Decentralized and Decarbonized: Regulating Bitcoin Mining Through Lex Mercatoria

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In this paper, Atty. Rafael Padilla, Co-Founder and Trustee of BlockDevs Asia, Professor of Law at San Beda Alabang, and author of Fintech: Law and First Principles, discussed how private ordering can lead to the organic integration of environmental, social and governance (ESG) principles as a uniform commercial practice or lex mercatoria among bitcoin miners.

Find more papers of Atty. Rafael Padilla on BitPinas:

Decentralized and Decarbonized:

Regulating Bitcoin Mining Through Lex Mercatoria

Rafael Angelo M. Padilla

12 November 2022

Updated: 02 May 2023

Abstract: The economic and security model of Bitcoin requires proof-of-work as the optimal consensus algorithm for its decentralized network. The high energy cost required to secure and maintain the Bitcoin network is a feature and not a bug. The decentralized verification of transactions within the network is accomplished through bitcoin mining. Although mining is energy intensive, bitcoin miners incorporate substantial amount of renewable energy sources in their energy mix. Further, there are various environmental use cases for bitcoin mining such as flare gas capture, load balancing mechanism for power plants, and consumption of curtailed energy, which directly benefits the sustainable operation of renewable energy plants. “Green” or sustainable bitcoin mining is necessary to ensure the long-term institutional adoption of bitcoin as a new asset class and Bitcoin as an alternative financial infrastructure. Regulation can accelerate the adoption of sustainable bitcoin mining practices, but regulation by legal or administrative fiat is suboptimal compared to regulation through market forces (e.g. incentive offset) and through private ordering. Private ordering can lead to the organic integration of environmental, social and governance (ESG) principles as a uniform commercial practice or lex mercatoria among bitcoin miners.

1. Introduction

Macroeconomic, monetary, and technological developments compel companies to consider how blockchain can optimize their businesses, and how cryptoassets could help preserve the corporate treasury. Indeed, some publicly-listed companies now include bitcoin as part of their corporate treasury reserve. Further, some of the largest asset management groups and financial institutions have now allowed their clients to gain exposure to bitcoin. Several bitcoin-focused exchange traded funds are also now listed in securities exchanges like the New York Stock Exchange and Nasdaq.

However, environmental, social and governance (ESG) considerations pose as an important factor in the institutional adoption of bitcoin as a new asset class and as a financial infrastructure that the financial sector can employ as a new delivery channel (similar to how the internet enabled financial services to be delivered online).[1] From an ESG perspective, the main concern is whether bitcoin mining, i.e., the decentralized validation of transactions in the network, is sustainable, and whether the expansive growth of bitcoin transactions and the corresponding mining operation required to maintain the network pose danger to the environment.

Is bitcoin mining compatible with the notion of “green fintech”?[2] If ESG is a showstopper in the adoption of bitcoin as a new asset class and Bitcoin as an alternative, decentralized, open, and tamper-proof financial layer or infrastructure, can regulation come to the rescue and color it green by requiring ESG principles/standards to be incorporated by the crypto mining industry? In relation to this question, this paper will explore the extent by which bitcoin mining can be regulated by law, or whether it would be best regulated through private ordering as lex mercatoria.

2. Bitcoin as decentralized network, and bitcoin as decentralized money

The purpose of Bitcoin,[3] the first cryptocurrency, and how it technically operates as electronic cash were described by its inventor, Satoshi Nakamoto, in the abstract of the Bitcoin white paper: “(a) purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double-spending.”[4] The abstract reflects valuable insights about money and community, and the economic incentives required to effect rules that compel its participants to behave in the greater interest of the community.[5]

Bitcoin’s value is fundamentally driven by what the technology can offer the users of the network. Bitcoin’s utility value refers to what the underlying blockchain is utilized for, which triggers demand both for (1) its use as a decentralized payment system and (2) its native unit of account (numéraire), bitcoin. The Bitcoin network is used to transact bitcoins and therefore much of the value is driven by demand to use bitcoin as a medium of exchange. Bitcoin can also be employed as a savings technology because of its capacity to store value, hence a significant percentage of mined bitcoins is also demanded for this use case.[6]

Technological developments such as the Lightning Network enhance bitcoin’s property as an alternative currency because it makes the asset “more alive” or useful as a medium of exchange for payment transactions. Bitcoin can be transacted globally and domestically without being hampered by slow and cumbersome confirmation process.[7] Gold and bitcoin are both scarce assets yet the Bitcoin network’s ability to allow finality of settlement in a natively electronic execution gives it a massive advantage over gold amid a rapidly developing digital economy.[8]

3. Decentralized verification through bitcoin mining

One of the key operational features of Bitcoin is decentralized verification, which allows Bitcoin to eliminate the need for trusted intermediaries. Such verification is accomplished by requiring transactions to be recorded by every node within the network so that they all share one common ledger of all balances and transactions.[9] Due to its decentralized nature, the network needs to obtain consensus among its participants and Bitcoin achieves this through proof-of-work. As explained by Ammous: “(i)n order for a node to commit a block of transactions to the ledger, it has to expend processing power on solving complicated mathematical problems that are hard to solve but whose correct solution is easy to verify. xxx (O)nly with a correct solution can a block be committed and verified by all network members.”[10]

