ESG considerations have become increasingly important when evaluating individual investments and funds. At the same time, we’ve seen cryptocurrency growing in popularity over the last decade and becoming a staple in many portfolios.
While investing in crypto can offer several advantages to a portfolio, there are many debates in the cryptocurrency community surrounding its carbon footprint, a high incidence of hacker theft, and decentralized governance.
In this blog I’ve looked at crypto from the perspective of each ESG factor, shared my thoughts on the key highlights and looked at what’s being done to improve them.
Some cryptocurrencies such as Bitcoin are reported to have a similar energy consumption to that of a mid-sized country like Austria, Spain or France.
The primary cause of its enormous energy usage comes from the “mining” of cryptocurrencies, specifically the proof-of-work (PoW)consensus mechanism which is used by bitcoin and many other cryptocurrencies.
Mining is the process of verifying and recording transactions on a blockchain network and rewarding this work with newly minted cryptocurrency. [LE1] With the PoW network, members are all working to solve an encrypted hexadecimal number at the same time but only the first person to solve it is rewarded. This means that many people are consuming energy to solve the encryption as fast as possible, when only one is necessary.
We now see more environmentally friendly cryptocurrencies that utilize a new method called Proof of Stake (PoS), which uses significantly less computational power and energy. With PoS, participants stake their coins as collateral for the chance to validate transactions and earn rewards. The random selection of one participant eliminates the need for additional members to compete, which is a characteristic of the PoW mechanism. This results in a reduction of unnecessary energy usage.
Bitcoin's top competitor Ethereum was using PoW on its blockchain until September 2022 when they made the transition to PoS. As a result of the change, the network has cut its energy usage and carbon footprint by approximately 99.99% each, according to a report from the Crypto Carbon Ratings Institute.
Ethereum is not the only energy efficient crypto currency. There are many currencies today that utilize PoS. One example is Stellar, a company building efficient cross-border payment systems. Stellar consumes only 0.173 Watts per hour compared to the 659.18 kilowatts per hour for a single bitcoin transaction.
In addition, some crypto blockchains are actively working towards putting crypto to good use.
Ecoterra was especially created to empower action towards climate change. SolarCoin aims to incentivize the use of solar energy and Powerledger gives the buyer access to their network as it works towards clean energy tracking and verification.
Although Bitcoin takes up 45% of the total crypto market, it’s important to keep in mind that it does not represent all crypto currencies and tokens, nor does it reflect the efforts being made by other digital assets to improve their environmental impact.
From a product liability point of view, decentralized transactions can be exploited as a form of payment for illegal operations. For example, in 2022, crypto-related crime was over $20bn.
There are two views when it comes to crypto-crime rate in recent years. As per an article by CoinDesk, although the proportion of criminal activity relative to the total crypto transactions has decreased, the actual amount of money lost to crypto crime has increased due to the overall rise in usage.
Furthermore, although there is an argument to be said around the ease of access to the crypto world, and therefore minimizing discrimination, crypto still faces diversity challenges. For example, CoinDesk statistics suggest that only 4% - 10% of crypto sector workers are women.
Decentralizing financial institutions allows the unbanked to make digital purchases and connect globally.
“The benefits of promoting financial inclusion are well known. The McKinsey Global Institute calculated that widespread use of digital finance could boost annual GDP of all emerging economies by $3.7 trillion by 2025, a 6% increase versus a business-as-usual scenario, and create an addition 95 million jobs across all sectors.” *3
Cryptocurrencies have also been seen to increase economic empowerment, as they have the potential to empower individuals in economies with volatile or unstable currencies. By providing an alternative store of value and means of exchange, cryptocurrencies can enable individuals to protect their wealth.
Additionally, both the PoW and PoS methods require network participants to solve an encrypted hexadecimal number to verify transactions and earn rewards. This unique characteristic of cryptocurrency creates an adjustable system for human capital and labor management. Since miners are randomly selected without any pre-requisite qualifications, the system is fair and unbiased, promoting the principles of equality and justice. Anyone can participate in mining and earn rewards without any discrimination.
Governance looks at a collection of rules and best practices, as well as a set of processes that dictate how an organization is governed and regulated and how it interacts with external stakeholders, such as shareholders and governments.
Because of the de-centralized nature of crypto, some companies have seen this as a way to bypass any type of financial regulation including what is ordinarily deemed as good governance.
For example, in early 2023 investors experienced a shock from the volatile crypto market caused by the FTX scandal. FTX operated largely without a board of directors (its US entity only implemented one in early 2022), and Sam Bankman-Fried, the CEO of the company, misappropriated $8 billion in customer assets.
Furthermore, because blockchain-based cryptocurrencies are open-source, anyone with basic programming skills and a working knowledge of the technical infrastructure can create and market their own private digital currency. This has led to a market which is now saturated with cryptocurrencies which are created with little value proposition, resulting in them being worthless or harmful to investors who put money into them.
Cryptocurrencies are built on decentralized blockchain technology, which means that control over transactions and financial systems is distributed among participants rather than being concentrated in a central authority. This decentralization can promote greater transparency, reduce the potential for corruption, and democratize access to financial services.
Although the unrestrained nature of crypto means that there are few bylaws governing the currency, governments can regulate the transfer of crypto into government issued currencies, or fiat. Some governments are also forming their own Cryptocurrency Taskforce to regulate financial promotions of crypto assets to protect consumers from fraud or scams using blockchain technology.
This has been a very top line and basic look into the E, S and G factors surrounding crypto. We hope you’ll use it as a guide to investigate the different aspects that could affect the sustainability score of crypto, but we recommend that you should always do your own research as well.
Additionally, investors should consider the specifics of various digital currencies and analyze the advantages and disadvantages considering their own sustainability objectives within the context of their own portfolio.
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*1 - Source: Cambridge Bitcoin Electricity ConsumptionIndex (CBECI), Digiconomist, Cambridge Centre for Alternative Finance,International Energy Agency, Morgan Stanley, and ECB calculations
Note: Thehorizontal lines denote the annual electricity consumption of countries in 2020and the annual electricity production capacity of the Three Gorges Dam.
*2 - Source: https://www.nasdaq.com/articles/cryptocurrency-and-the-esg-issue%3A-why-cryptos-are-more-esg-friendly-than-you-think
*3 - Source: https://www.weforum.org/agenda/2022/05/can-cryptocurrencies-become-environmentally-friendly/
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