Does ESG Investing Apply To Cryptocurrencies? The Answer Lies in Blockchain Technology
Image Credit: Kelly Heng on Unsplash

Does ESG Investing Apply To Cryptocurrencies? The Answer Lies in Blockchain Technology

14th December 2021 | 6 min read

Cryptocurrencies have always been on the naughty list of climate activists and bureaucrats. Bitcoin, the poster coin of crypto, is estimated to consume 0.5% of all electricity used globally – nearly seven times Google’s total usage. It’s consistently drawn flak from environmentalists and the likes of Bill Gates and Elon Musk, with the latter abruptly suspending Bitcoin payments for Tesla in May, after learning of the “rapidly increasing use of fossil fuels for Bitcoin mining”. On the other hand, armchair critics like the 97-year-old Charlie Munger, who labelled cryptocurrencies as “just dementia” and “contrary to the interest of civilisation”, are still living in an analog world and harbouring ludicrous notions that digital currencies only have criminal applications. 

As much as I hate to agree with tech-illiterate traditionalists or the self-proclaimed “Dogefather”, the harsh reality is that if everyday transactions require an entire country’s worth of electricity to be validated, cryptocurrencies will never become part of the global financial system and might just be relegated to the “online credit” category. 

The effects of climate change are becoming more apparent than ever, and a growing number of retail and institutional investors are placing more emphasis on ESG analysis in their investment process. This begs the question of how cryptocurrencies, an asset class known for its anonymity and high electrical usage (for cryptocurrencies such as Ether and Bitcoin), is sustainable enough to fit into an ESG portfolio. 

Blockchain consensus mechanisms

In a previous Bread article, we said that the long-term value of a cryptocurrency comes from its underlying blockchain technology. Apart from the utility of a blockchain, its consensus mechanism, or how a blockchain comes to a collective agreement to validate transfers, determines how environmentally friendly the network is, thus offering investors an insight into the long-term sustainability of its native cryptocurrency. 

There are two popular consensus mechanisms currently adopted by blockchains: proof of work (PoW) and proof of stake (PoS). PoW blockchains like Bitcoin and Ethereum require copious amounts of energy, as the right to validate transactions is earned by solving complex mathematical equations that require a substantial amount of computational power. 

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US Treasury Secretary Janet Yellen once described Bitcoin as an extremely inefficient way of conducting transactions, and that the amount of energy it consumes is staggering. At a time when governments around the world are trying to curb carbon emissions, PoW blockchains are undoubtedly the worst representation of the cryptocurrency industry. This is also why countries like China have repeatedly tried to shut down bitcoin mining rigs, as these infrastructures can quickly increase a country’s carbon footprint. 

However, what governments and institutions have conveniently left out to preserve their environmental impact argument against cryptocurrencies is that Bitcoin and PoW blockchains no longer define the industry. Newer PoS blockchains like Ethereum 2.0, Polkadot, and Cardano have emerged as possible solutions to cryptocurrencies’ carbon footprint problem. These blockchains are significantly more sustainable as there is no need to solve complex mathematical equations. Rather, validators, or the supercomputers that verify transactions on PoS blockchains, have to own the network’s cryptocurrency and put it up as “stake”, which gives them a vested interest in the security of the network while also removing the need for energy-inefficient mining rigs.

Therefore, the transition from PoW to PoS is a groundbreaking development for the industry as a whole as it drastically changes the make up of blockchains without altering their purpose. More importantly, it enables blockchains to operate as a more sustainable and efficient technology, therefore reducing the carbon footprint of cryptocurrencies. 

Applications of a blockchain beyond its cryptocurrency

Despite the high degree of anonymity in the industry, blockchain technology is supposedly designed to promote transparency and improve record-keeping procedures, which means that it has potential applications across a wide range of industries apart from cryptocurrencies. For example, blockchains can be used as a more transparent supply chain – products can be collectively tracked to minimise waste and unethical practices. Crucial environmental data can also be monitored and stored on blockchains. 

Cardano is an example of how an eco-friendly blockchain can be used for social initiatives. While it’s not the only PoS blockchain on the market, it’s estimated to consume only six gigawatt hours of energy annually, or less than 0.01% of Bitcoin’s energy consumption. This means that as a cryptocurrency, Cardano is far more environmentally sustainable than Bitcoin or Ethereum. 

Image Credit: Carles Rabada on Unsplash

“If they truly believe care about alternative energy, sustainability, carbon reduction, and carbon neutrality, you can’t be in a system where there is no built-in mechanism to constrain the energy consumption”, said Charles Hoskinson, founder of Cardano, when asked if Tesla should accept ADA as a more environmentally friendly cryptocurrency for payments. The Cardano blockchain is also going to be used as the record-keeping infrastructure in the Ethiopian educational system, allowing teachers and students to store tamper-proof education records. 

Another example of a green project is Plastic Bank, a recycling initiative built with blockchain technology on IBM’s servers. It allows users in developing countries to earn and spend Plastic Bank Tokens based on the amount of plastic they recycle. These digital tokens can then be spent in stores that support the initiative, therefore incentivising users to recycle. Because 80% of ocean plastic waste comes from developing nations, Plastic Bank believes that they will be able to decrease pollution and poverty levels. 

Social good of cryptocurrencies 

Truth be told, despite my frequent rants against crypto naysayers, I’m unsure if mainstream cryptocurrencies can really benefit society. Yes, cryptocurrencies can be a more equitable medium of exchange and a potential store of value, but if they remain decentralised and unregulated, they will always be used for illicit activities. However, the risks of financial crime can never be completely mitigated (cryptocurrencies or not), and hence the critical question that arises is whether the blockchain industry as a whole can contribute to the betterment of society and the environment. 

An increasing number of crypto fund managers are diverting their attention to smart-contract enabled blockchains that are centred around the principles of sustainability. Dan Liebau, former COO at HSBC Securities Singapore, and now founder of the Singapore-based Lightbulb Capital, said that the fund’s strategy is to ignore PoW blockchains and invest in Layer-1 PoS protocols like Ethereum, Polkadot, and Solana instead. The tokenomics of these networks are also taken into consideration. For example, whether the governance tokens on these blockchains can be fairly distributed or are they merely designed to be owned by whales. Liebau also argues that the long-term value of a blockchain depends on the above factors. “It’s early for ESG and platform tokens. Few understand the relevance”, he said. 

Image Credit: Rice Media

What investors need to understand is that while the blockchain industry is currently defined by the explosive rise of decentralised finance and NFTs, the effects of these activities on society and the environment will inevitably come under the spotlight. Therefore, it’s imperative that investors take a more macro approach when investing in cryptocurrencies. More emphasis should be placed on the design of a blockchain, rather than the price fluctuations of its cryptocurrency. Because it’s the ESG factors that might ultimately determine the long-term sustainability of a blockchain and its cryptocurrency. 

If the broader applications of decentralisation can be harnessed by new and existing blockchains to provide feasible solutions for the pressing issues that society is facing, then cryptocurrencies will be an extremely powerful tool that will fit right into an ESG portfolio.

Written by Timothy Goh

Timothy is a financial journalist at Bread News. He’s in constant deep thought, plotting to become the next celebrity chef. He also pretends to know about blockchain and coffee.

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