Energy and Blockchain: Is the future distributed ledgers and smart contracts?

Blockchain has gone from an unknown technology to a panacea to an overhyped buzzword in the last 5 or 6 years. People have suggested its use in areas as diverse as insurance and Fairtrade supply chains to voting and, of course, energy. But what does it really mean and is it of any use in the energy sector? In the lead up to our next Briefing Paper on data and digitisation, Dr Aidan Rhodes has written us this great long read about the issues surrounding this new digital frontier.

The building blocks

Blockchain seems to be everywhere, but what is it? It is the most well-known version of a technology known as Distributed Ledger Technology (DLT), a method for enabling and validating digital transactions on a large computer network. Not the most exciting of ideas but DLT, and blockchain in particular, has been gaining considerable momentum in recent years due to its potential to enable peer-to-peer, decentralised, transactions. It should be a completely secure and reliable way of allowing people to trade goods and services in a digital environment.

This has meant that many people have seen potential applications from finance and logistics to taxation and public registries . The headline grabbing applications of DLT have been the blockchain cryptocurrencies Bitcoin and Ethereum. However, while these have demonstrated the feasibility of large-scale distributed ledgers there are also the challenges of implementation, including wildly variable currency values, very high electricity usage and a slow rate of transactions. Bitcoin, for example, can only process 4-7 transactions per second. This is much too slow for the level we are used to seeing in centralised digital transaction services.

Digital bookkeeping

The system is relatively simple. When a transaction between two parties is agreed, for example a transfer of money, it is combined with all other transactions made through the same period to form a block. This block is encrypted and verified and creates a tamper-proof record of the transactions. It is a sequence of these transaction blocks that is commonly referred to as a “blockchain”.

Blockchain’s strengths are twofold, it can work across a network of any size and it is a “public ledger”. The public ledger keeps the tamper-proof records of every transaction on the system and can be checked, and verified, by anyone. The ability to scale to as large, or small, a system as needed is due to that fact all of this communication is in a peer-to-peer fashion, with no central coordinator.

The ledger is like a very large, complex spreadsheet that everyone has a copy of and can look at but not edit on their own. The spreadsheet is constantly changing and being updated so that the current state of the systems is obvious to everyone.

However it is how it is updated/edited that creates the key differences between how different types of DLT work, are they Permissioned or Permissionless?

  • Permissioned
    The only users who can add data to the ledger are verified administrators
  • Permissionless
    Any user can add data, provided it passes a ‘consensus mechanism’.

The rationale for employing a permissionless distributed ledger is that there is no central authority controlling access. Instead, ledger updates are added by participants and are pushed out to every copy on the network. Because over 50% of the other participants on the network must verify and approve a transaction before the ledger can be updated it is extremely secure. Each copy of the distributed ledger is also secured, by using peer-to-peer technologies and complex cryptographic methods, so they can’t be edited after a transaction is recorded.

Consensus building

It is the permissionless systems that are generating real interest so an important part of any DLT design is how the consensus mechanism is implemented.

Most current DLT implementations utilise a proof-of-work algorithm, in which validators, known as “miners”, compete to solve a difficult cryptographic problem using their computers. The solution to this cryptographic problem forms the verification of the block, and the miner responsible for calculating it receives a financial reward – in the case of a cryptocurrency, units of that currency.

Criticisms of proof-of-work relate to transaction speed and energy use. As each block needs to be verified by miners through cryptographic solving, the time taken to verify transactions can vary from a few minutes in perfect circumstances through to hours or even days in congested networks, as seen recently on the Bitcoin blockchain. In addition, as the mining activity required to maintain proof-of-work provides revenue from the reward structures and the algorithms scale to the computational resource available, miners seeking profit can push the energy usage of the validation mechanism to extreme levels. In 2018, the Bitcoin network was estimated to use over 2.5GW, more than the energy consumption of Ireland.

There is an alternative, Proof-of-stake, it allocates blocks for verification to miners in rough accordance to how much of the underlying commodity tokens they own. This is designed to prevent the ballooning of energy required for verification and ensure that those who have a greater investment, both financially and in resource terms, in the blockchain bear more responsibility for verifying it. Proof-of-stake is currently untested in a large blockchain application, though the Ethereum cryptocurrency is currently in the process of moving to this method.

Building smart contracts

Smart contracts are a relatively new term for programmes that transfer currency or commodities. They are simple pieces of computer code that are executed by the Blockchain when certain conditions are met, changing the contents of the ledger to represent the outcome of the contract.

Smart contracts, due to existing on the distributed ledger, are tamper-proof, publically available and should be self-enforceable, which means that they could drastically reduce the costs of contracting, enforcement and compliance. This opens up the potential to form numerous smart contracts over low-value transactions. Some cryptocurrencies have already included different forms of smart contracts, with the Ethereum cryptocurrency being currently the most advanced implementation.