To encourage network validators, known as miners, to participate in the Bitcoin network, they are rewarded a fresh supply of bitcoins (block reward) along with transaction fees.[11] This incentivizes existing mining operators to maintain the security of the network; it also attracts more miners to participate thus making Bitcoin more robust. However, the amplified hash power supporting the network has no bearing on the output of bitcoins that can be mined. Instead, such increase in hash power only triggers the Bitcoin protocol’s difficulty adjustment.[12]

The “hardcoded” difficulty adjustment in mining makes it a trustworthy technology that would restrict bitcoin’s supply schedule from unpredictably rising. This makes bitcoin fundamentally different from other asset classes. Whereas typically the rise in the value of a commodity—such as gold—incentivizes more resources to be dedicated to its production thereby increasing its supply, in the case of bitcoin, allocating more resources (in terms of energy and equipment) to mine bitcoins will never result in the production of more bitcoins; Bitcoin’s design makes this technically impossible. Adding more miners will only increase the processing power required to commit valid transactions to the Bitcoin network, which makes it more secure and harder to attack.[13]

More computing power does not produce more bitcoin. The protocol fixes bitcoin’s issuance per block and adjusts the difficulty of mining to keep blocks coming approximately every ten (10) minutes. Over time, the expected reward for a given amount of computing power becomes inversely proportional to the total amount of computing power in the network. This means that the greater the total hashrate of the network, the lower the payout, in bitcoin, at any given hashrate.[14]

The supply schedule of Bitcoin is defined mathematically and set in code at the genesis of the protocol. Bitcoin provides for a maximum of twenty one (21) million units by 2140, and it gets there by cutting the rate of supply inflation every four (4) years. As of 2020, the supply schedule is at two percent (2%) annually, and in 2024 it will decrease to one percent (1%) annually.[15] This inflation schedule is practically immutable[16] and is essential to Bitcoin’s monetary policy. Over nineteen (19) million bitcoins have been mined as of May 2023, leaving less than two (2) million bitcoins left to be mined.

4. Bitcoin as alternative financial system

The Bitcoin ecosystem is expanding and maturing in many areas of the economy, such as in banking, trading, remittance, payments, lending and derivatives. As it grows, Bitcoin could eventually evolve as a widely-accepted global settlement system that could compete with the current international monetary system.[17] Indeed as pointed out by Bhatia, bitcoin “gives people around the world the first genuine alternative to their national currencies, a trend which is impossible to reverse now that over 100 million people own it globally.”[18]

Bitcoin’s supply schedule is enforced automatically by code without any intervention from any government or any central intermediary. The supply schedule is well known to the public at large, and the quantities as well as the growth rates of bitcoins can be verified with certainty on the network’s publicly shared ledger, and therefore this alternative system cannot be impacted by monetary policies conjured by the Federal Reserve or any other influential central banks or international monetary agencies.[19] Just like gold as a safe have asset, Bitcoin’s alternative financial system can also serve as a systemic hedge against the fragility of the present U.S. dollar-centric international monetary system.

The invention of Bitcoin created a novel independent alternative framework for international settlement that does not rely on any central intermediary. By independence, it means that the Bitcoin network operates separately from the prevailing financial infrastructure.[20] Bitcoin features an independent monetary policy that is safeguarded by a decentralized network of computers that maintain the Bitcoin blockchain through proof-of-work.[21] Proof-of-work fortifies bitcoin’s property as a store of value by ensuring that network transactions will be irreversible. It also proves that a large amount of computational work took place, which can be verified quickly as compared to the effort and time it took to conduct the work.”[22]

5. Bitcoin network as a public good

It is convenient to argue that bitcoin mining uses a lot of energy more than what is needed and therefore unsustainable, especially when ignoring the underlying social and economic purposes that Bitcoin serves. Lives have been destroyed by economic hardships brought by the mismanagement of economic and financial systems by central planners (e.g. governments, central banks, monetary authorities). Bitcoin offers a savings technology that can enable its users to be protected from inflation and the fragility of the present international monetary system.[23]

Bitcoin has been adopted by more than a hundred million people worldwide, which validates the institutional qualities of bitcoin as a denationalized, decentralized, censorship-resistant and market-determined currency. One does not need to personally subscribe to these views in order to grasp the significance of the technology. It is sufficient that a rapidly growing number of people are actively using them for various economic transactions, especially in countries with dysfunctional financial system, or those marred by hyperinflation, or where freedom is suppressed by totalitarian regimes. If this much is true, then bitcoin serves a public good and therefore its network should be maintained despite apparently high energy costs.

6. Institutional adoption of bitcoin as new asset class

a. Bitcoin as inflation hedge

While Bitcoin has existed for less than two decades, the digital asset is also quickly becoming more liquid as the adoption of cryptocurrencies as a new asset class becomes more mainstream and as the trading volume of cryptocurrencies continues to increase.[24] Indeed during the 2007-2008 global financial crisis, Bitcoin did not yet exist and investors flooded into the age-old safe haven asset, gold, which almost tripled in price in two years.[25] Today, bitcoin offers an alternative safe haven that is even optimized for use in today’s ever-expanding digital economy.[26]

