ESG and Cryptocurrency: Considerations for Market Participants

Seventy percent of American consumers in 2021 want their favorite companies to make a positive social and environmental impact. (Business Wire). A willingness to socially and environmentally improve society is therefore more than good ethics—it is good business. Beyond consumer sales, many companies raise capital by attracting investments based on their environmental, social, and governance efforts (“ESG”). (James Chen, Investopedia). ESG investing criteria represent the broad non-financial factors investors increasingly apply to their analysis of potential investments. (CFA Institute). Although traditionally ESG standards are not a formal part of financial reporting requirements, ESG is rapidly becoming a commonly recognized investment metric. Id. For example, in 2018, investors held over $11 trillion in assets chosen based on ESG criteria. (James Chen, Investopedia). This post will explore how investor focus on ESG intersects with the rise of cryptocurrency, and the unique ESG challenges faced by the cryptocurrency industry. As there are thousands of cryptocurrencies worldwide, making generalizations about the cryptocurrency industry is difficult. (SoFi). This post therefore relies on data from a few popular cryptocurrencies, including Bitcoin.

The “environmental” metric of ESG is often divided into four subcategories: climate change, natural resources, pollution, and environmental opportunities. (Rob Griffin, CityWire). In the cryptocurrency industry, one environmental concern often pushed by the media is the immense amount of power required to mine cryptocurrency. (Deric Behar et al, JDSUPRA). This use of power has negative implications on climate change and pollution. Id.

Bitcoin miners—both individuals and companies—are cryptocurrency market participants that invest in equipment that uses electricity to validate Bitcoin transactions and organize Bitcoin into “blocks.” (CrossTower). A block is a record of a cryptocurrency transactions that operates like an electronic ledger; blocks are linked together to form a “blockchain.” (Jake Frankenfield, Investopedia). The energy needed to mine and create blocks is often harnessed in ways damaging to the environment. (Deric Behar et al, JDSUPRA). For example, 75% of all Bitcoin miners are based in the coal centric nations of China and Mongolia. (Sam Shead, CNBC; Id.) Bitmain—a Chinese firm—has recently expanded into Inner Mongolia, where coal usage accounts for much of the usable electricity. (Morgen E. Peck, IEEE Spectrum). The use of coal as an energy source is damaging because its extraction destroys natural environments, and coal combustion results in harmful emissions. (U.S. Energy Information Administration). At Bitmain’s Mongolia facility, 21,000 computers are used, accounting for 4% of all Bitcoin computing power worldwide. (Morgan E. Peck, IEEE Spectrum). Joule, an energy research publication, ranks Bitcoin’s global carbon dioxide emissions higher than the country of Jordan. (Umair Irfan, Vox). As of August 2021, only 40% of worldwide cryptocurrency mining operations use renewable energy sources like wind, hydroelectric, and solar power. (Deric Behar et al, JDSUPRA). As Bitcoin and other cryptocurrencies grow in popularity and profitability, ESG conscious investors may soon be forced to reckon with this undeniable environmental hurdle. Id.

Billionaire Elon Musk (“Musk”)—CEO of Tesla and SpaceX—exemplified this potential environmental reckoning on Twitter. In May 2021, Musk posted a tweet stating that Tesla would suspend vehicle purchases using Bitcoin because of Bitcoin’s “rapidly increasing use of fossil fuels for [cryptocurrency] mining.” (MacKenzie Sigalos, CNBC). This sudden, public announcement negatively impacted Bitcoin’s stock valuation. (Catherine Thorbecke, ABC News). Musk subsequently changed his stance since his May 2021 tweet by announcing that Tesla will likely resume accepting Bitcoin for vehicle purchases if Bitcoin’s use of renewable energy for mining exceeds 50%. (MacKenzie Sigalos, CNBC). This policy change highlights how non-financial metrics captured by ESG interplay with cryptocurrency and how corporate decisions are made based on these ESG metrics and concerns.

Investors concerned with the social and governance components of ESG might view the cryptocurrency industry in a more positive light than environmentally conscious investors. For example, Bitcoin boasts numerous social benefits including its minimal barriers to entry; an investor interested in Bitcoin simply needs an internet connection. (Catherine Thorbecke, ABC News). Cryptocurrency transactions are often transparent and traceable because each payment is recorded in the blockchain. Id. However, challenges do remain because global regulations significantly vary. Id. For example, the United Kingdom, Indonesia and Singapore have cryptocurrency regulations while the United States and Brazil do not. (Ikigai Law, Mondaq). Some countries, like Bolivia, have banned the use of cryptocurrency altogether. Id. An additional challenge in the cryptocurrency industry is a lack of diversity (Robert Bourret & Casey McClaren, Katten). The nonprofit “Diversity in Blockchain” released a 2019 report revealing that a mere 4-6% of employees in the cryptocurrency industry are women. Id. Included in this statistic are developers, investors, and casually interested individuals. Id. To combat this lack of representation, industry participants are creating organizations to actively support and recruit diverse persons, including women. Id.

Corporate governance in the cryptocurrency context often refers to policymaking, management structure, and employee compensation. (Catherine Thorbecke, ABC News). Typically cryptocurrency governance concerns center on corporate transparency, taxation, cybersecurity, diversity, and sustainability initiatives. Id. As cryptocurrencies continue developing, corporate governance concerns may be mitigated by requiring public registration of cryptocurrencies and incorporating cryptocurrency into mainstream commerce. Id. Public registration would require initial coin offerings to be registered with the SEC, like any other security. (Jay Clayton, U.S. Securities and Exchange Commission).

As climate change and more commonly occurring natural disasters impact our planet, the pressure to enforce ESG initiatives across all industries, including the cryptocurrency industry, is increasing in popularity. (Melissa Eddy, The New York Times). Some cryptocurrency companies have announced strategies for sustainability efforts. In 2021, Crypto.com, a cryptocurrency trading mobile application, announced its intention to become carbon negative. (Lyllah Ledesma, Coindesk). Carbon negative refers to a company that removes more carbon from the atmosphere than it puts out. (David Vetter, Forbes). Ethereum, a popular cryptocurrency, also announced in 2021 that it plans to transition towards a “proof-of-stake” model and away from its original “proof-of-work” format. (Emilia David, New Private Markets). In a “proof-of-work” structure, cryptocurrency miners are rewarded for having the most computing power. Id. The “proof-of-stake” model, in contrast, relies on the amount of hard drive storage available and rewards miners who hold a larger percentage of coins. Id. Ethereum argues that this transition will allow its cryptocurrency mining process to use 99.95% less energy. Id.

As the cryptocurrency industry grows and develops, the industry will hopefully better align with contemporary ESG expectations. In the meantime, ESG conscious investors must decide whether the benefits of investing in cryptocurrency outweigh the existing harms.