NFTs – are they bad for the environment?

In recent years, blockchains have been accused of imposing an unsupportable burden on the environment. The energy needed to operate Bitcoin alone has been compared to the national requirements of a small country.[1] Does this mean your new non-fungible token (NFT) artwork is killing the planet? Is your digital pride and joy a badge of shame?

Blockchains are often mentioned in the same breath as Bitcoin as if they were interchangeable. They are, of course, very separate concepts: blockchain is the underlying technology of which Bitcoin is merely a specific implementation (albeit the first and most prominent). But they have been together from the start,[2] so what is true of Bitcoin is sometimes taken as being true of all blockchains. However, as this article will discuss, that is not necessarily always the case.

So, what is the difference between blockchain and Bitcoin?

What is a blockchain?

At its simplest, a blockchain is a dataset which can be added to but not otherwise modified. Each set of entries (a 'block’) on the blockchain is cryptographically secured to the blocks immediately preceding and succeeding it, in much the same way as a row of knitting is secured to the rows immediately before and after it. Just as a row, once knitted, cannot be altered without unpicking all subsequent rows, so a block, once committed to the blockchain, cannot be edited without altering all subsequent blocks.

What is Bitcoin?

Bitcoin is a specific cryptocurrency secured on a particular blockchain. It was conceived in the depths of the Global Financial Crisis of 2007-2009 as a response to the perceived failure of central banks to protect fiat currencies against inflation. The overriding priority for Bitcoin was therefore to avoid coming under the control of any single interest or interest group who might choose to manipulate it to their advantage. Consequently, it was designed to be maximally decentralised and ‘trustless’, relying solely on the consensus of its participants (‘nodes’) for its operation.

Proof-of-work

In the case of Bitcoin, this consensus is protected by ‘proof-of-work’ (POW), a ‘consensus mechanism’ which requires nodes to justify their participation in the blockchain by solving algorithmic puzzles. In theory, these puzzles are so complex that it is technologically and economically infeasible for anyone to dominate the consensus to gain control over the Bitcoin blockchain.

As a technical solution to Bitcoin’s specific demands, POW is extremely elegant, but it is energy intensive and poorly scalable. It comes at a cost of significant computational effort and hardware and this cost rises dramatically as the blockchain grows, requiring an increasing investment of resources for ever-diminishing returns. POW may have suited Bitcoin’s needs in the early days but now looks increasingly unsustainable and needlessly wasteful. Nevertheless, where Bitcoin has led, other blockchains have followed.

Not all blockchains are created equal

POW is often touted as the gold standard consensus mechanism but that does not make it a ‘one size fits all’ solution. The size and complexity of Bitcoin arguably necessitate the highest levels of security and decentralisation: it exists in billions of individual units and subunits which are widely and frequently traded and are highly fungible (i.e. each is indistinguishable from all others).

NFTs, by contrast, are significantly fewer in number, are traded less often and are (by definition) non-fungible,[3] so cheaper alternatives to POW may be appropriate.

Furthermore, POW may not actually be as effective as is claimed. Far from being a magic shield against overbearing centralisation, it has failed to prevent economic pressures consolidating influence over Bitcoin in a handful of mining pools.[4] Worse still, in 2014, a single mining pool (Ghash.io) inadvertently achieved a critical 51% share of control, before voluntarily reducing this to 39.99% to restore trust in the cryptocurrency.

Alternative consensus mechanisms

There are numerous alternatives to POW, each of which strikes a different balance between security, cost, and scalability.

The most popular alternative is ‘proof-of-stake’ (POS) which requires miners to demonstrate a specified holding of a blockchain’s tokens. This rewards investment of time and commitment to the blockchain and consumes orders-of-magnitude less energy than POW — perhaps as little as 0.05%, according to the Ethereum Foundation.[5] While a POS-secured blockchain could theoretically fall under the control of a cabal of incumbent interests, the considerable cost savings can make this a risk worth taking, especially bearing in mind that even POW has not saved Bitcoin from the threat of oligopoly.

Ethereum (which hosts many NFTs) is in the process of converting from POW to POS over the course of 2020‑2021, and cryptocurrencies, such as Cardano and BitGreen, have shown they can also operate successfully on POS while still providing adequate levels of security.

Other consensus mechanisms include:

  • ‘Proof-of-authority’ (POA): a designated number of actors are essentially appointed as moderators of the blockchain based on their reputation;
  • ‘Proof-of-personhood’ (POP): analogous to a universal franchise, each participant is given a single, equal vote in the blockchain’s management;
  • ‘Proof-of-burn’ (POB): participants buy influence over a blockchain by spending that blockchain’s tokens, effectively equating wealth with power;
  • ‘Proof-of-elapsed-time’ (POET): influence over the blockchain is allocated at random by lottery;
  • ‘Proof-of-storage’ (POSt): replaces the computational requirements of POW by rewarding the commitment of memory space to record the blockchain.

The future

NFTs and cryptocurrencies are growing in popularity and in value, with ever-greater amounts of information being committed to blockchain. As the technology becomes more pervasive, its economic and environmental cost is becoming more evident, and operators and users are increasingly concerned in ensuring their activities remain sustainable.

At the inception of blockchain, POW was the consensus mechanism of choice, but it is not the right choice for all use-cases. Whether in the interests of speed and scalability, or reduced energy bills and environmental impact, many blockchains are adopting POS or other energy efficient alternatives.

If you are thinking about investing in NFTs or cryptocurrencies, it is worth understanding the difference between NFTs and the blockchains they are secured on. You should also investigate how a blockchain operates and whether this fits with your green credentials. Like all economic activities, some options are cleaner than others, while some come with a hefty carbon footprint and environmental price tag.

In previous articles on NFTs (Digital art – NFTs and intellectual property and Beyond digital art - implementing NFTs to your business), we examined what they are, what laws govern them, and how they can work with your business. In part 2 of this article, we will look further into the environmental impact of NFTs and blockchain and consider how you can benefit from this groundbreaking technology in a sustainable manner.

This memo presents an overview and commentary of the subject matter. It is not provided in the context of a solicitor-client relationship and no duty of care is assumed or accepted. It does not constitute legal advice.

© Moulis Legal 2021

 

[1] The country in question being variously Argentina, Malaysia, Norway or any number of others depending on your source.

[2] Both were first described by Satoshi Nakamoto in ‘Bitcoin: A Peer-to-Peer Electronic Cash System’ (White Paper, 31 October 2008) <https://bitcoin.org/en/bitcoin-paper>

[3] i.e. they are inherently distinguishable from each other.

[4] Perhaps as few as five such pools by 2020, according to Bloomberg (Blog Post, 31.01.2020) https://www.bloomberg.com/news/articles/2020-01-31/bitcoin-s-network-operations-are-controlled-by-five-companies

[5] Carl Beekhuizen, Ethereum Foundation https://blog.ethereum.org/2021/05/18/country-power-no-more/

Key contacts
Graeme Fearon
Special Counsel