Bitcoin is being considered by institutional investors (e.g. investment banks,[27] hedge funds[28] and large enterprises[29]) as an inflationary hedge against a depreciating U.S. dollar. In explaining this trend, Saylor remarked: “the global acceptance, brand recognition, ecosystem vitality, network dominance, architectural resilience, technical utility, and community ethos of Bitcoin (are) persuasive evidence of its superiority as an asset class for those seeking a long-term store of value.”[30] Lawyer and best-selling author Rickards, on the other hand, commented that the rapid adoption of bitcoin as a new asset suggests that communities around the world are seeking alternatives to the U.S. dollar and fiat currencies as money that can effectively store value.[31]

b. Bitcoin as part of corporate treasury reserve

Demonstrating the growing institutional adoption of bitcoin as a new asset class, some of the largest publicly-listed companies now own bitcoin as part of their corporate treasury reserve. Among these companies include Microstrategy (one of the largest business intelligence company globally) that holds 132,500 BTC; Tesla which owns 10,725 BTC; Coinbase (the largest crypto exchange in the United States) with 9,000 BTC; and Twitter’s financial technology arm Block (formerly Square) which owns 8,027 BTC as of May 2023. The synergic convergence of macroeconomic, monetary, and technological developments created the impetus for innovative companies to look into alternative assets to form part of their balance sheet. As observed by Phong Le, the current CEO of Microstrategy, the “ecosystem and the regulatory environment for digital assets, especially Bitcoin, have matured to the point that this strategy is becoming approachable and mainstream.”

Considering that among the main purpose of the treasury function is risk management and the preservation of capital,[32] these publicly-listed companies considered how bitcoin as an alternative investment vehicle fits within their broader investment strategy. Their decision to include bitcoin as part of their treasury reserve had the input of the chief finance officer, chief risk officer, chief executive officer, chief technology officer and the board of directors who had the opportunity to assess and understand bitcoin’s risk profile and how it might align with or diverge from their company’s risk tolerance. They have also considered how bitcoin can be strategically used to advance efficiencies in vendor payments, trade, customer relations and cross-border transactions.[33]

From the experience of these publicly-listed companies, liquidity has not been a major issue in holding bitcoin because of the abundance of exchanges, traders, market makers and other intermediaries who can facilitate the conversion of bitcoin back to fiat currency. For example, in the case of Tesla, they had to sell 75% of their bitcoin holdings in the second quarter of 2022 as the company needed liquidity amid uncertainty in its operations in China due to the extended COVID-19 lockdowns. In the case of Microstrategy, liquidity is much less of an issue considering that the company adopts a long-term strategy in holding bitcoin as its main treasury asset.

c. Bitcoin-focused exchange traded funds (ETF)

Another significant development that further highlights the expanding institutional adoption of bitcoin is the listing of various bitcoin-related exchange traded funds (ETF) in the United States, the largest financial market in the world. The first ETF approved by the U.S. Securities and Exchange Commission was the ProShares Bitcoin Strategy ETF (BITO). The objective of the fund is to provide capital appreciation through managed exposure to bitcoin futures contracts. However, the fund does not invest directly in bitcoin.

The launch of the landmark BITO ETF in October 2021 caused bitcoin to appreciate at a new all-time high of USSD66,000. It also became the fastest fund ever to reach one billion dollars in assets under management (AUM), in only two days. Lastly, ProShares’ ETF broke the record for the highest-ever first day of organic volume which hit USD1 billion when it launched on 19 October 2021.

BITO was quickly followed by Valkyrie Bitcoin ETF (BTF) and Bitcoin Miners ETF which was also launched on the last week of October 2021. The U.S. SEC also authorized NYSE Arca and Teucrium to issue a bitcoin futures ETF in April 2022.

d. Bitcoin trading and custody services

Some of the largest financial institutions are now offering trading and custodial services for bitcoin, which is another indicator of its growing institutional adoption. BlackRock, the world’s largest asset manager, now provides bitcoin trading services for institutional clients in partnership with Coinbase. This partnership allows Aladdin, BlackRock’s investment management platform, to offer direct access to bitcoin trading and custody. According to BlackRock, their institutional clients are interested in gaining exposure to digital asset markets and Aladdin offers a solution to help clients manage the operational life cycle of these assets.[34]

On the other hand, Fidelity, also one of the largest asset managers in the world opened a commission-free trading services that will allow its clients to buy and sell bitcoin and ether. This initiative is apart from the earlier offering by its subsidiary, Fidelity Digital Assets for custodial and trading services. According to Fidelity in a statement shared with CNBC: “(a) meaningful portion of Fidelity customers are already interested in and own crypto. We are providing them with tools to support their choice, so they can benefit from Fidelity’s education, research, and technology.”[35]

For BNY Mellon, the world’s largest custodial bank by assets and the oldest lender in the United States, client demand for cryptocurrency was the key factor in launching a crypto custody offering. BNY added bitcoin and ether in its custodial offering in October 2022. For the bank’s CEO, Robin Vince, crypto is “a very long-term play,” and he envisions full-scale adoption to be years or even decades away.[36]

7. ESG considerations

a. Bitcoin mining and its environmental use cases

Considering the societal value of Bitcoin as discussed above, the high energy cost of maintaining its decentralized settlement network is required by the need to maintain a decentralized monetary system that is outside the control of governments and central bank or monetary authorities. Papers have been written exhaustively discussing the feasibility of Bitcoin achieving net zero carbon emission (despite its high energy costs) in view of several key factors such as the bitcoin mining industry’s renewable energy mix, the industry’s use of carbon offsets, portability of mining equipment which allows miners to go to locations with high proportion of renewable electricity, as well as use of “curtailed” or wasted energy, or energy that would otherwise be wasted if not utilized for bitcoin mining.[37]

