Do the benefits brought by Bitcoin and the improvement in our standard of living justify this additional use of energy?
Bitcoin arouses passion, curiosity and has received more and more media attention, especially after having climbed the ranks of the best financial asset of the decade. However, whenever its price goes up, many doubts and questions arise, mainly around its origin and the energy expenditure by miners.
The Bitcoin protocol has created a unique digital asset
Before Bitcoin, there was neither a digital value to be transferred nor a digital asset to be divided into several parts. That is, if you scanned a $100 bill and wanted to transfer this bill to someone, you could only send a copy of this bill.
We are all used to smartphones and computers already. We send emails, photos, but we don’t realize that process in reality: We send a copy of the email (and not the original email), a copy of our photos (and not the original). When we click the send button on a smartphone or computer, a copy of the original will always remain on our device.
Likewise, regarding financial transactions, when we click on the send button in our internet banking accounts or at an ATM, there is always an intermediary that transfers the money from one account to another. And that’s the problem Bitcoin aims to solve — the double-spending problem.
When you click the send Bitcoin button on your cell phone, for example, you are not sending a copy, you are actually sending a digital object. Once a transaction is made in Bitcoin, it becomes irreversible and cannot be tampered with.
For that reason, it is impossible to cancel or reverse a Bitcoin transfer after it has been validated by the blockchain network because the Bitcoin protocol has solved the problem of double-spending. It made a single asset, Bitcoin, digitally unique, enabling value transactions on the internet without intermediaries (independent of a central entity).
Who issues Bitcoins?
While traditional money is issued (created) through (central) banks, Bitcoin is issued by algorithms, whose rules are pre-established in its protocol — the Bitcoin blockchain.
In turn, the Bitcoin blockchain is a transaction registration system, maintained in an open (distributed) network of “suspicious” participants, who do not know or trust one another.
So, when Satoshi Nakamoto wrote the source code for the Bitcoin protocol software and published it on the internet, he proposed the following: If you provide security for this network and help this financial network to operate, you will be rewarded.
The logic of the pre-established rules in the Bitcoin protocol was very transparent and was written in a programming language. The breakthrough brought by the first blockchain, after years of research on digital currencies, is not just about computer science solutions.
The secret is in incentives
To create the Bitcoin blockchain architecture, Satoshi Nakamoto looked at existing research — bit-gold, b-money, hashcash, time-stamped cryptography — and added game theory.
Using game theory, Satoshi implemented an incentive mechanism (consensus mechanism) called proof-of-work that enabled a new field of economic coordination, now called “cryptoeconomics” (the fields of economics and computer science to study the decentralized marketplaces and applications that can be built by combining cryptography with economic incentives).
It is this economic incentive system that ensures that Bitcoin network participants behave in favor of the security and the perfect functioning of the system. This is the main reason why the Bitcoin blockchain has yet to be hacked.
The importance of mining
As more and more people realized the potential incentives in Bitcoin and started to “plug in” their computers to provide security to the network, the Bitcoin blockchain became more and more viable and secure. Now, there is enormous computational power guaranteeing transactions: Bitcoin is computational strength.
A Bitcoin is “extracted” from the blockchain protocol by miners (validators) who need to solve mathematical algorithms to earn the right to include Bitcoin transactions in the blockchain network and be rewarded for it.
Each Bitcoin transaction, before being added to the blockchain, is sent to the “mempool,” a retention area for pending transactions, where it awaits its inclusion in a block. The miners then take the pending transactions, which are waiting to be recorded, and combine them to create a “block” of transactions.
Realize that the miners compete with one another so that their computers are chosen to record the most recent transactions in the next block that will be included in the network. And the best way to win this competition is by solving the algorithms as many times as possible (before someone else reaches the correct result, called a “nonce”).
As it takes trillions of attempts to guess the correct nonce, only those who have more computational strength to win this competition will be awarded Bitcoin as a reward for their efforts.
We can draw two main consequences from what we have said so far.
The first consequence is that PoW prevents miners from circumventing the system and creating Bitcoin from scratch. Miners must burn real computing energy with each attempt and find the nonce to have a chance to win Bitcoin. As electricity to supply miners is not free, proof-of-work, therefore, generates a financial cost for Bitcoin mining.
The second consequence refers to the fact that PoW makes Bitcoin’s transaction history immutable. If an attacker tries to change a transaction, that attacker will have to redo all the work that has been done since then to recover and establish the longest network. This is theoretically impossible and that is why miners are said to “protect” the Bitcoin network.
As mining has become a legitimate industry over the years, it is supported by dedicated professionals with specialized hardware, which requires large data centers and a lot of electricity.
It is worth mentioning that although there are other consensus mechanisms, PoW is the most used in blockchains because it is the most effective in terms of cybersecurity.