Can investors embrace both cryptocurrencies and ESG?

2020 saw a surge in the price of cryptocurrencies, but also increased consciousness about the impact that investing in cryptocurrencies can have on the environment, society, and the governance of firms (ESG investing). Martin Walker analyses whether the two trends are compatible.

Cryptocurrencies are a close-to-unique asset class. They provide no coupons or dividends, give no ownership rights and have no utility. They can, however, provide amazing returns, which is their primary attraction to investors. Bitcoin, the most popular cryptocurrency, increased over 300% in value during 2020. Other cryptocurrencies also saw spectacular gains. Some, such as Stellar and Dogecoin, saw 100% gains over a few hours at the beginning of this year.

Another hot topic for the investment management industry is ensuring that investments meet criteria related to improving the environment, dealing with social concerns, and improving corporate governance (ESG). Short-term gains are given lower priority than investments that improve our world and, in the process, generate higher longer-term returns. ESG has steadily been gaining attention due to concerns about climate change, but there was also an explosion in interest last year due to factors such as the Black Lives Matters movement. A recent survey of 600 people in the fund management industry found that 96% expected their firms to increase the prioritization of ESG this year. One of the more challenging questions facing investors is whether ESG and cryptocurrency are compatible investment strategies.

The case for cryptocurrencies supporting ESG objectives, not surprisingly, mostly comes from those with material interest in their value appreciation. To put those claims into context, it is first necessary to break down and elaborate the ESG criteria, something that is only possible to do with a degree of simplification because there are no legal standards defining ESG.

Environment

The major environmental concerns of ESG relate to reducing the impact of climate change and ensuring sustainable development. The uncomfortable truth about cryptocurrencies is that the process of validating transactions used by the leading cryptocurrencies such as Bitcoin, Ethereum and Litecoin (generally referred to as “mining”) is incredibly energy inefficient and generates vast amounts of carbon dioxide. The numbers looked at in aggregate are bad enough. According to the Digiconomist website, Bitcoin mining alone generates as much CO₂ as New Zealand, and uses as much electricity as Chile, a middle income nation of 18 million people. The inefficiency and waste look even worse compared to existing financial infrastructure. The CO₂ produced processing one bitcoin transaction is the same as that generated processing 722,705 Visa card transactions.

The arguments used in favour of cryptocurrencies from an environmental perspective are that they mostly use renewable energy, and that their energy consumption acts as an incentive to develop more environmentally friendly forms of energy production.

It is true that a significant proportion of Bitcoin mining is powered by renewables, according to research by the University of Cambridge, but most is not and the heavy concentration of Bitcoin mining in China means a great deal of the mining is powered by burning coal, particularly during seasonal fluctuations in the output of hydroelectric power. Hence the alarming estimates of energy use and CO₂ production. One of the more creditable arguments for Bitcoin mining encouraging innovative forms of energy generation is the use of natural gas produced as a by-product of shale oil production to power bitcoin mining. This a superficially persuasive argument, but the reality is that shale oil production is environmentally damaging in itself. Bitcoin mining is subsidising more production of shale oil is not necessarily good for the environment.