For market participants pivoting toward ESG and digital assets, weighing the issues at the crossroads of these two megatrends is critical.
The huge rise in popularity of Bitcoin — and the growing interest by mainstream financial institutions in virtual assets as an investable and tradable asset class — has shone a light on the cryptocurrency industry’s environmental, social, and governance (ESG) performance.
The vast majority of the world’s financial institutions manage climate risk and other ESG risks in their own portfolios. As a result, many financial institutions perform related diligence on corporates they look to service, whether by traditional lending, capital markets underwriting, or direct investment. While the focus has primarily been on the ESG performance of cryptocurrency miners (given their role in the creation of cryptocurrencies and the energy requirements associated with that process), the ESG performance of the broader cryptocurrency industry will increasingly need to be considered, particularly as institutional investment in this space is accelerating. Accordingly, investors in cryptocurrency miners, in cryptoasset service providers, and even in companies that put cryptoassets on their balance sheets must now weigh the potential for increased returns against the possible negative impact on their ESG credentials.
While much has been written about the sustainability challenges related to cryptocurrency mining, ESG represents a broad range of considerations. This post explores the ESG-related challenges that cryptocurrency market participants are facing and practical steps to meet them.
Environmental concerns have circulated in popular media relating to the amount of energy expended in mining cryptocurrencies, particularly those that rely on a proof of work consensus model (such as Bitcoin and Ether) rather than proof of stake or proof of authority consensus models. Such emissions, it has been argued, have the potential to significantly contribute to the acceleration of global warming.
According to research by the University of Cambridge, the majority of Bitcoin miners are based in China, a country heavily reliant on coal for energy. Until recently, a large amount of cryptocurrency mining was conducted in Inner Mongolia, an autonomous province in northern China, where coal-burning power plants provided the electricity for mining operations. However, in March 2021 the provincial government of Inner Mongolia announced that it would ban all cryptocurrency mining operations in a bid to achieve carbon-reduction targets set by the central government. In addition, a significant portion of cryptocurrency mining occurs in Sichuan province, the most hydroelectric-rich region in the country. With China publicly stating that it is targeting carbon neutrality by 2060, further policy decisions and initiatives to shift from fossil fuels to clean energy sources may reduce the cryptocurrency mining carbon…