This is an opinion editorial by Level39, a researcher focused on Bitcoin, technology, history, ethics and energy.
On December 14, the U.S. Senate Committee on Banking, Housing & Urban Affairs received inaccurate testimony regarding Bitcoin from actor Ben McKenzie and Professor Hillary J. Allen. The hearing, entitled "Crypto Crash: Why the FTX Bubble Burst and Harm to Consumers," had all the markings of political theater and provided a stage to misinform senators and the public. It coincided with Elizabeth Warren's new financial surveillance bill, which is a disaster for privacy and civil liberties. On December 18, the Senate Banking Committee Chair Senator Sherrod Brown divulged on “Meet The Press” that the hearing was intended to “educate the public” on the dangers of cryptocurrencies and floated the idea of banning them altogether.Mr. McKenzie Goes To Washington
Actor Ben McKenzie, who has starred in “The O.C.,” “Gotham” and “Southland,” lacks the qualifications and expertise one would expect for being called before the U.S. Senate Banking Committee to testify on the inner workings of financial technology. It should therefore come as no surprise that he made basic errors in his testimony, and could have been avoided altogether had witnesses with actual expertise been called. According to Mr. McKenzie:"Bitcoin cannot work as a medium of exchange because it cannot scale. The Bitcoin network can only process 5 to 7 transactions a second. By comparison, Visa can handle tens of thousands. To facilitate that relatively trivial amount of transactions, Bitcoin uses an enormous amount of energy. In 2021, Bitcoin consumed 134 TWh in total, comparable to the electrical energy consumed by the country of Argentina. Bitcoin simply cannot ever work at scale as a medium of exchange.
–Written testimony of Ben McKenzie Schenkkan, December 14, 2022, U.S. Senate Banking Committee
McKenzie’s testimony leaves one with the impression that he intentionally sought out the most biased and unreliable sources to confirm his own predetermined conclusions. Unfortunately, it was false information.
Leaving aside the fact that he referenced Digiconomist, an unreliable, exaggerated and seriously flawed electricity consumption estimate from a Dutch central bank employee's personal blog that lacks peer review (Cambridge University’s data is well respected and estimates that Bitcoin consumed 105 terawatt hours (TWh), or roughly 22% less energy than Digiconomist estimated, for 2021), McKenzie is effectively comparing a car engine to a wheel and not realizing how they relate to each other.
In technical terms, McKenzie conflated Visa’s transaction network with Bitcoin’s final settlement network, to make the illogical claim that Bitcoin cannot scale. This is a novice mistake. One could use the same faulty logic to make the erroneous claim that millions of retail payments within the banking system should be impossible because banks typically wait until the end of the business day to settle funds with each other. That, of course, is not true, as gross settlement is precisely how high-volume retail payments are batched between banks.
Visa is a credit-based transaction network. It’s not a financial institution, so it does not actually transfer money and cannot perform final settlement like Bitcoin can. Visa is effectively an IT company that informs its member banks how to clear and perform gross settlement with each other during business hours. If you’ve ever waited a few days for a check to clear, you know that payments between two bank accounts are not instantaneous. Credit card transactions take one to three days to post. And 90 to120 days to settle.
The Visa system works well and offers services such as risk assessment, fraud prevention and clawbacks, but can incur high fees from the banks and intermediaries along the way. Member banks aren’t actually sending each other tens of thousands of payments every second. Instead, they batch millions of transactions together into a small number of final settlement payments. The settlements are typically routed through lower-volume real-time gross settlement (RTGS) networks operated by central banks, such as Fedwire in the U.S. or TARGET2 in the EU.
Source: Level39. Original from Donald McIntyre.
Bitcoin and Fedwire can perform about the same number of transactions per year. In December of 2020, Bitcoin performed 26 million transfers (counting multiple outputs) across 9.6 million transactions, while Fedwire settled 18 million transactions during the same time period. Just as Visa operates on transactional layers that batch transactions into gross settlement layers, Bitcoin is designed to scale in a similar manner.
Bitcoin’s Lightning Network was formally theorized as a scaling solution at MIT in 2016 and today is a burgeoning Layer 2 open payments protocol, layered on top of Bitcoin. The Lightning Network enables instant payments, and micropayments down to a fraction of a penny, and can scale up to the entire world. Micropayments alone could change e-commerce and the internet itself as we know it. Imagine machines or people streaming fractions of pennies for content or APIs and you can already begin to see a new future for the internet emerging. Traditional finance simply cannot achieve this.
