How do cryptocurrencies fit in Environmental, Social, and Governance Investing?

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Environmental, Social, and Governance (ESG) Investing is a practice that evolved from the practice of excluding equities based on moral values. ESG Investing is broad and constantly evolving, and key organizations are working on the definition and standardization of it. ESG Investing has been gaining traction with both institutional and retail investors over the last decade, and there is no sign that this trend will stop anytime soon.

From the CFA Website on ESG

 

One of the main tenets of ESG Investing is the conservation of the natural world. Professional investors that practice ESG Investing are supposed to analyze whether a company mitigates factors that affect the natural world, and invest based on the conclusion that the company is not purposely engaging in activities that go against this tenet. For example, oil producing companies typically do not qualify for an ESG Investment mandate, as their main driver of economic activity involves extracting a nonrenewable resource that cause human carbon emissions to rise.

Bitcoin and Energy Efficiency

Bitcoin and a few other cryptocurrencies rely on the Proof-of-Work mechanism to maintain their decentralization and security. Coindesk recently came out with a comprehensive explanation on how Proof-of-Work operates within the Bitcoin ecosystem. From the website:

Bitcoin is a blockchain, which is a shared ledger that contains a history of every Bitcoin transaction that ever took place. This blockchain, as the name suggests, is composed of blocks. Each block has the most recent transactions stored in it. 

Proof-of-work is a necessary part of adding new blocks to the Bitcoin blockchain. Blocks are summoned to life by miners, the players in the ecosystem who execute proof-of-workA new block is accepted by the network each time a miner comes up with a new winning proof-of-work, which happens roughly every 10 minutes. 

Finding the winning proof-of-work is so difficult the only way to provide the work miners need to win bitcoin is with expensive, specialized computers. Miners will earn bitcoin if they guess a matching computation. The more computations they churn out, the more bitcoin they are likely to earn.

What computations are the miners making exactly? In Bitcoin, miners spit out so-called “hash,” which turns an input into a random-looking string of letters and numbers. 

The goal of the miners is to create a hash matching Bitcoin’s current “target.” They must create a hash with enough zeroes in front. The probability of getting several zeros in a row is very low. But miners across the world are making trillions of such computations a second, so it takes them about 10 minutes on average to hit this target.

Whoever reaches the goal first wins a batch of bitcoin cryptocurrency. Then the Bitcoin protocol creates a new value that miners must hash, and miners start the race for finding the winning proof-of-work all over again.

Like the explanation above states, in order for miners to find the winning proof-of-work, they need specialized computers to solve very complex computations, and hope they beat hundreds of thousands of other specialized computers in order to get the reward. All that computational power trying to solve those complex equations requires a significant amount of energy. How much exactly? Researchers at the University of Cambridge estimate that all that computational power uses about 121 terawatt-hours per year, roughly the same amount of energy that the country of Argentina uses.

In the cryptocurrency world, it has not been a secret that this is a major problem in the use case of bitcoin. Several researchers and developers are attempting to solve this problem: most notably The Ethereum Foundation is in the process of moving from proof-of-work to proof-of-stake, a move done in part to reduce the energy consumption of securing the Ethereum protocol.

With Tesla disclosing that it invested part of their cash in Bitcoin, and other companies looking into potentially doing the same thing, I started wondering whether this trend would affect how investment professionals that engage in ESG Investing look at these companies. When a company purposely invests in a concept that indiscriminately consumes a significantly amount of energy, going against the ESG tenet of conserving the natural world through energy efficiency, is it prudent to include the company in an ESG Investing mandate?

I don’t know the answer to that question. What do you think?

Disclaimer: Not investment advice. For informational purposes only. I hold positions in Bitcoin, Ethereum, and Tesla through Exchange Traded Funds.

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If you are investing via arbitrary criteria and something falls outside that criteria then it falls outside that criteria. Why would you include it if it fails your test?

I hold positions in Bitcoin, Ethereum, and Tesla through Exchange Traded Funds.

For Bitcoin and Ether, do you mean the Grayscale trusts, GBTC and ETHE? My impression is that these are similar to ETFs, but not exactly the same thing, and I'm not aware of other ETFs that give you exposure to crypto (except for the small amount of exposure you'd get from owning shares in companies that have a little BTC on their balance sheet, like Tesla, Square, or MicroStrategy).

There's a good chance that doubling the price of Bitcoin will actually double the energy wasted on it given that roughly doubles how lucrative mining is. This is worse then doubling the market cap of a company that's generally bad for the enviroment where doubling the market cap usually doesn't mean doubling the enviromental problems.

From an ESG perspective a person investing in crypto would do better to invest it into a different coin then Bitcoin which actually has a plan to be less wasteful with energy. That might be Ethereum, something like Polkadot or even Filecoin (the work that has to be done to mine filecoin is storing files for people which is economically useful).

I don't see a principled reason to treat it different from other processes/activities that require energy/resources.

That said a efficiency comparison to other payment processors might be interesting.

