Blockchain, ESG Investing And Why Investors Must Care

As we grapple with how best to combat climate change, fossil fuels, nuclear energy and industrial pollution are significant offenders. To fight climate change efficiently, we need to re-adjust our perception of pollution.

The scope of this article is to invite investors to focus on decentralised investment and its environmental cost.

Here are a few nuggets that will provide clarity as you read this article:

1. Blockchain is the technology that enables the existence of cryptocurrency (among other things). Bitcoin is the name of the best-known currency. The blockchain was invented for Bitcoin.
2. There are top seven index funds that claim to be ESG funds. All those funds have top 5 technology stock holdings. None of them are 100 per cent ESG kosher.
3. At least 52 companies that fall under the ESG umbrella of the major stock index provider MSCI have "creeping exposure to cryptocurrency.[ii]
4. Cryptocurrency is an energy hog.
5. Most corporations are not addressing the core challenge – the source of energy.
6. Non-renewable sources make up 85 per cent of worldwide energy usage—from sources that eventually will be depleted, such as oil, natural gases and coal.[iii]

So, how much energy does crypto mining consume and is it sourced from renewables or fossil fuel? It depends on whom you ask.

Crypto-Investments And Energy Consumption

Presently, the green energy sector, which includes the Electric Vehicle (EV) market, is expected to reach nearly a trillion dollars by 2027; the Environmental and Social Governance (ESG) asset is expected to hit US$53 trillion by 2025, a third of global assets under management (AUM)[iv]; on that same note, the cryptocurrency market is now worth more than US$3 trillion.[v]

Cryptocurrencies have emerged as one of the most intriguing, volatile investments in the world. It is like a "cult". The currency exists virtually, yet the mining of a cryptocurrency uses humungous amounts of electricity. The challenge is that it is almost impossible to pinpoint the energy source used for mining - renewables or fossil fuels.

Why does it matter to investors? First, investors need to understand the invisible cost involved in cryptocurrency. As an investor, if your portfolio has top holdings of iShares MSCI USA ESG,^[vi]  there is a high chance that you are indirectly investing in non-ESG investments.

Investors are not aware that their investments in the ESG fund indexes are not 100 per cent  genuine.

Understanding Blockchain

To understand the environmental impact of crypto, we need to understand Blockchain and Bitcoin. Blockchain is the technology that enables the existence of cryptocurrencies like Bitcoin. Bitcoin miners receive a coin as a reward for completing "blocks" of verified transactions added to the blockchain.[vii]

There are four kinds of blockchains.[viii] Not all blockchains are created equal; their diverse consensus mechanisms have unique accessibility, security, and sustainability implications. The most common consensus mechanisms are PoW and PoS and the methods used by private and consortium blockchains. For brevity, let us focus on PoW and PoS as they are dominantly used in consensus.

SOURCE[ix]

Proof-of-Work (PoW) Blockchains

The PoW consensus mechanism is among the most widely utilised methods in blockchain and was popularised first by Bitcoin (BTC). The defining components of PoW systems are miners and the electricity they expend to make the calculations that verify BTC transactions. Miners operate computer hardware to run network nodes that employ computational power to algorithmically solve mathematical puzzles called proofs of work (PoW). The miner who solves the puzzle first confirms the most recent block of transactions on the blockchain.[x]

Mining, particularly Bitcoin mining, uses an immense amount of energy. What percentage of mining sources electricity from renewable energy and what percentage is sourced from fossil fuels? The energy source determines whether crypto-mining is a friend or foe of the environment.

Bill Harris, former CEO of Intuit and founding CEO of PayPal and Personal Capital, says: "Bitcoin is absurdly wasteful of natural resources. Because it is so compute-intensive, it takes as much electricity to create a single Bitcoin — a process called "mining" — as it does to power an average American household for two years. If Bitcoin were used for a large portion of the world's commerce (which won't happen), it would consume a substantial portion of the world's electricity, diverting scarce power from useful purposes."^[xi]

IMAGE SOURCE[xii]

Crypto mining is an energy hog. There is no sugar coating the fact. Yet, reports after reports claim renewables primarily power it. Be sceptical – says Umair Irfan^[xiii] in his article to Vox.

Umair Irfan is right to be suspicious. It is tricky to figure out exactly how much Bitcoin mining is powered by renewables because of the very nature of Bitcoin: a decentralised currency whose miners are mainly anonymous.

Globally, estimates of Bitcoin’s use of renewables range from 40 per cent to almost 75 per cent. But in general, experts say, using renewable energy to power Bitcoin mining means it won't be available to power a home, a factory, or an electric car.[xiv] There is a supposedly "energy-friendly" option to PoW.

Proof-of-Stake (PoS)

PoS is the second most popular consensus mechanism and solves the disadvantages found on PoW blockchains like inefficient energy consumption. 

Instead of miners validating transactions, PoS blockchains have validators. Validators are network node operators that validate data similarly to PoW systems, but there is no energy-intensive computational process to earn the right to validate. Instead of solving proofs of work, validators "stake" some of the blockchain's native tokens to become eligible for selection as a validator node. The prospective validator will essentially stake crypto tokens native to the blockchain as collateral. 

