More and more investors are thinking about environmental, social and corporate governance (ESG) issues when allocating their portfolios. Additionally, cryptocurrency is starting to capture an allocation from a growing number of portfolios.
However, some investors may hesitate due to reports that bitcoin is not environmentally friendly, so is there any way investors can include cryptocurrency in their portfolios if they are taking ESG into consideration? Are some cryptocurrencies more ESG-friendly than others? It all depends on how you look at the space.
Unpacking the ESG arguments for Bitcoin (BTC)
The primary argument for bitcoin not being ESG-friendly stems from the processing power required to mine the cryptocurrency and complete transactions in it. Even Tesla CEO Elon Musk, whose tweets usually move the crypto market, temporarily suspended the automaker’s acceptance of bitcoin for purchases last year due to concerns about the cryptocurrency’s impact on the environment.
A couple of months later, Musk announced that Tesla may again accept bitcoin payments — as long as at least half of the energy used to mine bitcoin is renewable.
“Digital mining is no different than any other industry that uses electricity,” said Ben Gelfand, CEO of Bluesky Digital Assets Corp. “However, it depends where you mine. If you mine using hydroelectric power, then your carbon footprint is small. For example, we use hydroelectric power and then share our offtake heat with another business, so our electricity is used twice for one spend.”
There hasn’t been any update yet on Tesla’s view on bitcoin, although Musk said in December that the automaker would start accepting the meme cryptocurrency Dogecoin as payment for some merchandise sales.
However, not everyone buys the argument that bitcoin and, by extension, other cryptocurrencies, have an ESG problem.
Two ways to approach energy use for cryptocurrencies
One consideration that’s important to make in light of the ESG argument for cryptocurrencies is the difference between proof-of-work and proof-of-stake. These two models differ in how computers are used to solve the complicated math problems required to mine or trade with cryptocurrencies.
The Ethereum Foundation said proof-of-stake is up to 99.9% more energy efficient than proof-of-work validation. In other words, cryptocurrencies that follow a proof-of-stake model are more environmentally friendly than those that utilize a proof-of-work model.
CoinDesk explains that proof-of-work requires significant amounts of computing power from an entire network of crypto miners to confirm each transaction. However, proof-of-work spreads the responsibility for validating each transaction among all of the holders of that cryptocurrency.
Bitcoin and Ethereum were both built on proof-of-work models for transaction validation, but Ethereum is working on moving to a proof-of-stake model, leaving bitcoin behind. Other cryptocurrencies were created using a proof-of-stake model, meaning they should be more ESG-friendly, in theory. In an effort to make proof-of-work cryptocurrencies like bitcoin more environmentally friendly, some miners are moving to parts of the world that have an abundance in sustainable energy available.
“Bitcoin mining enables a permissionless, global, free market for energy that anyone can participate in,” BitcoinTV.com co-founder Matt Odell explained. “Bitcoin incentives leverage human greed to reduce waste and boost efficiency on a global scale as miners seek the lowest energy cost available.”
Other potential ESG problems for cryptocurrencies
Some raise another potential issue with cryptocurrencies, which is their accessibility. Proponents argue that cryptocurrencies are good from an ESG standpoint because they are decentralized and enable underserved people around the globe to access financial services.
However, using cryptocurrencies requires access to the internet, money and the understanding required to use them, which weakens that ESG argument in favor of cryptocurrencies. Others point out that cryptocurrencies are a favorite method of transaction for criminals like the hackers who received their ransom for disrupting the Colonial Pipeline in bitcoin.
And then there are the potential governance issues associated with cryptocurrencies. By their very nature, most of them are decentralized, which might lead some to believe that they have no governance.
However, they are still governed by software engineers who tweak their code every so often. In that sense, some would argue that cryptocurrencies also have a diversity problem as CoinDesk cited statistics that suggest only 4% to 10% of the workers in the crypto sector are women and that it is dominated by white and Asian men.
One final argument for cryptocurrencies
With all these ESG issues, it might seem like game over for cryptocurrencies, especially bitcoin due to its energy-heavy proof-of-work model. However, we must be careful about holding cryptocurrencies to a higher standard than fiat money.
Some of the ESG arguments against cryptocurrency could also be said of fiat money. For example, CoinDesk spoke to Scott Eichler of Standing Oak Financial, who said some studies suggest 80% to 90% of fiat money has traces of cocaine on it. The world of finance and investment banking is also dominated by white men with few women involved. In terms of energy efficiency, Coinshare’s 2019 analysis of the energy used by the bitcoin network suggested that 74.1% of the electricity it used then came from renewable sources.
Environmentally, fiat money has its own set of problems. The U.S. Federal Reserve estimates that the average lifespan of $5 and $10 bills is around five years. Producing new bills and coins requires not only energy but also water, wood pulp, cotton, various metals, linen and other natural resources.
A HackerNoon writer estimates the amount of energy used by banks at about 100 terawatts per year, making it almost double the amount of energy used by bitcoin. Further, banks cannot relocate to areas where sustainable energy is cheap and abundant like bitcoin miners can, so they are stuck with whatever type of energy is being used in their neighborhood, which is often coal.
When central banks print more money through quantitative easing, it creates yet another issue for fiat money. In fact, this issue doesn’t exist for cryptocurrencies because most of them have a set maximum number of tokens that will ever exist on their blockchains.
What about the blockchain?
While we could debate the ESG challenges of cryptocurrencies versus fiat money at length, one thing we need to keep in mind is the fact that cryptocurrencies have an ace in the hole: the blockchain. Cryptocurrencies are more than just a method of payment.
They are built on blockchain technology, which gives them more utility than fiat money. Even if one were to say the cryptocurrencies themselves do not belong in an ESG-friendly portfolio, it seems clear that blockchain technology does. The Financial Times spoke to Doug Miller, a master’s student at Imperial College in London who also works at the global non-profit Energy Web. He uses blockchain technology in “engineering a certification system for digital assets that rely on clean energy.” Miller noted that “helping energy companies manage their grid better is very different from Dogecoin.”
It remains to be seen whether cryptocurrencies are here to stay, but whatever happens to them, it seems undeniable that the blockchain technology they are built on is here to stay. Looking at them from this point of view offers an ESG-friendly perspective that fiat currency can never have.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.