Are NFTs environmentally friendly?

#NFT #fintech #environment #climatechange

Introduction

NFTs are all the hype nowadays, and not without reason. This technology empowers digital content creators in more ways than one. As mentioned in the previous article, selling NFTs allows them to generate income, earn royalties, and create scarcity of their work, and it’s not just artwork we’re talking about, but also music, memes, tweets, fashion, in-game items, digital tools, real estate – you name it!

For buyers, buying NFTs can be a means for you to support your favourite digital creators, and it can also be a worthy investment for others. You’ve probably heard of the artist Beeple, and how they sold the famous digital collage “Everydays: The First 5,000 Days” for 69.3 million at Christie’s in March 2021. Or perhaps you’ve heard of NBA Top Shot, which captures the best moments in basketball in the form of NFTs and sells them for incredible prices: the top sale of the Lebron James Dunk was for $99,999 in 3 February, 2021¹.

NFTs are no doubt an incredible innovation but we mustn’t neglect its downsides. One obvious detriment of NFTs is its potential damage to the environment.

The process of making NFTs is extremely energy-consuming; not to mention that the cryptocurrencies used to buy and sell NFTs are also a major source of carbon dioxide emissions. However, as you will later find out, there are some ways you can become a more environmentally-friendly NFT investor.

“Proof-of Work”: How it Works and the Environmental Impact

Why are NFTs or cryptocurrencies potentially so damaging to the environment? This is due to an extremely energy-consuming system that many blockchains use to maintain their trustworthiness called ‘proof-of-work’ (PoW).

When a new NFT or cryptocurrency transaction takes place, a new block is validated and confirmed (refer to our previous article) on the blockchain. Most blockchains, e.g. Ethereum, use the proof-of-work (PoW) operating method for this process.

How does PoW work? In layman’s terms, PoW requires nodes on the network to solve a mathematical puzzle (also called “mining”) as a way of verifying the legitimacy of transactions on the network². Miners compete for the right to confirm new blocks by racing to solve the math puzzle, which requires a lot of attempts. To be the first to come up with a solution, miners have to use vast computing power and specialised computing hardware, which consumes a large amount of electricity.

Moreover, the difficulty of the math puzzle increases proportionately to the amount of computing power in the network working on the puzzle. This increasing difficulty incentivises miners to optimise their ability to solve the puzzle, and thus the ability to verify transactions³. It also makes it nearly impossible and extremely energy-intensive for anyone to alter the blocks, discouraging wrongdoers from doing so.

As a reward for solving the math puzzle and verifying the transactions, miners ‘win’ the right to create new blocks (a.k.a. the NFT), which gives them transaction fees and other rewards⁴.

PoW is therefore an effective way to ensure security of the blockchain in a decentralised environment.

Yet, in terms of environmental impact, PoW creates a vicious cycle – the more computing power spent on the puzzle, the more difficult the math puzzle becomes, which in turn requires more computing power to solve.

You can then see how the PoW process of NFT minting encourages mass usage of electricity, which is often produced by fossil fuels that release greenhouse gases – and hence, how the creation of NFTs could directly contribute to climate change. Ethereum, a major platform for NFTs, uses 113 terawatt-hours per year, which is, according to Digiconomist, ‘comparable to the power consumption of the Netherlands’⁵.

“Proof-of-Stake” – A Solution?

That is not to say it is impossible to find more environmentally friendly ways to support your favourite digital content creator.

Some platforms use an alternative system called proof-of-stake (PoS) to maintain security of the network, which doesn’t require as much computing power. The creator of the new block is chosen from a group of users that have staked (agree to not buy or sell⁶) a certain amount of cryptocurrency and the chosen gets a fee for every transaction. They are incentivised to verify only legitimate transactions as they would otherwise lose the money they’ve staked, which is usually a lot of money. Given that there are no math puzzles or competition involved, there will be no excessive consumption of energy.

Platforms that use PoS are therefore a much more environmentally friendly alternative, and these platforms include Solana, Algorand, Cardano and Tezos. Ethereum plans to switch to the PoS mechanism by merging with the Beacon chain that it tested its PoS system on. This merge is expected to occur in Q2 2022⁷. Currently, Ethereum has staked 9,500,000 ETH ($37 billion, in current value)⁸ in the Beacon chain.

Other Ways to Help the Environment

NFT marketplaces have further sought to reduce the energy consumption by batching transactions, meaning it batch-processes multiple transactions instead of processing them one by one. This approach is currently used by Bitcoin Lightning Network. Miners can also do their part and use renewable energy sources for mining.

And what can we, as consumers and investors, do? Investopedia suggests that we can use the proceeds we get from investing in NFTs to help the environment, for example by investing in renewable energy or experimental technologies designed to mitigate or reverse the effects of climate change or buying carbon offset credits to encourage reduction in greenhouse gases emitted.⁹

If you would like to consult an expert or have training on specific topics and areas, please do not hesitate to reach out to Annie Tang by email at annie.tang@staranise.com.hk to learn more about the training services we provide at SALT.

Disclaimer: This article is of a general nature only. It is not legal, financial or any other form of professional advice. If you have any questions for your specific situation, please consult a licensed professional.

Writer: Serena So is a first-class law graduate from the University of Durham, England. She joined Star Anise in 2021 as a Research Analyst until the following summer, after which she embarked on her PCLL. 

References:

1. https://sportsnaut.com/10-most-expensive-nba-top-shot-digital-cards-now/
2. https://www.youtube.com/watch?v=-C19r0UsYws
3. https://archive.is/q3EW4
4. https://www.investopedia.com/nfts-and-the-environment-5220221
5. https://ethereum.org/en/upgrades/merge/
6. https://www.technologyreview.com/2022/03/04/1046636/ethereum-blockchain-proof-of-stake/
7. https://www.investopedia.com/nfts-and-the-environment-5220221
8. https://www.youtube.com/watch?v=-C19r0UsYws
9. Reward of newly created bitcoins in context of bitcoin https://www.investopedia.com/terms/b/bitcoin-mining.asp