It must be remembered that new technologies tend to consume relatively high intensity of energy, but it eventually becomes more energy-efficient as the technology matures. Moreover, Bitcoin’s electricity consumption is still lower compared to other energy-intensive modern conveniences, such as domestic refrigeration, air conditioners, washing machines and tumble dryers.[38]

There are a number of scenarios by which the Bitcoin network can achieve net zero carbon emission, considering miner’s energy mixes and geographies (which is relevant in view of the portability and interruptibility[39] of bitcoin mining operations), the industry’s accelerating use of carbon offsets, renewal energy certificates and curtailed energy. Considering that bitcoin mining is highly portable and modular which allows mining to operate anywhere on earth (i.e., where it is energy-efficient to do so) due to the ubiquity of satellite internet such as Starlink, the bitcoin mining industry can help renewable energy power plants to monetize novel energy assets before these are fully integrated to the grid.[40]

Some bitcoin miners build modular stations on-site at clean power plants to repurpose energy that would otherwise go to waste. They purchase curtailed energy from renewable power plants. Curtailed energy is a common problem in clean energy development. Up to thirty percent (30%) of clean power generated on solar and wind farms can be “curtailed” or wasted which therefore decreases the profitability of these power plants. Curtailed energy is a problem because many power grids are inflexible due to their legacy architecture of equalizing supply and demand, which are not designed to handle the volume of clean energy that may have already been produced.[41] As “buyers of first resort,” bitcoin miners have the potential to improve the economics of new renewables projects by providing a flexible and immediate offtake for curtailed energy.[42]

Bitcoin mining can also be employed as a load balancing mechanism for power plants. Power utilities could use their excess power to run mining machines, and collect the value of the energy consumed in the process in the form of bitcoin. Later, when energy production is lower and could fall below power demand, the bitcoins mined can be used to buy back surplus energy from nearby power utilities on the grid, or alternatively, to pay for or offset the cost of fuel (whether coal, oil, natural gas, or biofuels) or other input needed to produce more energy.

In sum, the controversy concerning bitcoin’s alleged wasteful energy consumption ultimately boils down to a misunderstanding of the fundamental subjective nature of value. As pointed out by Ammous:

“Electricity is generated worldwide in large quantities to satisfy the needs of consumers. The only judgment about whether this electricity has gone to waste or not lies with the consumer who pays for it. People who are willing to pay the cost of the operations of the bitcoin network for their transactions are effectively financing this electricity consumption, which means the electricity is being produced to satisfy consumer needs and has not been wasted. Functionally speaking, (proof-of-work) is the only method humans have invented for creating digital hard money. If people find that worth paying for, the electricity has not been wasted.”[43]

b. Bitcoin’s high intensity energy consumption

Father and son Don Tapscott and Alex Tapscott discussed how apparent “showstoppers” or implementation challenges in bitcoin mining can be overcome, especially in relation to the high energy cost of maintaining the Bitcoin network. For them, the Bitcoin network’s high energy consumption is a feature, not a bug. “It’s by design. It’s what secures the network and keeps nodes honest.” For Jennings, “the cost for having no central authority is the cost of that energy.” The electricity consumed by mining bitcoin accomplishes the purpose of securing payment transactions through a decentralized network that provides a service to its users.[44]

Further, the technology in mining bitcoin is constantly improving. For example, application specific integrated circuit (ASIC) computers are now being used to mine bitcoin and they are more energy efficient compared to ordinary laptops and graphic processing units (GPU). ASIC machines and mining operations will continue to become more energy efficient and sustainable. Due to the portability of bitcoin mining, operation can be relocated to cold climates where energy is cheap and renewable, such as hydro or geothermal, and where the environment naturally handles the cooling or heat is captured in an efficient way to be used as heater in commercial buildings and residential apartments.

Tapscott and Tapscott also noted that the “smartest technologists on the planet are working on creative solutions to the energy problem, with more efficient devices and use of renewable energy.”[45] The energy problem currently experienced by the Bitcoin network is not insurmountable. Solutions can be reasonably foreseen as the technology matures, which will allow bitcoin mining to become more energy-efficient and more sustainable.

c. Green Fintech: is bitcoin investing compatible with sustainable investing?

Green Fintech aims to protect the environment and at the same time reduce poverty by providing people access to finance at a reduced cost.[46] Bitcoin mining can be aligned with “Green Fintech.”[47] The environmental, social and corporate governance (ESG) agenda should not be a showstopper in the adoption of bitcoin as a new asset class and Bitcoin as an alternative, decentralized, open, and tamper-proof financial layer/infrastructure.

