility in crypto assets. Prior to joining FalconX, David was charged with building front office tools at Ridgeline. He recently joined FalconX as a member of the product team focused on the institutionalization of crypto as an asset class.
This document is not investment advice and FalconX is not an investment advisor. This information is for informational purposes only. The information contained herein is the opinion of the author and does not necessarily reflect the opinion of FalconX.
