Can Crypto Fix the “E” for ESG-Conscious Investors?
“Just because mining Bitcoin uses energy, doesn’t immediately mean that it’s wasteful, to come to that conclusion would require a value judgment of the activity to begin with.”
Several years ago, a fund manager from Hong Kong who was considering an investment in my fund shot at me, “Did you know that mining Bitcoin uses as much electricity as Belgium?”
As if somehow, I was personally responsible for Bitcoin’s energy consumption simply through my firm’s trading of cryptocurrencies.
“It’s actually the energy consumption of Italy (at the time),” I demurred, but I don’t think he was getting the point.
While attention-grabbing headlines drawing false equivalencies between the amount of electricity it takes to secure the Bitcoin blockchain, with the energy consumption of whole countries make for great clickbait, they gloss over the subtleties and nuances surrounding the question of just how energy-intensive are cryptocurrencies.
Somehow, investments in cryptocurrencies in general, and Bitcoin in particular, have been singled-out as “uninvestable” for failing the “E” criteria among investors with strict environmental, social and corporate governance (“ESG”) concerns as part of their investment mandates.
But are cryptocurrencies really destroying the environment?
Just because an activity uses energy does not in and of itself makes it an undesirable endeavour.
For instance, few would argue that street lighting and heating homes are ignoble pursuits which the world must wean itself of.
So just because mining Bitcoin uses energy, doesn’t immediately mean that it’s wasteful, to come to that conclusion would require a value judgment of the activity to begin with, and much depends on how an investor views the nascent digital asset class.
If Bitcoin is considered pure speculation, akin to Beanie Babies, then it’s understandable that an investor would consider mining Bitcoin a wasteful use of energy that could otherwise have been directed towards heating homes and keeping streets safe at night.
But if Bitcoin was viewed as intended to either supplant or supplement the financial system, acting as a store of value like gold, or a medium of exchange reducing the need for intermediaries, its carbon footprint would need to be assessed against those value propositions.
And it’s in this sense that Bitcoin shines.
The energy consumption of Bitcoin is by orders of magnitude less than that of the global financial system and when held up against the brilliance of gold, Bitcoin’s mining impact is a fraction of the environmental cost compared to the extraction of the precious metal.
Which is why, if mining Bitcoin is considered an activity worth pursuing, further investigation needs to be made as to the sources of the electricity it’s consuming.
Until China banned cryptocurrency mining, most cryptocurrency mining relied on electricity that was generated from fossil fuels.
As recent as 2020, an estimated 70 per cent of all Bitcoin was mined in China and thanks to its abundant coal deposits, roughly 60 per cent of all electricity in China is generated from coal-fired power stations.
Which explains why when electric vehicle maker Tesla initially said it would accept Bitcoin as payment for its vehicles, it soon suspended the practice thereafter over environmental concerns, until at least half of the electricity used to mine Bitcoin was found to be from renewable sources.
But in 2021, Beijing’s crackdown on its cryptocurrency miners sent them packing (literally) to other countries, many of which rely on renewable sources of energy for power, including hydro power from Laos, natural gas in Russia and Central Asia, and even solar and wind in Australia.
While ESG considerations do not factor highly on the decision-making matrix of most cryptocurrency miners, the combination of Beijing’s crackdown and pure circumstance have resulted in as much as half of all Bitcoin mining using renewable energy.
Nevertheless, it’s difficult for ESG-conscious investors to determine if investing in a particular cryptocurrency adds to environmental costs.
Because blockchains are decentralised, anyone can mine cryptocurrency whether through their own computers or purpose-built hardware, and use whatever source of energy they deem best, regardless of the environmental impact.
Decentralisation is both a feature and a limitation of cryptocurrencies, because it means that there’s no way to guarantee that mining uses renewable energy, and it will take far more than a tweet from Elon Musk to change that.
But dismissing cryptocurrencies outright on ESG concerns assumes that mining cryptocurrencies is inevitably energy intensive when that simply isn’t the case.