The Lightning Network allows high throughput Layer 3 retail payment apps and services such as Cash App, Strike and many other apps to efficiently batch transactions into Bitcoin's "blocks" for final settlement. Services on Layer 3 can offer the same protections we are used to in the legacy financial system, but anyone can freely access Bitcoin’s Layer 2 or Layer 1 whenever they want."While it would require time and investment, Visa’s payment network could sit on top of the bitcoin network to fulfill payments much the same way it sits on top of the existing banking system."
–Parker Lewis
While Fedwire adheres to limited operating hours, shutting down on weekends and holidays, Bitcoin never shuts down and it continues settling transactions roughly every 10 minutes — 24 hours a day, seven days a week, 365 days a year. Bitcoin has achieved a similar uptime to Fedwire since Bitcoin's inception and has demonstrated better uptime than Fedwire since 2013. Fedwire experienced a major outage in 2021.
There is no doubt that the larger cryptocurrency industry has become rife with fraud, scams and deception and it's commendable that McKenzie makes an effort to warn the public about those dangers. However, in his haste to condemn the entire industry, he failed to fundamentally understand what sets Bitcoin apart from the seemingly endless “crypto” scams and fraud that have sprung up around Satoshi Nakamoto’s invention.
Bitcoin's Lightning Network has a theoretical throughput of 40 million transactions per second. Just as the internet took more than a generation to achieve today's levels of connectivity and reach, the Lightning Network would need time to grow its liquidity for it to achieve this theoretical maximum throughput. The performance of the Lightning Network is already astounding and is faster than traditional contactless payments. Thus, the testimony McKenzie provided to the U.S. Senate Banking Committee that, "Bitcoin simply cannot ever work at scale as a medium of exchange" was not only misleading, it was false.
Bitcoin uses multi-layered architecture, modeled after the existing financial system and banking systems going back to at least the 15th century. Layered architecture is an ideal pattern for well-built information technology systems — including mobile networks and the internet itself. This kind of deliberate and intelligent architecture is what enables Bitcoin to become a decentralized medium of exchange for the entire planet.
In his written testimony, McKenzie highlighted the issues plaguing El Salvador’s Bitcoin banking system, Chivo — a privately-built, government-controlled Layer 3 system that plugs into the Lightning Network. However, he failed to inform senators that users in El Salvador are free to use high-quality open-source wallets, such as Muun or Bitcoin Beach wallet and a wide range of others. More importantly, the technology is starting to make a difference in the lives of those who would otherwise be unbanked, as journalist Sharyn Alfonsi of “60 Minutes” discovered on a visit to El Salvador earlier this year.
McKenzie, who after getting high one evening decided to write a book on the rampant fraud in the crypto industry, has since begun a collaboration with journalist Jacob Silverman on the endeavor. McKenzie earned his bachelor of arts degree from the University of Virginia in 2001, majoring in foreign affairs and economics. That the U.S. Senate Banking Committee felt that an actor with an atrophied undergraduate degree in economics would somehow make an expert witness for a particularly complicated financial innovation suggests that the hearing was solely intended as political theater.Senators Regurgitate Ben McKenzie’s Fallacious Testimony
When it was Senator Mark Warner’s turn to ask questions, he remarked:“I do think it’s curious that China made the decision to basically take that kind of risk, to ban crypto, because of their, at least, risk/reward analysis… The clunkiness of the technology behind Bitcoin, it could never go to scale no matter what! If you can only do 5 or 6 transactions per second, that is not a scalable tool and obviously a technology at a power and environmental cost. It just doesn’t make sense to me.”
–Senator Mark Warner
Ignoring for a moment that Senator Warner thought it was “curious” that an authoritarian country made the risk/reward calculation to ban free speech of code and software — which is protected under the First Amendment — McKenzie’s false testimony had misinformed the senator into thinking that Bitcoin cannot scale when it is in fact already rapidly scaling.The Energy Debate
Earlier this year, McKenzie toured Riot Blockchain’s Whinstone U.S. — North America's largest Bitcoin mining facility, located about an hour outside Austin, Texas. When it was Senator Tina Smith's turn to ask questions, she turned to McKenzie and, doing her best to act confused, asked what appeared to be a series of pre-scripted questions:SMITH: As I understand it, crypto mining is built on a process that becomes more and more energy intensive, over time. Is that correct?
