Many cryptocurrency advocates claim their asset class is good for ESG (Environmental, Social and Governance) investing. But do their claims stand up to scrutiny? The environmental concerns of ESG relate mostly to climate change and sustainable development. Martin C. W. Walker, Director of Banking and Finance at the Center for Evidence-Based Management, offers his analysis on how ESG and cryptocurrencies intersect in the world of investing and whether they are in union or at odds with each other.
Cryptocurrencies are a close to unique asset class, providing no return, giving no ownership rights and having no utility. Returns though, the primary concern to investors can be staggering. Bitcoin, the most popular, increased over 300% in value during 2020. Some, such as Stellar and Dogecoin, saw 100% gains in hours during January.
In contrast to a focus on short term gains, ESG (Environmental, Social and Governance) investors seek longer term gains from investments that improve our world. ESG has steadily been gaining attention due to factors such as climate change and more recently social questions raised by the Black Lives Matter movement.
While price appreciation is attracting more mainstream investors to show interest in Bitcoin, a recent survey of the fund management industry found 96% expected their firms to place a higher priority in ESG. One of the trickier but seldom asked questions facing fund managers is whether ESG and crypto are compatible.
Many cryptocurrency advocates claim their asset class is good for ESG. But do their claims stand up to scrutiny? The environmental concerns of ESG relate mostly to climate change and sustainable development. The uncomfortable truth about cryptocurrencies is that the cryptocurrency “mining” process of leading cryptocurrencies such as Bitcoin and Ethereum is incredibly energy inefficient, generating vast carbon dioxide emissions.
According to the Digiconomist website, Bitcoin mining alone generates as much CO2 as New Zealand and uses as much electricity as Chile. The picture looks even worse compared to existing financial infrastructure. The CO2 emitted from processing one bitcoin transaction is equivalent to that produced to process 722,705 Visa card transactions. Cryptocurrency advocates claim that they mostly use renewable energy and the high energy consumption incentivises innovation in energy production.
A significant proportion of Bitcoin mining is powered by renewables, according to University of Cambridge research. But most is not, and the heavy concentration of mining in China leads to a reliance on coal, particularly during seasonal fluctuations in hydroelectric power output. One of the more credible claims for encouraging innovative energy generation is the use of natural gas produced as a by-product of shale oil for mining. Persuasive, except that shale oil production is environmentally damaging in itself and this form of power simply subsidises more environmental damage.
Social concerns typically include diversity, human rights, consumer protection and financial inclusion. The relative anonymity of most cryptocurrencies offers some protection from oppressive regimes and any member of the “unbanked” with an internet connection can potentially own Bitcoin. Sadly the privacy benefits of cryptocurrencies in oppressive nations are simply a tool for the criminal in nations with the rule of law. In terms of financial inclusion the necessity to own a smartphone and an internet connection removes the possibility of helping the poorest of the poor. Even for those that can afford to access cryptocurrencies they face severe price volatility and the costs of converting cryptocurrencies into real world money.
Perhaps the worst conflict with social concerns relates to consumer protection. Assets of such volatility are simply not suitable investments for most investors. Markets have high potential for manipulation. Cryptocurrencies are bought and sold at “exchanges” that are not regulated as exchanges, leverage in provided by a shadow bank (stable coin issuer Tether) that is not regulated as a bank, and the creators of these assets are generally not held responsible for the misinformation spread to encourage sales.
It is conceptually very hard to apply standards of corporate governance to cryptocurrencies. Cryptocurrencies claim to be without any central controller. The reality of de-centralisation is very different. Many cryptocurrencies are clearly centralised and have a single organisation that acts as a creator of cryptocurrency, maintainer of the network and prime beneficiary from sales of the cryptocurrency. In some cases this is hidden behind complex legal structures, including notionally independent foundations that were set up to avoid the creators of cryptocurrencies from appearing to be issuers of unregistered securities.
In others cryptocurrency firms launched vocal PR campaigns claiming no connection between the cryptocurrency and the company created to profit from it . Even Bitcoin itself has highly concentrated control over the mining process (by a very small number of mining “pools”), the sales process through cryptocurrency exchanges and the maintenance of the code (the Bitcoin Core group). Looked at in detail, the difference between the perception/illusion created and the reality is the truly worrying thing about cryptocurrencies from a governance perspective. Cryptocurrencies rate extremely poorly on any measure of governance.
In short cryptocurrencies and ESG principles are far from compatible and any mainstream fund manager or pension fund seeking to place a portion of their portfolio in crypto risks completely undermines any attempt to raise its ESG credentials. As will any other firm that invests in or facilitates the cryptocurrency industry.
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Martin C. W. Walker is Director of Banking and Finance at the Center for Evidence-Based Management. He has published two books and several papers on banking technology. Previous roles include global head of securities finance IT at Dresdner Kleinwort and global head of prime brokerage technology at RBS Markets. He received his master’s degree in computing science from Imperial College, London and his bachelor’s degree in economics from LSE.