There are, at present, about 300-400k bitcoin transactions daily (~1.3e8/yr), as far as I can Google. That plus the 121 TWh/yr figure (1.2e11 kWh/yr) suggests almost 1 MWh electric per transaction. Retail, that's high tens to low hundreds of dollars worth of electricity.

There are reason to treat using energy to grow food for people differently then using energy to ship luxury yachts through the ocean. 

Bitcoin seems like wasting energy on high status luxury yachts.

But luxury yachts aren't a good comparison. PoW-coins are a technology for coordination among humans. They need this energy to work. I don't think that is a general argument against them.

PoW-coins are a technology for coordination among humans. 

Bitcoin is not effective for transfering wealths among humans with transaction costs of ~15$ per transaction. People buy Bitcoin because they believe it will rise in price and largely not because they want to use it as a payment platform. Even if you want a crypto-currency there are solutions that more effective and don't burn as much unnecessary energy.

Store of value is an important function too.

Even if you want a crypto-currency there are solutions that more effective and don’t burn as much unnecessary energy.

Sure it's great if they work out. But switching may be a coordination problem as well. I'm not sure why, but it hasn't happened yet.

Bitcoin is not effective for transfering wealths among humans with transaction costs of ~15$ per transaction.

The amount of money you'd have to be moving to attract that $15 fee would have a vastly greater fee attached for any of the interbank systems.

You need to change your exchange and/or bank if you're being robbed that badly here.

People buy Bitcoin because they believe it will rise in price and largely not because they want to use it as a payment platform.

Bitcoin is already a payment platform, it's just not evenly distributed as such (as to whether it will ever be I couldn't say, but the fact that countries and traditional financial institutions are scrambling to create their own crypto says a lot to me).

If I desperately want to pay with crypto then I've got a debit card in my wallet right now to do that with. All I need to do is load it with crypto and it will pay out in my local currency at the BTC/AUD rate at the time of transaction. If I had to do a direct crypto transaction there's no reason beyond disinclination by the other party that that transaction couldn't go ahead.

If people want to invest in crypto there's no reason to treat that any differently to any other form of day trading. The only real difference here is that instead of the synthetic currency being a promissory note from a government it is a promissory note from distributed holders on the internet.

Even if you want a crypto-currency there are solutions that more effective and don't burn as much unnecessary energy.

If you want to hold or move money in a manner that is effectively impossible to interfere with are few solutions so democratised as crypto. 

If you want to hold or move money in a manner that is effectively impossible to interfere with are few solutions so democratised as crypto. 

There's a difference between advocating crypto in general and advocating Bitcoin. Bitcoin is technically inferior to the more modern coins which provide different advantages on top. 

Apart from that the Chinese government essentially has control over Bitcoin given that more then half of the mining is in China and they can direct companies to do what they want. It's power is not democratically distributed. 

Bitcoin has market support that comes from maturity, that's its main value. It's the reserve currency of crypto at this point.

China can do stupid shit with bitcoin if they want and the market will drop them like a hot rock. Besides, crypto was designed to cross borders and that's what it's doing here. Crypto is specifically not fiat, so it has none of the protections of fiat. If people want to put fiat into Sinocoin then that's their own (terrible) investment decision to make.

Markets are never democratic, that's kind of the entire point.

The amount of money you'd have to be moving to attract that $15 fee would have a vastly greater fee attached for any of the interbank systems.

No, every transaction in bitcoin costs that much.

If you enjoy pain you can do a zero fee transaction. It will probably take days to complete, but complete it will. The entire point of paying more is to ensure the transaction is verified in a reasonable timeframe.

There is no such thing as a [one currency] to [other currency] rate. They are constantly fluctuating, and whoever is making the market is taking value out, either as a fee or in the bid/ask spread.

Also, 90% of the ways a government or malicious actor can interfere with an electronic transfer of wealth apply to crypto transfers. Specifically, they can threaten your trading partner with reprisals, and the whoke point of crypto is that it keeps a public log of all transactions forever.

Specifically, they can threaten your trading partner with reprisals, and the whoke point of crypto is that it keeps a public log of all transactions forever.

Not of all of crypto. Zcash gives you a more private way to transact. That's why you would expect it to outcompete Bitcoin for the usecases where privacy is desireable. 

A rate that fluctuates is by definition a rate that exists.

Nothing is free and nobody should expect otherwise. The function of the market (at least ideally) is to establish the acceptable price for transactions. 

If you are the subject of state attention then it is safe to assume that you are a criminal and have access to money laundering. Clean your money first and then put it in crypto. 

If you want to be serious about criminal finances and you have the funds to justify it then you don't goof around with crypto, you just go straight to the bank. They deal with dirty money all the time. Every couple of years they'll get caught, cop a slap on the wrist fine, and be back at it the same day.

Specifically, they can threaten your trading partner with reprisals, and the whoke point of crypto is that it keeps a public log of all transactions forever.

Well it's at least pseudonymous.