MCKENZIE: Yes.
SMITH: So, it's inherently inefficient. Is that correct?
MCKENZIE: The technology is bad.
SMITH: And so, where is the benefit of this kind of innovation? How should we think about the impacts when it comes to the climate and energy impacts? Because when crypto mines are located in communities, those communities often see their energy prices go up — their energy rates go up — is that correct?
MCKENZIE: That's right. I visited the largest crypto mine in the country, Whinstone, which is in Rockdale, Texas, just outside of my hometown of Austin, Texas. Local citizens are upset. It raises the cost of electricity for all citizens. And it also uses an enormous amount of energy. It took over a former Alcoa aluminum smelting plant that had been abandoned and now we are using it to mine ephemeral digital assets of no productive value.
While it's convenient that McKenzie just happened to have visited a mining operation and could provide Smith with the exact answers that confirmed her biases, unfortunately he has zero expertise on energy markets, demand response programs, power engineering or mining and has no qualifications to inform congress or policy on the matter.
The idea that Bitcoin mining is an "inefficient" technology and therefore needs the government to reign it in is nonsensical. If it were as inefficient as claimed, there would be no need to stop it, since more efficient technologies would be able to outcompete it and easily replace it. This is precisely the reason we have markets — to let the most efficient and cheapest technologies win over the inefficient and expensive technologies that will fail. Those who are willing to take the risk on those technologies are either rewarded or bear the consequences.
McKenzie doesn't divulge that ERCOT, the Texas grid, is isolated and therefore is required to have excess dispatchable energy for extreme weather events. That excess energy needs to be consumed by large scale flexible customers who are willing to pay for it is an open market when it’s not needed. Buying energy that would otherwise go wasted, for computation, keeps dispatchable energy profitable and officially classifies Bitcoin miners as beneficial large flexible loads (LFLs) by the ERCOT grid. A recent ERCOT study showed miners are essential to its demand response strategy.
As demand response consumers, miners purchase wholesale energy in advance and buy private insurance products that incentivize them to turn off their machines when prices rise during periods of increased consumer demand — thus balancing the grid and its prices, while increasing grid reliability. The idea that McKenzie or any critic could isolate escalating power prices to a single consumer in a deregulated wholesale market is extremely dubious. Such a claim ignores the recent tripling in natural gas prices, as well as the recent build out of over 10 gigawatts of solar power and Texas load growth from non-mining customers, such as the Tesla Gigafactory.
While the Tesla Gigafactory may be considered a more productive use of energy, it is not nearly as flexible at demand response as miners. Miners de-risk excess renewable power and will instantly shut down for high consumer demand when prices rise. In fact, contrary to what McKenzie claims, The U.S. Department of Energy explains that demand response technologies are beneficial for "balancing supply and demand" and says "such programs can lower the cost of electricity in wholesale markets, and in turn, lead to lower retail rates."
While McKenzie may have come across local residents of Rockdale, Texas who were "upset" about the Whinstone mining operation replacing the town's abandoned Alcoa aluminum plant. In reality, the new mining facility is a net positive for the struggling community, boosting its economy, local tax collection and grid stability.
Senator Smith and McKenzie's suggestion that mining becomes "more and more energy intensive over time" is highly misleading and shows a lack of understanding of the technology. Like any publicly-traded commodity such as bitcoin, the energy required is economically linked to the public's demand for its declining issuance, and unfolds in a highly-competitive open energy market. There is nothing about the technology that requires the consumption of more and more energy over time. Bitcoin's four-year "halving" cycle reduces the rewards that miners receive to purchase energy. In fact, Bitcoin's critics claim that miners may not be able to afford to buy as much energy, decades from now — a topic which is hotly debated. Eventually, critics will need to get their stories straight. Either miners will have the money to purchase energy in the future or they won’t, however, both outcomes cannot be true.
Using energy to remove the need for equity-based governance is not “bad.” Equity-based governance was a common criticism of proof-of-stake "crypto" networks in the hearing. Using energy for issuance and security is breakthrough technology that has many applications for energy innovation that we are only just beginning to discover.<phoenix-ad