DLT and the Energy sector

Currently, the energy industry is starting to explore more decentralised models, including peer-to-peer trading, microgrids and local demand response and DLT could provide an important factor for facilitating interactions without a central authority. If it can make peer-to-peer transactions more transparent, robust and remove the need for central supervision it will make the transition to these new models much easier.

Key areas in which distributed ledger technology could engage in the energy sector include:

  • Metering, Billing and Security
  • Decentralised Energy Trading
  • Green certificates and carbon trading
  • IoT, smart devices, automation & asset management
  • Grid Management
  • Electric e-mobility
  • Cryptocurrencies, tokens and Investment
140 energy blockchain initiatives, sorted by field
140 energy blockchain initiatives, sorted by field (Andoni, 2019)

Decentralisation and disruption

Embracing DLT could significantly disrupt the current centralised wholesale market structure. Generators would be able to trade directly with consumers without intermediaries such as supply companies by operating through a trading platform.

Energy delivery would be contracted between parties by recording in a central blockchain, and transfer of both energy and payment would automatically occur at the time of delivery via an encoded smart contract.

Difference in current and blockchain market structures (from PWC via Andoni 2019)
Difference in current and blockchain market structures (from Andoni 2019 via PWC)

It would be easier to verify the exact source of supplied electricity through the DLT model, simplifying the process of issuing certificates of origin and calculating emissions on a per-user basis. Transactions recorded in the blockchain would be visible to all parties, including the system operator for balancing purposes. This model could be combined with autonomous AI agents, who could scan the trading platform and book the lowest-priced energy for given time periods without direct human intervention.

This model would be extremely disruptive to the current market, requiring massive changes in structure, regulation and consumer engagement. We could see energy brokers and retail supply companies disappearing completely or at least changing function dramatically. In addition, a DLT-enabled wholesale market is an untested proposition and is unlikely to be adopted at scale on critical infrastructure without lengthy testing. As such, it is very unlikely that it will happen in the near future, and that’s before taking into account the serious concerns with transaction times, energy use and privacy.

I think a more likely application for DLT in the near future would be community level decentralised peer-to-peer energy trading, either across a self-contained microgrid or at distribution level. This would still entail considerable changes to centralised market, supply and balancing arrangements in most electricity markets. There are various trials currently taking place, with Centrica partnering with LO3 to explore blockchain usage on a constrained part of the Cornwall network.  Other trials are currently underway in New York, Japan and Australia, among others.

Metering and demand-response applications

An obvious application for DLT is incorporation into smart meters and smart appliances for billing, usage and demand-response functionality. Smart meters would record usage information and communicate directly to a blockchain, with appliances requesting and monitoring energy use in the same manner. Energy utilities could use this blockchain data to monitor usage at a more granular level then at current, as well as using the blockchain to send demand-response requests to appliances to consume less energy at times of high demand.

This would allow a decentralised open platform for metering, billing and demand response, circumventing the need for a central data communications provider as seen at present. Virtual power plants, where dozens or hundreds of distributed generation or storage assets are combined to form a single larger plant for the market, could also be mediated via a blockchain to transparently track contributions and payment to the component assets.

Differences of opinion

Implementing DLT in the energy sector comes with several significant challenges – some technical, some market and regulatory and some to do with consumer acceptance, security and trust.

DLT is a relatively new and immature technology, with considerable technical development currently taking place, but with little consensus on final, mature forms of the technology for diverse applications. There is considerable debate over the future viability of DLT, with some experts seeing it as a transformative technology and others seeing it as innately slow, complex, expensive in energy use and computational time and vulnerable to manipulation and fraud.

Technical challenges

Blockchain technology currently suffers from several key technical issues. Firstly, transaction speed is slow, with the speed of transactions reliant on the number of nodes available to process and verify blocks and the number of transactions currently being processed by the network. Bitcoin currently processes roughly 7 transactions per second on average, with Ethereum processing approximately 15. These times increase rapidly during periods of high activity. In comparison, the Visa payment network processes around 24,000 transactions per second. While faster DLT methods are being developed, such as ‘Sharding’, a method for the parallel processing of transactions, the current slow speed of transactions seriously limit its usage for high-throughput or time-critical energy sector functions.

Energy usage, particularly using the proof-of-work verification method, is also very high, with a great deal of electricity and processor power. The Bitcoin network is currently estimated as using nearly 0.3% of the world’s total electricity consumption, by any metric inefficient for the utility provided. Once again, future developments in DLT could bring usage dramatically down, but it is questionable if it could ever be as efficient as a more centralised method.

Another issue is data storage. As of June 2019, the Bitcoin blockchain is over 225GB, with a full copy required by every node on the network (Statista, 2019). This is because it contains a record of every transaction made since its conception. Newer implementations including Ethereum require nodes to have only a partial copy of the blockchain, but even in this case the data storage requirements are still quite large.

Data storage and processing requirements for blockchain nodes would be needed to be taken into account for internet-of-things connected devices – it is unlikely, for example, that the UK’s current SMETS2 smart meter configuration provides enough capability to support blockchain applications.