Corporate ESG leaders are getting behind the PoS consensus as it makes environmental sense. However, there is a crucial challenge. Proof of Stake is NOT crypto.

PoS achieves the exact opposite of the decentralising control expected of cryptocurrency protocols. PoS is permissioned by internally held tokens that can deny entry to independent external parties. Let me preface by saying PoS is a technical improvement beyond PoW. It allows the network to use significantly fewer resources in mining (though it doesn't mean the source of energy is renewable).

It is a centralised platform, not decentralised. What made PoW novel is providing economic finality in a permissionless system.

PoS leads to the centralisation of mining.^[xv]

ESG Investing Is Not Equal To Clean Investing

As ESG investing goes mainstream, institutional investors are potentially experiencing exposure to cryptocurrency; the asset class creeps into the indexes as established firms like MSFT, Apple, Facebook invest in cryptocurrency. As a result, investors targeting ESG funds need to factor cryptocurrency risk in their portfolio as their clean investing interest might not be aligned with the indexes.

IMAGE SOURCE[xvi]

ESG investing is not equal to clean investing. The research available predominantly boasts the high returns associated with ESG investing. However, the reality is that of seven major ESG indexes, at least half of them have five technology-driven stocks. Moreover, most of them are directly or indirectly exposed to cryptocurrency among those technology stocks.

Cryptocurrencies carry potential environmental and social governance risks.

The process of creating Bitcoin to spend or trade consumes around 91 terawatt-hours of electricity annually, more than is used by Finland, a nation of about 5.5 million. As a result, mining happens worldwide, often wherever cheap energy is abundant. For years, much of the Bitcoin mining has been in China although recently, the country has started cracking down.

Bitcoin mining means more than just emissions. The miner shuns old hardware as they want the newest, fastest hardware, which causes e-waste problems.

Alex de Vries, a Paris-based economist, estimates that the computational power of mining hardware doubles every year and a half or so, making older machines obsolete. As a result, according to his calculations, at the start of 2021, Bitcoin alone was generating more e-waste than many midsize countries.[xvii]

 

IMAGE SOURCE: Digiconomist

Green-house Gas Emissions And E-Waste

Crypto mining causes greenhouse emissions from energy usage and electronic waste (E-waste). According to an article in Vox, between 60 and 80 per cent of Bitcoin mining revenue goes straight back into paying for electricity.[xviii] The quest for the cheapest kilowatt has led miners to set up shop in remote regions of China and Mongolia. The hunt for cheap power has even led to cases of electricity theft.[xix]

However, identifying the source of energy supply for crypto mining is tricky.

Christopher Bendiksen, head of research at CoinShares, explained that to assess Bitcoin's energy use, you can't just look at the energy mix in a country as a whole; you have to zoom in on specific regions, down to provinces, cities, and sometimes individual mining facilities. It was found that Bitcoin miners were using a disproportionate share of renewables.[xx]

IMAGE SOURCE: GETTY IMAGES.

Miners of the cryptocurrency each year produce 30,700 tonnes of e-waste. Miners earn money by creating new Bitcoins, but computing consumes large amounts of energy. Researchers estimate that Bitcoin mining devices have an average lifespan of only 1.29 years. But as the computers used for mining become obsolete, it also generates lots of e-waste.[xxi]

However, big corporations like MSFT seek an alternative to energy hogging crypto mining using the PoS concept  instead of the existing PoW concept. So, in a nutshell, shifting to PoS from PoW moots the very purpose of decentralisation of cryptocurrency.

Why Do Crypto And ESG Matter?

They matter to investors because about 76 per cent of firms mining proof-of-work cryptocurrencies combine green and fossil-fuel power sources. Still, less than 40 per cent of the total energy used to mine Bitcoin and other cryptocurrencies comes from renewable sources, according to a survey of 280 crypto firms by the University of Cambridge's Centre for Alternative Finance.[xxii]

ESG Fund Index And Crypto Exposure

Crypto is mainstream. It is seeping into individual and institutional portfolios. According to MSCI ESG Research, approximately 52 companies represent US$7 trillion worth of stocks exposed to cryptocurrencies.

According to MSCI, while most cryptocurrencies are speculative investments with little utility, some have seen limited success as genuine currencies. Many have posted eye-popping returns that have captured the eyes of established companies that are also ESG compliant. For instance, the crypto exposure comes from a range of companies, such as pure-play crypto firm Coinbase to Facebook, which logs no revenue from digital coins but explores ways to monetise the system. Nvidia is the chipmaker with a dedicated graphics-processing unit for professional cryptocurrency miners.^[xxiii]

Here is a snapshot of the top three ESG funds of 2022[xxiv]

Vanguard FTSE Social Index Fund (VFTAX)     AAPL, MSFT, AMZN, F.B., and GOOGL

iShares MSCI USA ESG Select ETF (SUSA)       MSFT, AAPL, GOOGL, H.D., and F.B.