The environmental use cases for bitcoin mining can justify sustainable investing in this new asset class and in the Bitcoin ecosystem (i.e., Bitcoin-related ventures or projects) in general. ESG considerations, should encourage, rather than deter the institutional adoption of: (1) bitcoin as a new asset class and; (2) Bitcoin as a financial infrastructure that the financial sector can employ as new delivery channel. The ESG agenda and bitcoin mining are therefore compatible, and it is also technically and commercially feasible to practice sustainable bitcoin mining. The expansive growth of bitcoin transactions and the corresponding mining operation required to maintain the network therefore does not necessarily pose danger to the environment, as critics usually would claim.

d. Energy production, not energy consumption, is the “more relevant question”

The written statement of Brian Brooks, former Acting Comptroller of the Currency, during the U.S. House of Representatives hearing on the energy impacts of blockchains in early 2022 gave an overview on the implications of bitcoin mining both from a regulatory and industry perspective.[48] Brooks responded to critics of bitcoin’s high-intensity energy consumption. According to him, bitcoin should not be judged solely on the basis of how much energy it uses, but rather on the basis of its energy mix relative to other energy users in the economy and on the basis of the incentives bitcoin creates for creating a more sustainable energy mix.[49]

Another important insight from Brooks, this time from a policy perspective, brings the attention to the “more relevant question,” which is energy production rather than energy consumption. For Brooks, it is within the Congress’ political discretion to regulate a particular source of energy. But once the energy mix has been established in a market economy, the market (i.e., aggregate decision of consumers and businesses) should decide the most productive use of the energy that is produced. The energy consumption of a given activity should be justified by the economic productivity created per unit of energy consumed, as well as based on the productivity ratio relative to other alternative uses of that energy. To illustrate, if bitcoin competes as a store of value with gold, then the proper question is whether the energy used in bitcoin mining produces more economic value per unit of energy than gold mining; if bitcoin competes with banks for payment transactions, then the question is whether the energy used in bitcoin mining produces more economic value per unit of energy than banking.[50]

While bitcoin consumes nontrivial amount of energy relative to the amount of value that bitcoin creates, such energy is on average drawn more from sustainable sources than the U.S. electric grid as a whole. For example, according to the Bitcoin Mining Council, the energy mix for bitcoin mining is about fifty eight percent (58%) sustainable as compared to thirty one percent (31%) for the U.S. energy grid as a whole, using the term “sustainable” per definition by International Energy Agency.[51] Meanwhile, only twenty four percent (24%) of the Philippines’ energy mix comes from renewable energy sources.[52]

Bitcoin miners significantly consume excess capacity which is energy that has the lowest cost. Through this approach, bitcoin miners contribute to total energy efficiency, in addition to providing baseload consumption for solar and wind power generators that otherwise would be unable to sell significant amounts of their production capacity; flare gas capture—a byproduct of oil drilling which produces carbon emissions with no counterbalancing economic value except when used for mining bitcoin; and by reducing energy loss related to transmission and distribution that is made possible by the portability of bitcoin miners.[53]

8. Regulation of bitcoin mining

a. Regulation ensures sustainable bitcoin investing and sustainable bitcoin mining

Professor Lawrence Lessig of Harvard Law School described various modes of regulation through what he calls as the pathetic dot theory. According to this theory, an actor is imagined as a dot constrained from all four sides by the four modes of regulation, namely, law, social norms, market, and architecture.

Regulation plays a strategic role in encouraging sustainable investing in bitcoin and in sustainable bitcoin mining. However, it would be wrong to assume that the only source of regulation would be a statute enacted by Congress or Parliament or administrative issuances by unelected bureaucrats.

The market also effectively regulates the behaviors of economic actors. Therefore, it is possible for the “invisible hand” to act as a regulator by influencing market participants to invest in bitcoin without contributing to unsustainable bitcoin mining. For example, Cross and Bailey describe the following practical solution in the form of incentive offset to encourage sustainable bitcoin mining, which if applied consequently creates a disincentive to carbon-intensive bitcoin mining:

“If one co-invests in sustainable mining operations in proportion to the size and duration of one’s bitcoin holdings, one’s bitcoin and green mining investments together will produce no net incentive to mine bitcoin in a carbon-intensive way. We estimate that, given current price, hashrate, issuance, and transaction fee levels, a quarterly allocation of approximately 0.5% of one’s bitcoin investment into green mining will suffice.”[54]

The above proposal differs from mere carbon offsetting. An incentive offset ensures that one’s bitcoin holdings do not lead to any new carbon-intensive mining which later requires atonement via carbon credits. Unlike carbon credits, the incentive offset can be expected to be net profitable, and thus relies on neither charity nor legal coercion. Lastly, this offset does not require knowing the total energy mix of bitcoin mining, such as how much hashrate derives from burning coal or natural gas. In simpler terms, bitcoin holders or investors can literally mine what they incentivize, and so investors only need to know that the hashrate they are purchasing is green, regardless of how they define “green.”[55]

On the other hand, abandoning Bitcoin’s proof-of-work consensus algorithm because it is energy-intensive will be counterproductive. The assurances provided by Bitcoin’s security model are battle-hardened in an adversarial environment and a key element of bitcoin’s economic model. Synthetic products such as tokenized assets fail because they are untested both in terms of their security and economic model. A wrapped token, such as so-called “Wrapped Bitcoin” (WBTC) created by trusted custodians that can become attack vectors, and hosted on another blockchain (i.e., Ethereum, instead of Bitcoin) cannot make good on the promises that have attracted capital to bitcoin in the first place.[56]

Some institutions perceive ESG mandates as barrier to bitcoin investing, reinforcing the misconception that ESG is a showstopper for bitcoin’s institutional adoption. Instead of changing Bitcoin itself—undermining fungibility, abandoning proof of work, or hosting wrapped bitcoin on a another blockchain—bitcoin’s own inner workings can be used to engineer an incentive offset that eliminates its negative environmental externalities.[57]