Proof-of-work vs. Proof-of-stake
While most blockchains like Bitcoin employ proof-of-work, where cryptocurrency miners use computing power and electricity to solve complex math problems, to secure the blockchain and add transactions to the decentralised ledger, an alternative known as proof-of-stake exists.
Proof-of-stake blockchains rely on holders of cryptocurrency to use their “stakes” (hence proof-of-stake) to secure the blockchain by relying on algorithms which randomly select such “stakes” to validate transactions and secure the blockchain.
By using proof-of-stake to secure the blockchain, the computational and energy costs associated with proof-of-work blockchains is avoided entirely and provides a potential gateway for ESG-conscious investors.
Without further investigation, most ESG investors would assume that all blockchains use proof-of-work, but increasingly more blockchains are moving away from energy-intensive algorithms to more sustainable means to secure their blockchains.
Some of the world’s most valuable blockchains are already using proof-of-stake, including Solana, Cardano and Algorand, all of which are rivals to the world’s second most valuable blockchain by market cap, Ethereum, which still uses proof-of-work.
But even Ethereum is evolving and later this year will attempt to make one of the most ambitious shifts for an established blockchain ever, moving from the energy-intensive proof-of-work to the far more energy efficient proof-of-stake.
Ultimately, moving to proof-of-stake is a function of software design and a consensus mechanism that has almost nothing to do with the constraints of the blockchain or cryptocurrencies.
Because cryptocurrencies require at least a significant critical mass of users to maintain adequate levels of decentralisation, proof-of-stake blockchains were until fairly recently not considered viable.
Proof-of-stake blockchains needed to overcome serious hurdles, including the need for stakes not to be so concentrated that they would be perceived as manipulable, as well as robust software to ensure that the selection of validators to secure the blockchain was truly random.
Shifting blockchains to proof-of-stake isn’t impossible, but it takes time and cryptocurrencies have reached a stage of maturity where it may now be possible to find a more environmentally sustainable path forward.
And that shift is important as more asset managers and investors pay greater heed to ESG concerns, while still considering the benefits of investing in cryptocurrencies.
Last week, the world’s largest asset manager BlackRock, projected that by 2030, at least three quarters of its investments in companies and sovereign debt will be tied to issuers with a scientific target to cut net greenhouse gas emissions to zero by 2050, up from 25 per cent currently.
BlackRock is also actively exploring methods to offer its clients cryptocurrency exposure and given its focus on ESG, it’s more likely to invest in cryptocurrencies whose blockchains use environmentally sustainable models and renewable energy.
With over US$10 trillion of assets under management, where BlackRock eventually places its bets in the cryptocurrency space will have a major impact on which blockchains will succeed and which cryptocurrencies will see their prices soar.
It’s highly unlikely that Satoshi Nakamoto, the creator of Bitcoin, had intended for the cryptocurrency to have a negative impact on the environment — he, she or they were simply using the best methods to secure the blockchain that were practicable in those circumstances.
But unlike the internal combustion engine which can only rely on fossil fuels, cryptocurrencies and the blockchain are far more plastic, and can adapt to improving methods, including ways to secure the blockchain that do not rely so heavily on electricity.
- READ MORE: Could DeFi be Crypto’s DeFining Moment?
Because proof-of-work was a deliberate choice with the best information available at the time, proof-of-stake should be seen as an evolution of blockchain technology, catering for the decentralisation that makes it valuable, as well as limiting its environmental impact.
Whether Bitcoin will ever obtain the consensus it needs to shift to the more energy-efficient proof-of-stake remains to be seen, but ultimately may not matter, because other cryptocurrencies will rise to meet that challenge and that’s what ESG investors should focus on.
By Patrick Tan, CEO & General Counsel of Novum Alpha
Novum Alpha is the quantitative digital asset trading arm of the Novum Group, a vertically integrated group of blockchain development and digital asset companies. For more information about Novum Alpha and its products, please go to https://novumalpha.com/ or email: ask@novum.global
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