How do cryptocurrencies fit in Environmental, Social, and Governance Investing?
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.
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-work. A 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.