Parnassus Core Equity Investor (PRBLX)        MSFT, AAPL, GOOGL, H.D., and F.B.

Here is a challenge: investors with crypto exposure may also be running counter to their ESG goals.

A few weeks ago, Apple CEO Tim Cook made headlines when he said he owns cryptocurrency while mentioning that Apple is looking at it from a technology perspective, but not from a treasury decision.[xxv] What will Apple do with Bitcoin and cryptocurrency? No-one knows.

However, it is important to understand AAPL is on the top three places of at least six ESG indexes. AAPL is still trying to be "socially responsible" in producing its products and now the company has cited interests in crypto investing.

Microsoft (MSFT) became the early adopter of Bitcoin in 2014 when it began accepting cryptocurrency as a payment for games, apps, and other digital content for its platform. As a result, Microsoft also ranks first out of 2,360 public companies based on Dow Jones ESG data when coupled with IBD Composite Ratings.^[xxvi]

Corporations are shifting to PoS. For instance, MSFT invested US$27 million in early funding in crypto start-up Palm, NFT Studio.[xxvii] Palm NFT runs on Ethereum and not Bitcoin. Etherum provides a critical foundation for Web3 infrastructure and can be environmentally friendly. However, Layer 1 Etherum has a significant carbon footprint. It would be interesting to observe what NFT studio offers for MSFT investors.

Now, What?

In short, cryptocurrency – whether the consensus is through PoS or PoW – has no place in ESG indexes until we can trace the source of its energy consumption.

Blockchain is the future. It has the ability to record information in a way that makes it difficult or impossible to change, hack, or cheat the system. It is most simply defined as a decentralised, distributed ledger that records the provenance of a digital asset. By inherent design, the data on a blockchain cannot be modified, making it a legitimate disruptor for industries like payments, cybersecurity, and healthcare.

Presently, there are ways in which crypto can be mined with less impact on our environment. However, since we are in the early stages of "environmentally friendly" blockchain, environmentally cautious investors need to be aware of the "creeping crypto" in their portfolios. Until then, ESG investing needs to be approached with a dash of scepticism.

 

Footnotes:

[i] https://markets.businessinsider.com/currencies/news/bitcoin-uses-more-energy-than-american-airlines-bank-of-america-2021-3-1030224439

[ii] https://cryptonews.com/news/dozens-of-esg-companies-have-creeping-exposure-to-crypto.htm

[iii] https://courses.lumenlearning.com/boundless-physics/chapter/case-study-world-energy-use/#:~:text=Nonrenewable%20sources%20makes%20up%2085,primary%20worldwide%20energy%20sources%20nonrenewable.

[iv] https://www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by-2025-a-third-of-global-aum/

[v] https://time.com/6115300/cryptocurrency-value-3-trillion/

[vi] The MSCI USA ESG Leaders Index is a capitalization weighted index that provides exposure to companies with high Environmental, Social and Governance (ESG) performance relative to their sector peers. MSCI USA ESG Leaders Index consists of large and mid-cap companies in the US market.

[vii] https://www.investopedia.com/tech/how-does-bitcoin-mining-work/

[viii] https://www.techtarget.com/searchcio/feature/What-are-the-4-different-types-of-blockchain-technology

[ix] https://www.techtarget.com/searchcio/feature/What-are-the-4-different-types-of-blockchain-technology

[x] Cryptopedia

[xi] https://www.vox.com/2018/4/24/17275202/bitcoin-scam-cryptocurrency-mining-pump-dump-fraud-ico-value

[xii] https://www.cell.com/joule/fulltext/S2542-4351(19)30255-7

[xiii] https://www.vox.com/2019/6/18/18642645/bitcoin-energy-price-renewable-china

[xiv] https://www.nytimes.com/interactive/2021/09/03/climate/bitcoin-carbon-footprint-electricity.html#:~:text=It's%20tricky%20to%20figure%20out,percent%20to%20almost%2075%20percent.

[xv] Reddit.com

[xvi] https://www.msci.com/

[xvii] Alex de Vries

[xviii] https://www.vox.com/2019/6/18/18642645/bitcoin-energy-price-renewable-china

[xix] https://www.vox.com/2019/6/18/18642645/bitcoin-energy-price-renewable-china

[xx] https://www.vox.com/2019/6/18/18642645/bitcoin-energy-price-renewable-china

[xxi] https://www.bbc.com/news/technology-58572385#:~:text=Miners%20of%20the%20cryptocurrency%20each,)%20per%20transaction%2C%20they%20say.

[xxii] https://www.wsj.com/articles/crypto-miners-struggle-to-cut-carbon-emissions-11634808781

[xxiii] Carla Mozée Oct 14, 202, Market Insider

[xxiv] Forbes Advisor

[xxv] https://www.theverge.com/2021/11/9/22772092/tim-cook-cryptocurrency-investment

[xxvi] https://www.investors.com/news/technology/microsoft-stock-attracts-esg-investing-interest/

[xxvii] https://www.yahoo.com/now/microsoft-leads-27-million-early-160955946.html