New compromise proposal
MiCAR has long been a bone of contention between the EU Commission, Parliament and the market. In particular, many ambiguities in its important definitions led to MiCAR being a long time coming. A final vote in the ECON Committee was scheduled for 28 February 2022, but the majority that MEP Stefan Berger thought was secure had dissolved. At the beginning of this week, there was no final vote on the final compromise proposals: instead there is a new compromise proposal, which now refrains from a PoW ban. Austria in particular is said to have lobbied against the original draft, probably primarily because of the planned ban on PoW. This ban had previously been supported by representatives of the SPD, the Greens and the Left.
The core of the controversial regulation is a ban from 2025 on the provision of crypto services in connection with environmentally unsustainable consensus mechanisms, unless they are operated on a small scale (see Art. 61 para. 9c, Art. 3 para. 6c and Art. 2a MiCAR Draft (MiCAR-E)). Environmentally unsustainable consensus mechanisms are mechanisms whose operation gives rise to significant adverse environmental impacts on a large scale and which undermine the achievement of the climate targets of the Paris Agreement (Art. 3 para. 6c MiCAR-E). This explicitly concerns consensus mechanisms based on PoW.
In PoW mechanisms, participants are paid a reward in the respective cryptocurrency for solving complex and computationally intensive cryptographic tasks. The solution to the task is marked in the blockchain by generating a new block (mining) and by comparing it with the rest of the data in the blockchain, it is proven that the transaction was carried out without errors. Computer and graphics card capacities are often pooled in mining pools in order to be able to handle the complex calculations. Many well-known cryptocurrencies such as Bitcoin, Ethereum or Litecoin use PoW.
The main problem with PoW is that mining is time-consuming and cost-intensive. For example, the operation of the Bitcoin blockchain consumes more electricity per year than the entire country of Lebanon. According to experts, electricity consumption is 130 terawatt hours per year, which is about 0.08% of global energy consumption. With PoW, blockchain information can also be infiltrated if the absolute majority of mining providers come together in a mining pool. Although this is currently not to be feared, since the mining providers are scattered all over the world, this infiltration would be possible if a bigger nation were to enter the mining business.
Ethereum, however, has been planning to move to a different consensus mechanism, the proof-of-stake (PoS), for some time (the move is expected to be completed by spring/summer 2022). Unlike PoW, PoS does not create crypto assets through complex calculation tasks. Put simply, small portions of crypto assets are instead held in a wallet (staking) and unlocked through the process. In this way, each participating user validates the transactions that are processed via the blockchain. In return for the validation, each user receives an amount for their held amount of crypto assets. The well-known cryptocurrencies Avalanche and Solana are based on PoS.
Impact of ban
Those affected by the ban would be the crypto service providers that offer crypto services in connection with these unsustainable crypto assets, for example trading or custody of Bitcoin. (There are no issuers for crypto assets based on PoW).
The main argument in favour of the ban is that PoW is energy-intensive and therefore considered a rather environmentally damaging process for the production of crypto assets. Due to the energy transition, there are generally already gaps in the power supply of European countries, that should be closed, or at least reduced, by a ban on PoW. Furthermore, the hardware of the mining pools has to be replaced every one to two years, which probably results in 30,000 to 65,000 tonnes of electronic waste per year. There are also more modern, less energy-intensive consensus mechanisms available that are less harmful to the environment. Finally, there are already other countries like China, Tunisia, Egypt, Algeria or Iraq that have already banned PoW. Thus, the EU would not be alone.
One argument against a ban, however, is that it would be detrimental for the technology and would probably lead to a migration abroad, which in turn would significantly damage the European crypto and FinTech market. The ban could put the EU itself at a severe disadvantage in competition with other markets and lose geopolitical access to Bitcoin. This is likely to be highly problematic, with Bitcoin alone dominating the market by around 40%.
Moreover, there is already an awareness of the problem in the market: half of the miners already use renewable energies and FinTechs create initiatives to offset CO2 emissions. Furthermore, it remains unclear what exactly “operated on a large scale” or “operated on a small scale” should mean. These unclear definitions have been criticised by experts and the market itself throughout the MiCAR process. Unclear definitions make it difficult to determine the scope of regulation and therefore undermine MiCAR’s goal of creating complete and harmonised regulation for crypto assets in the European Union.
Instead of banning crypto assets based on PoW, European legislators could take measures to make the crypto industry more sustainable. For example, an obligation to register and report energy consumption for miners, as successfully introduced by Iran, could be an equally effective but less intrusive solution. An obligation to offset CO2 by investing in sustainable projects or buying CO2 certificates is also conceivable. Finally, an obligation to use electricity from renewable sources for the operation of a mining pool could also be introduced.
It remains to be seen how the tensions between digitalisation and sustainability will resolve, as the arguments on this controversial topic continue. Even if it now looks like a surprising turnaround on the PoW ban, the outcome cannot yet be predicted. The decisive ECON meeting has already been postponed to 14 March 2022 due to the need for further discussion.
We’ll keep you posted!