For Cross and Bailey, Bitcoin’s difficulty adjustment and hardcoded schedule of issuance enable investors to precisely balance their price-based incentive to mine with an equal and opposite difficulty-based disincentive, simply by mining sustainably themselves or by investing in the green mining of bitcoin. Broad adoption of this practice would fortify bitcoin’s settlement and security assurances, improve not only bitcoin’s environmental reputation but its actual environmental impact, and unlock capital currently bound by either ESG mandates or individual conscience. Therefore, there is no real tension or tradeoff between an optimistic sentiment for bitcoin and a long-term commitment to a low-carbon future because incentive offset offers a viable free-market solution to disincentivize carbon-intensive miners.[58]

b. Regulating bitcoin mining through private ordering (lex mercatoria)

In his book Order without Law: How Neighbors Settle Disputes, Professor Robert Ellickson described how people frequently resolve their disputes in cooperative fashion without paying any attention to the laws that apply to those disputes. Order often arises spontaneously. Statists who favor expanding the role of government do not sufficiently appreciate holocratic systems of social control.[59] Neighbors in fact are strongly inclined to cooperate, but they achieve cooperative outcomes not by bargaining from legally established entitlements, but rather by developing and enforcing adaptive norms of neighborliness without regard to formal legal entitlements.[60]

Lex mercatoria refers to the customary rules relating to commercial transactions that are widely observed by merchants in the same industry or field. It is optimal to establish law based on commercial customs because merchants have a clear sense of their own customs that arose from their uniform practice.[61] In many instances, these commercial customs spontaneously evolve from consistent usage, practices and transactions among merchants. According to case law, the substantive law of the Philippines although having a civil law origin, can be supplemented by a reference to lex mercatoria.[62]

In view of the novelty, technicality and other peculiar aspects of bitcoin mining, it would seem unrealistic to expect politicians and bureaucrats to have the practical and technical knowledge to determine the policies that would be most ideal to discourage carbon-intensive bitcoin mining. Very definitely, politicians and bureaucrats do not have monopoly of insight and wisdom to conceive rules that would best accomplish the goal of decarbonizing the bitcoin mining industry. The appropriate regulator that can effectively attain such goal is not the government, as legal centralism would suggest, but rather the market through the cooperative action of its industry stakeholders. True enough, such initiative already exists. For instance, the Bitcoin Mining Council (BMC) is a voluntary and open forum for bitcoin miners committed to share best practices and promote transparency when it comes to their respective energy mixes.

BMC believes that Bitcoin’s high-intensity energy consumption is a feature, not a bug, considering that proof-of-work allows the Bitcoin network to enjoy tremendous security. By having a voluntary disclosure forum, bitcoin miners are able to share information and data with respect to their energy sources. Initially through moral suasion and peer pressure, bitcoin miners would be encouraged to utilize renewable energy sources in their mining operation. Eventually, these activities could develop into a uniform commercial practice among bitcoin miners.[63]

c. Incorporating ESG in bitcoin mining practices through lex mercatoria

Another advantage of regulating bitcoin mining through lex mercatoria is that it is easier to incorporate ESG principles as a customary commercial practice rather than through statutory regulation. Bearing in mind the imminent threat of a climate catastrophe—what Carney refers to as “tragedy of the horizon”),[64] there is an urgent need for a concerted effort to minimize the carbon emission by all stakeholders. But ESG standards are still relatively nascent and controversial, which makes it difficult for lawmakers to arrive at a consensus on the adoption of ESG principles in the conduct of economic activities. Because lex mercatoria can evolve spontaneously, industry stakeholders and associations are more agile when it comes to setting rules concerning their commercial practices. Therefore, it would be more feasible and viable to develop ESG standards and principles as a set of customary commercial practice rather than as a blackletter law.

In relation to bitcoin mining, it has become clear among many bitcoin miners that the sustainability of the industry and ultimately the Bitcoin network hinge on the miners’ conscious effort to increase renewable energy sources for their energy mixes. Bitcoin miners are taking action to achieve this objective, not because the Congress or regulators say so, but simply because it makes business sense. As rational economic actors, it aligns with their self-interest to ensure that bitcoin mining becomes environmentally sustainable for the long-term.

9. Conclusions

Environmental, social and governance considerations should not be a showstopper in the adoption of bitcoin as a new asset class and Bitcoin as an alternative, decentralized, open, and tamper-proof financial layer/infrastructure. Bitcoin has been adopted by over a hundred million individuals worldwide, which validates the institutional qualities of bitcoin as a denationalized, decentralized, censorship-resistant and market-determined currency. One does not need to personally subscribe to these views in order to grasp the significance of the technology. It is sufficient that a rapidly growing number of people are actively using them for various economic transactions, especially in countries marred by hyperinflation or where freedom is suppressed by totalitarian regimes. If this much is true, then Bitcoin serves a public good and therefore its network should be maintained despite its high energy requirements.

From a policy perspective, the “more relevant question” is energy production rather than energy consumption. It is within the Congress’ political discretion to regulate a particular source of energy. But once the energy mix has been established in a market economy, the market (i.e., aggregate decision of consumers and businesses) should decide the most productive use of the energy that is produced. The energy consumption of a given activity should be justified by the economic productivity created per unit of energy consumed, as well as based on the productivity ratio relative to other alternative uses of that energy.

