How to reduce the environmental impact of crypto

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Maintaining bitcoin and other cryptocurrencies is responsible for around 0.3% of global CO2 emissions. It may not seem like much, but it’s more than the emissions from Switzerland, Croatia and Norway combined. As many cryptocurrencies plummet and the FTX bankruptcy enters the litigation phase, regulators are likely to scrutinize the crypto world more than ever before. This is a great opportunity to limit their environmental damage.

The good news is that cryptocurrencies don’t have to be carbon-intensive. In fact, some have near-zero emissions. To encourage polluting currencies to reduce their carbon footprint, we must force buyers to pay for their environmental damage through taxes.

The difference in emissions between cryptocurrencies comes down to how they create new coins. Bitcoin and other major issuers use a system called proof-of-work: to generate coins, participants or miners must solve mathematical problems that require extraordinary computing power. This allows currencies to maintain their decentralized ledger via the blockchain, but requires huge amounts of energy.

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Greener alternatives exist. Most notably, the proof-of-stake system allows participants to maintain their blockchain by depositing cryptocurrency holdings into a pool. When the second-largest cryptocurrency, Ethereum, transitioned from proof-of-work to proof-of-stake earlier this year, its power consumption dropped by more than 99.9% overnight.

Bitcoin and other cryptocurrencies probably won’t follow unless forced to because proof of work offers huge profits to miners and they are the ones with the power in the system. Multiple legislative levers could be used to encourage them to change.

The most drastic solution is to completely ban cryptocurrency mining. China did it in 2018, but it only made the problem worse; mining has moved to other countries with even less efficient energy production, and emissions have increased. The only way for a mining ban to significantly reduce carbon emissions is to enact it across most of the world. Achieving this level of international consensus is unlikely, to say the least.

A second solution is to prohibit the buying and selling of proof-of-work currencies. The European Parliament’s Economic and Monetary Affairs Committee considered making such a proposal but voted against it in March. It’s understandable; like a mining ban, it would be seen as both paternalistic and difficult to implement politically.

Using a tax instead of an outright ban would largely circumvent these problems. As with taxes on gasoline, tobacco, plastics, and alcohol, a tax on cryptocurrencies could reduce the real harm by making consumers pay.

Most ways to tax cryptocurrencies would be ineffective, as they are easy to circumvent and difficult to enforce. To avoid these pitfalls, the tax should be collected as a fixed percentage of each proof-of-work-cryptocurrency purchase. Cryptocurrency exchanges are expected to collect the tax, much like merchants collect sales tax from customers before passing the money on to governments. To make evasion more difficult, the tax should apply regardless of how the proof-of-work currency is exchanged, whether for fiat currency or another cryptocurrency. More importantly, any state implementing the tax should target all purchases by citizens within its jurisdiction, even if they buy through exchanges with no legal presence in the country.

This type of tax would be transparent and easy to apply. Because most people buy cryptocurrencies from one of the few big exchanges like Binance, Coinbase, and Kraken, auditing them should be cheap enough to pay for themselves. If an exchange does not comply, it should be banned.

Even a small tax on proof-of-work currencies would reduce their damage to the planet. Imagine that you are new to cryptocurrency and want to become a first-time investor. You have the choice between a range of currencies: bitcoin, ether, litecoin, monero and others. You notice that all but ether add an environmental tax to your purchase price. Which do you buy?

Countries do not need to coordinate across borders for a proof-of-work tax on their own citizens to be effective. But early adopters should always consider ways to encourage others to join. This has a precedent. The European Union is trying to influence global politics with its carbon border adjustments, which aim to discourage people from buying carbon-intensive goods abroad in order to circumvent taxes. Similar rules for a proof-of-work tax could persuade other countries to adopt one.

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Of course, some people will try to evade taxes, just as people evade all other taxes. For example, people can buy zero-rated coins on centralized exchanges and then exchange them for dirty coins on decentralized exchanges. To some extent this is unavoidable; no tax is perfect. But the effort and technical know-how required to evade a proof-of-work tax will be a major deterrent.

Even if only a few countries implement this tax and even if some people evade it, the desirability of bitcoin will decrease globally, and the environmental benefit will be significant. A high enough tax could also cause a self-reinforcing cycle that will lower the prices of these cryptocurrencies. Because the value of many cryptocurrencies is largely based on speculation, they depend on future buyers. When speculators are deterred by the tax, the lack of demand will cause bitcoin’s price to plummet, which could induce more current holders to sell, further lowering prices and accelerating the effect. Falling prices will cause the bitcoin community to abandon proof of work altogether.

Taxing proof-of-work exchanges might hurt them in the short term, but it wouldn’t hinder blockchain innovation. Instead, it would redirect innovation to greener cryptocurrencies. It’s no different than how government incentives for electric vehicles encourage automakers to improve green alternatives to the internal combustion engine. These incentives do not restrict automotive innovation, they promote it.

Taxing environmentally harmful cryptocurrencies can win support across the political spectrum, from people with varied interests. This would benefit blockchain innovators and cryptocurrency researchers by shifting the focus from environmental harms to beneficial uses of the technology. It has the potential to make our planet much greener. This would increase government revenue.

Even bitcoin maximalists have reason to accept the proposal: it would offer the bitcoin community a chance to prove that it can survive and grow sustainably.

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