The world today is awash with countless contradictions and hypocrisies – whether it be celebrities virtue signalling about the perils of climate change from the comfort of their gas guzzling private jets - or leading corporate brands publicly endorsing anti-racism causes yet failing woefully to promote talented people of color from within their own organizations to meaningful leadership roles. One of the biggest paradoxes right now facing some financial services firms is their willingness to embrace ESG (environment, social, governance) causes while at the same time waxing lyrical about the benefits of crypto-currencies - two asset classes, which I would argue are utterly irreconcilable with each other.
ESG is being adopted by investors for a number of reasons although it has accelerated exponentially since the on-set of COVID-19. Many see ESG assets as a source of lucrative returns (after all, a sustainably run company is likely to be a stronger long-term investment) and a useful risk mitigation tool. In the case of the latter, it is becoming increasingly obvious that organizations or industries heavily reliant on pollutant commodities will struggle in a world where public policy is shifting markedly towards renewables. Regulators are also playing a vital role in incentivizing investment into ESG assets through the introduction of sustainability reporting requirements. These drivers are ultimately prompting investors to ramp up their holdings in ESG assets or transitory finance instruments.
ESG is of course a positive development for the industry, but how do its principles square up with the meteoric rise of crypto-currencies? The short answer is that they do not. In fact, crypto-currencies fail on all E, S and G levels. From an environmental perspective, crypto-currencies are an anathema. This is because the process of mining crypto-currencies is extremely carbon intensive as it is reliant on vast amounts of computational power which consumes enormous sums of energy (usually coal produced). Researchers say Bitcoin generates an annual carbon footprint roughly on a par with that of a mid-sized European country (see table below). According to the Italian Central Bank, Tips – the eurozone’s payment system had a carbon footprint which is roughly 40,000 times less than that of Bitcoin in 2019. Compounding matters further, experts believe that Bitcoin’s carbon footprint has only skyrocketed over the last two years amid the record trading volumes, which have taken place during the pandemic.
From an S and G perspective, crypto-currencies are also wanting. Absence any global regulations or industry standards, governance and oversight of crypto-currencies remains poor. In addition to the copious lack of basic macro fundamentals underpinning their price movements, the process of valuing crypto-currencies (of which there are many) is notoriously opaque and open to abuse. Elsewhere, the anonymity of crypto-currency transactions creates all sorts of headaches around ensuring compliance with things like AML (anti-money laundering), KYC (know-your-client) and anti-terrorist financing rules. Underscoring the scale of the problem, one paper in 2019 estimated 46% of all Bitcoin transactions conducted between January 2009 - April 2017 were involved in some form of illegality .
Although efforts are being made to green crypto-currency mining operations by leveraging renewables, the asset class is still a massive polluter and will be for some time. Moreover, its social and governance credentials are also rather questionable. While there is nothing precluding financial firms from participating in the crypto market, those that do are not in a position to preach about ESG.
Furthermore, it is entirely possible that with market regulators and certain institutional investors taking a more proactive approach towards ESG issues, the carbon footprint of crypto-currencies is likely to be subject to added scrutiny. If and when this happens, investors – including fund managers- may start thinking twice about trading crypto-currencies.
- Financial Times
- Financial Times
- Wall Street Journal