New technologies tend to consume relatively high intensity of energy, but it eventually becomes more energy-efficient as the technology matures. That said, Bitcoin’s electricity consumption—although nontrivial—is still lower compared to other energy-intensive modern conveniences, such as domestic refrigeration, air conditioners, washing machines and tumble dryers.[65]

There are environmental use cases that can justify sustainable investing in bitcoin as an asset and in the wider Bitcoin ecosystem, which consists of various bitcoin-focused projects or ventures. ESG should encourage, rather than deter, the institutional adoption of bitcoin as a new asset class and Bitcoin as a financial infrastructure that the financial services industry can coopt as a new delivery channel for financial services.

Bitcoin mining and ESG are therefore compatible, and it is technically and commercially feasible to practice sustainable bitcoin mining. In view of the environmental use cases of bitcoin mining, the expansive growth of bitcoin transactions and the corresponding mining operation required to maintain the network should not pose material environmental risks.

Regulation can accelerate the adoption of sustainable bitcoin mining practices, which could lead to mainstream institutional adoption. However, regulation by statute or administrative issuance is suboptimal compared to regulation through market forces, such as by introducing incentive offset. It would also be more effective to regulate bitcoin mining through private ordering, such as by evolving industry norms and best practices. More importantly, private ordering can pave the way to the organic integration of ESG principles as a uniform commercial practice or lex mercatoria among bitcoin miners and industry stakeholders.

This paper is published on BitPinas: Decentralized and Decarbonized: Regulating Bitcoin Mining Through Lex Mercatoria


  1. The phrase “Environmental, Social and Governance” and the acronym “ESG” was coined in 2004 in a landmark report by the International Finance Corporation (IFC) of the Word Bank Group (Who Cares Wins: Connecting Financial Markets to a Changing World, 2004). As of 2021, ESG investing is estimated at over USD20 trillion in assets under management (AUM) or a quarter of all professionally managed assets around the world (El-Hage, 2021). ESG investing is projected to continuously rise in the medium and long term.

  2. Green fintech aims to protect the environment and at the same time reduce poverty by providing people access to finance at a reduced cost. (Kabaklarli, 2022).

  3. Bitcoin” refers to the decentralized payment network. On the other hand, “bitcoin” refers to the digital asset that serves as native unit of account within the network. In other words, “Bitcoin” refers to the blockchain, while “bitcoin” refers to the cryptocurrency.

  4. Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System (https://bitcoin.org/bitcoin.pdf) (2008).

  5. Michael Casey & Paul Vigna, The Age of Cryptocurrency, p. 120 (2016 Ed.).

  6. Chris Burniske & Jack Tatar, Cryptoassets, p. 117 (2018).

  7. Nikhil Bhatia, The Bitcoin Second Layer, Medium, 08 August 2018, https://medium.com/@timevalueofbtc/the-bitcoin-second-layer-d503949d0a06

  8. Nikhil Bhatia, The Triumvirate of Liquidity, Medium, 25 June 2020, https://medium.com/@timevalueofbtc/various-writings-for-tantra-labs-b0b7ddae52d8

  9. Saifedean Ammous, The Bitcoin Standard, p. 171 (2018).

  10. Id., p. 172.

  11. Winston Moore and Jeremy Stephen, Should Cryptocurrencies be Included in the Portfolio of International Reserves Held by Central Banks? Cogent Economics & Finance, p. 2 (2016).

  12. Ria Bhutoria, Bitcoin Investment Thesis: An Aspirational Store of Value, Fidelity Digital Assets, p. 7 (2020).

  13. Saifedean Ammous, The Bitcoin Standard, p. 173 (2018).

  14. Troy Cross and Andrew M. Bailey, Greening Bitcoin with Incentive Offsets, p. 2 (2021).

  15. Chris Burniske & Jack Tatar, Cryptoassets, p. 115 (2018).

  16. Saifedean Ammous, The Bitcoin Standard, p. 178 (2018).

  17. Tur Demeester, The Bitcoin Reformation, Adamant Research, p. 13 (2019).

  18. Nikhil Bhatia, Layered Money, Kindle Edition p. 95 (2021).

  19. A.Seetharaman, A.S.Saravanan, Nitin Patwa3 & Jigar Mehta, Impact of Bitcoin as a World Currency, Accounting and Finance Research https://doi.org/10.5430/afr.v6n2p230 (2017)

  20. Saifedean Ammous, The Bitcoin Standard, p. 205 (2018).

  21. Ria Bhutoria, Bitcoin Investment Thesis: An Aspirational Store of Value, Fidelity Digital Assets, p. 3 (2020).

  22. Id., p. 10.

  23. Id.

  24. Winston Moore and Jeremy Stephen, Should cryptocurrencies be included in the portfolio of international reserves held by central banks? Cogent Economics & Finance, p. 8 (2016).

  25. The price of gold initially fell in response to crash of asset prices and the financial meltdown, but gold’s value eventually increased from $682 in October 2008 to $1,912 in September 2011.

  26. Paul Vigna and Michael Casey, The Age of Cryptocurrency, p. 297 (2015).

  27. Ben Winck, Guggenheim Says it Could Invest up to $530 million in a Bitcoin Trust as the Cryptocurrency Leaps to Record Highs, Markets Insider, 30 November 2020 (https://markets.businessinsider.com/currencies/news/guggenheim-fund-bitcoin-investment-cryptocurrency-market-rally-grayscale-trust-btc-2020-11-1029849060).

