Holdings of Bitcoin and other cryptocurrencies account for about 0.3 percent of global CO2 emissions. That may not sound like much, but it’s more than the emissions of Switzerland, Croatia and Norway. combined. As many cryptocurrencies collapse and the FTX bankruptcy moves into the litigation phase, regulators will be scrutinizing the cryptocurrency world more than ever. This presents a perfect opportunity to prevent the damage they cause to the environment.
The good news is that cryptocurrencies don’t have to be carbon intensive. In fact, some have near-zero emissions. To incentivize polluting currencies to reduce their carbon footprints, we need to make buyers pay for environmental damage through taxes.
The difference in emissions between cryptocurrencies is due to how they create new coins. Bitcoin and other top issuers use a system called “proof-of-work”: To create coins, participants, or “miners,” must solve math problems that require extraordinary computing power. This allows currencies to maintain their own decentralized ledger – the blockchain – but requires a large amount of energy.
Greener alternatives are available. Most notably, the proof-of-stake system allows participants to secure their blockchain by pooling their cryptocurrency holdings. When the second-largest cryptocurrency Ethereum switched from proof-of-work to proof-of-stake earlier this year, its energy consumption dropped by more than 99.9 percent overnight.
Bitcoin and other cryptocurrencies probably won’t follow suit unless forced to, because proof-of-work offers huge returns to miners and they are the ones with the power in the system. Many legislative levers can be used to induce them to change.
The most obvious solution is to ban cryptocurrency mining altogether. China did this in 2018, but it made the problem worse; mining moved to other countries with less efficient energy production and emissions increased. The only way a mining ban will significantly reduce carbon emissions is if it is implemented across most of the world. Achieving this international consensus is unlikely, to say the least.
A second solution is to ban the buying and selling of proof-of-concept currencies. The Economic and Monetary Affairs Committee of the European Parliament considered making such a proposal, but voted against it in March. This is understandable; as with the mining ban, this would be seen as both paternalistic and politically difficult to implement.
A tax instead of an outright ban would avoid these problems. As with gasoline, tobacco, plastic, and alcohol taxes, a cryptocurrency tax could reduce real-world harm by forcing consumers to pay for it.
Most ways to tax cryptocurrencies will be ineffective because they are easy to circumvent and difficult to enforce. To avoid these pitfalls, the tax should be charged as a fixed percentage of each cryptocurrency purchase. Just as merchants collect sales tax from customers before remitting the amount to governments, cryptocurrency exchanges must collect the tax. To make evasion difficult, the tax should apply regardless of how the proof-of-work currency is exchanged – whether for fiat currency or another cryptocurrency. Most importantly, each state that imposes the tax must target all purchases made by citizens within its jurisdiction, even if they are purchased through exchanges that do not have a legal presence in the country.
Such a tax would be transparent and easy to apply. Since most people buy cryptocurrencies from one of the few big exchanges like Binance, Coinbase, and Kraken, their audit should be cheap enough that it pays for itself. If the exchange does not match, it should be banned.
Even a small tax on proof-of-work currencies would reduce their damage to the planet. Imagine you are new to cryptocurrency and want to become a first-time investor. You are presented with various currencies to choose from: bitcoin, ether, litecoin, monero and others. Except for Ether, you’ll find that all of them add an environmental tax to your purchase price. Which one do you buy?
Countries do not need cross-border coordination for a proof-of-work tax to be effective for their citizens. But early adopters still need to consider ways to encourage others to come on board. There is a precedent for this. The European Union is trying to influence global politics with its carbon cap regulations, which discourage people from buying carbon-intensive products abroad to avoid taxes. Similar rules for a proof-of-work tax may persuade other countries to adopt this tax.
Of course, just as people avoid any tax, some will try to avoid it. For example, people can buy tax-free coins on centralized exchanges and then exchange them for polluting coins on decentralized exchanges. To some extent this is inevitable; no tax is perfect. But the effort and technical know-how required to evade the proof-of-work tax will be a major obstacle.
Even if only a few countries impose this tax – and even if some people avoid it – the desirability of bitcoin will be reduced globally and the environmental benefits will be significant. A high enough tax could also lead to a self-reinforcing cycle that would lower the prices of these cryptocurrencies. Since the value of many cryptocurrencies is largely based on speculation, it depends on the future buyers. When speculators are taxed away, the lack of demand will cause the price of bitcoin to fall, which may prompt more existing holders to sell – driving prices down even further and accelerating the effect. Falling prices will force the bitcoin community to abandon proof of work altogether.
Taxing proof-of-work exchanges may hurt them in the short term, but it won’t stop blockchain innovation. Instead, it will direct innovation to greener cryptocurrencies. It’s not unlike government incentives for electric cars that encourage automakers to develop green alternatives to the internal combustion engine. These incentives don’t limit innovation in cars, they encourage it.
Taxing environmentally harmful cryptocurrencies could garner support from people with diverse interests across the political spectrum. It will benefit blockchain innovators and cryptocurrency researchers by shifting the focus from harming the environment to beneficial uses of the technology. It has the potential to significantly green our planet. This will increase the state’s revenue.
Even bitcoin maximalists have reason to accept this proposal: It will give the bitcoin community a chance to prove that it can survive and thrive.