Market and regulatory challenges

Questions of ownership and control are central to DLT applications. Cryptocurrencies such as Bitcoin and Ethereum are designed, at least in theory, as permissionless – no organisation should have overall control over the system. While this has helped with rapid adoption, there is no oversight over transactions for consumer protection, leading to several high-profile cases of fraud and theft, or for the curtailing of transactions in illegal goods or money laundering.

In contrast, the electricity system, as critical infrastructure, would need methods of controlling and managing the distributed ledger. This naturally points towards a more centrally-controlled, permissioned blockchain consisting of trusted nodes. This approach, while providing the certainty of control required for the electricity system, at least partially removes one of the advantages of DLT – the lack of need for oversight in transactions between two actors – while retaining DLTs disadvantages of greater inefficiencies and longer transaction times compared to a centralised processing system.

Market arrangements would have the potential to change dramatically under a DLT-based system, as consumers and generators would be able to form direct relationships without intermediaries such as energy suppliers. As such, consumers would be directly responsible for their own security and balancing, and would need to submit details of their projected usage and supply details to the System Operator for system-wide balancing and stability.

This would require substantial changes in regulatory frameworks, with new regulations for direct trading of energy between consumers and more flexible tariff structures. The relative newness of DLT and the lack of experience with the technology in most sectors means that regulation may be initially more difficult and requiring of iteration and fine-tuning. Standardisation efforts throughout the sector are currently lacking, with several competing blockchain standards being pushed by various organisations. Given the increased potential for instability in a peer-to-peer system, it can be expected that policy and regulation will initially be conservative and possibly limiting.

Consumer acceptance, security and trust

Several proposed applications of DLT in the energy sector involve direct consumer engagement, from simple integration with energy billing through to complex applications involving peer-to-peer trading and smart home integration.

At present, the most visible application of DLT is the Bitcoin cryptocurrency, which has seen considerable bad press coverage around its facilitation of illegal trading, widespread fraud and theft, significant energy usage and rapidly fluctuating value. It may well be the case that some consumers would feel uncomfortable entrusting their energy usage details to a blockchain system.

Due to the way a blockchain operates, if a consumer loses their cryptographic key, they lose their access and data without recourse. There are also issues with visibility – a distributed blockchain is visible to its participants, and all transactions within the blockchain can therefore be publically viewed. In the case of DLT-based billing and metering, it could be that all energy consumed by specific appliances in specific homes would be visible to any interested party, which would be an unacceptable loss of privacy to many consumers. While this may be a disadvantage for domestic consumers, industrial and commercial consumers may welcome the transparency and granularity of this data.

In a decentralised DLT system, as seen in the major cryptocurrencies, there is no regulatory oversight entity able to reverse false or fraudulent transactions or mediate disputes. Transactions are irrevocable once completed, and fraud and theft from accounts is therefore attractive. An energy DLT would have to be designed from the ground up to be fully tamper-proof and secure, especially if it would be embedded into devices and regulating electricity flows across the network. Many start-ups and trials of energy DLTs are based on Ethereum technology, which has suffered serious hacks on both cryptocurrency and smart contracts. While these security issues can be mitigated by designing the blockchain with a centralised oversight entity able to control and override transactions, this loses some advantages in using the technology.

Recommendations

DLT and blockchain technology is new and has had significant press coverage and venture capital investment. This inevitably leads to widely dissenting views about its uses and future viability. The IT consultancy Gartner, in the 2018 edition of its widely quoted Hype Cycle of emerging technologies, placed blockchain technology as high on the inflated expectations peak, indicating that while it is an interesting and viable technology, it is still overhyped as to its future uses and markets.

As such, it is important to approach DLT with an understanding of its current advantages and limitations, as well as specific use cases in which the technology could prove beneficial. We’ll be providing a full list of our recommendations in our upcoming Digitalisation Briefing Paper, but here are a couple for thought:

  • Do not overestimate the technology: DLT could prove transformative, or it could be that the scale of adapting DLT to the energy system on a large scale is more expensive, disruptive and time-consuming than refining and evolving current systems.
  • Find a niche: Before embarking on large-scale applications, DLT should prove itself by providing low-cost and robust solutions to smaller, niche problems. As mentioned above, emissions certificates and carbon trading, especially across borders, could be one niche, as could billing for large industrial and commercial consumers.
  • Don’t be afraid to compromise: The anarchic natures of the large permission-less cryptocurrencies are ill-suited for the energy system – it may well be that the ideal DLT implementation for energy is more centralised and controlled than technology advocates may claim.

Overall, DLT is a fascinating technology with many significant hurdles to overcome before widespread adoption. Energy professionals should be aware of it and understand its characteristics, but should be wary of looking at it either as a ‘silver bullet’ which will solve issues with energy markets in a more distributed system, or viewing it too cynically through the lens of the major cryptocurrencies and their issues, without understanding the inherent flexibility of the technology. Interesting times are ahead!

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