  28. Will Hadfield and Emily Nicolle, Hedge Funds, Not Hipsters, May be Powering Bitcoin’s Second Big Rally, Financial News, 20 November 2020 (https://www.fnlondon.com/articles/hedge-funds-not-hipsters-may-be-powering-bitcoins-second-big-rally-20201120).

  29. Joana Ossinger, MicroStrategy Buys More Bitcoin at Average Price Above $19,400, Bloomberg, 04 December 2020 (https://www.bloomberg.com/news/articles/2020-12-05/microstrategy-buys-more-bitcoin-at-average-price-above-19-400).

  30. Michael Saylor, Chairman of MicroStrategy, a U.S. publicly traded business intelligence company.

  31. James Rickards, The Death of Money: The Coming Collapse of the International Monetary System, p. 254 (2014).

  32. Deloitte, Considerations Regarding Allocations to Digital Assets (2021).

  33. Id.

  34. Shawn Amick, BlackRock To Offer Bitcoin Trading, Custody In Coinbase Partnership, Nasdaq, 04 August 2022, https://www.nasdaq.com/articles/blackrock-to-offer-bitcoin-trading-custody-in-coinbase-partnership#:~:text=BlackRock%20will%20begin%20offering%20bitcoin,have%20external%20wallet%20transfer%20functionality.

  35. Tanaya Macheel, Fidelity to open commission-free crypto trading to retail investors, 03 November 2022 https://www.cnbc.com/2022/11/03/fidelity-to-open-commission-free-crypto-trading-to-retail-investors.html

  36. Michael Bellusci, BNY Mellon Says Client Demand for Crypto Led to Custody Offering, CoinDesk, 18 October 2022 https://www.coindesk.com/business/2022/10/17/bny-mellon-says-client-demand-for-crypto-led-to-custody-offering/

  37. Nic Carter and Ross Stevens, Bitcoin Net Zero, p. 4 (2021).

  38. Id.

  39. This means that energy interruption is not mission-critical to a bitcoin mining operation; the energy source can be interrupted when the supply of energy is low or when it needs to be diverted to more urgent requirements.

  40. Id.

  41. John Belizaire, Written Testimony Submitted to the U.S. House of Representatives Commission on Commerce and Energy (20 January 2022)

  42. Nic Carter and Ross Stevens, Bitcoin Net Zero, p. 35 (2021).

  43. Saifedean Ammous, The Bitcoin Standard, p. 218 (2018).

  44. Don Tapscott and Alex Tapscott, Blockchain Revolution: How The Technology Behind Bitcoin is Changing Money, Business and the World. Citing Eric Jennings, CEO of Filament, an industrial wireless sensor network, p. 259-260 (2016).

  45. Id., p. 261-263.

  46. Esra Kabaklarli, Green FinTech: Sustainability of Bitcoin, p. 2 (2022)

  47. Puschmann, Hoffmann and Khmarskyi, How Green Fintech Can Alleviate the Impact of Climate Change-The Case of Switzerland (2020).

  48. The Comptroller of the Currency is the head of the Office of Currency Comptroller (OCC), which is one of the federal agencies that regulate banking and currency in the United States. Before joining OCC, Brooks was Chief Legal Officer at Coinbase, the leading crypto exchange in the United States and now a publicly-listed company. After his stint at the OCC, he became the Chief Executive Officer of the U.S. subsidiary of Binance, which is currently the largest crypto exchange worldwide in terms of liquidity and user base. At the time he wrote the statement for the U.S. House of Representatives Committee on Energy, Brooks was the Chief Executive Officer of the Bitfury Group, which provides a suite of infrastructure products and services for the cryptocurrency ecosystem, including bitcoin mining. Bitfury’s majority-owned subsidiary Cipher Mining, is a publicly traded company listed on Nasdaq¯.

  49. Brian P. Brooks, Statement for the Hearing on Cleaning Up Cryptocurrency: The Energy Impacts of Blockchains, p. 4 (2022).

  50. Id., p. 5.

  51. Id., p. 6.

  52. U.S. International Trade Administration, the Philippines Energy Market, 2020 https://www.trade.gov/market-intelligence/philippines-energy-market (last accessed on 25 March 2023).

  53. Brian P. Brooks, Statement for the Hearing on Cleaning Up Cryptocurrency: The Energy Impacts of Blockchains, p. 8 (2022).

  54. Troy Cross and Andrew M. Bailey, Greening Bitcoin with Incentive Offsets, p. 1 (2021).

  55. Id., p. 5 (2021).

  56. Id., p. 6 (2021).

  57. Id.

  58. Id.

  59. Robert Ellickson, Order without Law: How Neighbors Settle Disputes, Harvard University Press, p. 1 (1991).

  60. Id., p. 4.

  61. Id., p. 137.

  62. Higgins v. Sellner, G.R. No. 15825 (1920).

  63. See Bitcoin Mining Council (https://bitcoinminingcouncil.com/)

  64. Mark Carney: Breaking the Tragedy of the Horizon – Climate Change and Financial Stability, Speech at Lloyd’s of London https://www.bis.org/review/r151009a.pdf (2015).

  65. Nic Carter and Ross Stevens, Bitcoin Net Zero, p. 4 (2021).

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