The Enormity of Centralized Costs
With the Coinbase IPO, we’re likely to hear a lot of fear-uncertainty-doubt about a bunch of topics: one of the most common is the…
The metaverse will depend upon decentralized and distributed technologies. And with the Coinbase IPO, we’re likely to hear a lot of fear-uncertainty-doubt about a bunch of topics: one of the most common is the concerns over the energy utilization involved in cryptoassets, which is a core part of our decentralized future.
A lot of my friends in the game industry and the metaverse are worried — justifiably — about the climate and the future of life on Earth. This has come up frequently within discussions of how some games and digital art are innovating with non-fungible token (NFT) technology; it also comes up more broadly in virtually all conversations about cryptoassets.
Confusing Fixed Costs vs. Marginal Costs
Most arguments about energy utilization focus on one particular metric: the cost of a transaction. For example, people cite data about a single Visa transaction costing hundreds of thousands of times more than a single Bitcoin transaction, or data about the carbon footprint of a single Ethereum transaction.
Simple analogy: what is the cost of producing a widget at a factory? Is it just the cost of stamping that one widget in the factory? Or is it the totality of costs — the cost of constructing and maintaining the factory that supports the production? Most people can understand that the true cost of the widget isn’t just the marginal costs (e.g., the incremental labor, materials and energy used to make the widget) but all of the fixed costs that went into making the production possible. Similarly, marginal energy costs alone aren’t a logical or fair way to compare the costs of a centralized financial industry to a decentralized ecosystem.
Decentralization requires an investment in security and replication to make the blockchain reliable; this necessitates more energy at the transaction level, and the energy costs of mining are distributed across all of these transactions. What all of these discussions tend to ignore is the fact that the energy involved in a “transaction” is only a small part of the totality of the costs. To continue the previous analogy: they’re focused on the cost of stamping a widget, not the costs of the whole factory.
Let’s contrast decentralization with the costs of centralization.
Traditional industries have enormous infrastructure, essentially “operating leverage” that allows them to decrease the cost of transactions due to the enormous investments they’ve made in centralized infrastructure.
For the financial ecosystem, this includes:
Building and operating from skyscrapers, offices, bank branches, etc.
Operating and leasing datacenters
Maintaining and securing physical vaults
Employing standing armies of personnel
Networks of middlemen and bankers to service their preferred sources of capital
Private-jet fueled roadshows, business meetings, etc.
Mining, shipping, storing and securing precious metals like gold
The cost of the traditional financial system is revealed by what the credit card system costs us. It isn’t the “free” that you experience compared to cash at the point-of-sale or the tiny energy cost to move some numbers around in some central databases.
What credit cards actually cost is reflected better by the 2–3% of a sale that is charged to a merchant every time you buy something from them. Imagine how low large this adds up across the entire world of purchases. This 2–3% is used to cover the enormous costs of operating centralized infrastructure. And that’s just credit cards — every part of the centralized financial industry whether insurance, real estate transactions, equity markets or banking are leveraged by the trillions of dollars of capital behind their infrastructure and standing armies. And credit cards are just one aspect of this system.
ARK investment compared the total costs of Bitcoin vs. gold mining and traditional banking, and you can read their report on the efficiency of Bitcoin versus traditional forms of wealth savings:
There are a number of other factors that few understand about the present or future of how blockchains work, or how they’ll continue to become more efficient over time. We can get into some of these: such as the fact that smaller transactions of Bitcoin tend to be batched together; or that the Ethereum blockchain is moving to exponentially more energy-efficient proof-of-stake solutions; or the fact that in my own industry — games and the metaverse — most NFTs are already on low-energy proof-of-stake platforms like WAX, Flow or Immutable X.
These are all great points to make, and speak to the spirit of innovation that energizes the decentralization movement — but they’re actually distractions. If someone wants to bring up the energy costs of cryptoassets, it is fair to ask them: how do you feel about the alternative — the total costs of operating the traditional industries?
More than likely, they don’t know, or they haven’t thought about it. They’ve been locked into institutionalized power systems that support these large investments of capital and their incredibly huge energy costs. Decentralization is about reducing our dependence on these institutions: their rent-taking, their winner-picking and their enormous costs in energy, innovation and society.
There’s a cost to making this transition — the marginal energy cost of decentralization will likely be higher on a per-transaction basis than the marginal energy costs of the traditional industries. But the totality of all costs (when fixed and variable costs are considered together) of decentralization is likely already much lower, and the technology improvements in store over the next several years are likely to reduce the marginal costs as well.
For people who care about the environment, decentralization is what they ought to celebrate.
If you’re curious about the role of decentralization in the future of the metaverse, here are a few other articles I’ve written you might enjoy:
The Permissionless Metaverse discusses why decentralization is an important aspect of maximizing creativity, options and experiences.
Game Economics, Part 2: Digital Collectibles and NFTs goes into use cases for non-fungible tokens in games.