Sustainable investors take the crypto out of cryptocurrency

Author’s note: This article focuses on environmental considerations and identifies options for sustainable or ESG investors who may wish to invest in more energy-efficient alternatives while keeping in mind the highly speculative nature of cryptocurrency investing.

In the 13 years since the publication of a white paper that launched the cryptocurrency digital wave with the introduction of Bitcoin, the market capitalization of cryptocurrencies has exploded to over $2.23 trillion with more than 13,506 such currencies in existence. The cryptocurrencies market is highly concentrated with the top five types, Bitcoin, Ethereum, Binance Coin, Tether and Solana, representing more than 72% of the market cap.

Cryptocurrency is a decentralized digital currency that relies on distributed ledger technology to keep ownership records and transfer ownership from one user to another, often with little to no information about the identity of the owner. Unlike the US dollar or the Euro, there is no central authority that manages and maintains the value of a cryptocurrency. Instead, these tasks are broadly distributed among cryptocurrency users via the internet in the form of a blockchain.

Blockchain is a little like a checkbook that’s distributed across countless computers around the world. Transactions are recorded in “blocks” that are then linked together on a “chain” of previous cryptocurrency transactions. With a blockchain, everyone who uses a cryptocurrency has their own copy of this book to create a unified transaction record. To prevent fraud, each transaction is checked using one of two main validation techniques: Proof of Work (PoW) or Proof of Stake (PoS).

This validation process, known as the “mining process,” has come under the increasing attention of sustainable and ESG (aka environmental, social, and governance) investors, due to the high levels of energy and resultant levels of greenhouse gases that are used. The PoW validation method employs a consensus mechanism that requires computers to solve complex mathematical problems that can require an intense amount of computer power and electricity:

Estimated energy consumption per cryptocurrency transaction, in KWh. (Chart via ImpactPHL)

For example, it is estimated that Bitcoin’s annualized electrical energy consumption is equivalent to that of the country of Thailand. The lesser-used PoS, introduced in 2012, reduces the amount of power necessary to check transactions because the number of transactions each person can verify is limited by the amount of cryptocurrency they’re willing to “stake,” or temporarily lock up in a communal safe.

New validation techniques are reported to consume far less energy and/or rely on renewable energy sources. For example, Chia describes itself as green money for a digital world and uses a new consensus algorithm that is referred to as a Proof of Space and Time to validate transactions. Another example is Nano, a digital currency network that shuns traditional mining practices in favor of an eco-friendlier solution, known as Open Representative Voting.

Michael Cosack. (Courtesy photo)

In the end, the lack of transparency and data makes it exceedingly difficult to point to any one currency being “greener” than others. For this reason, the recently announced formation of the Crypto Climate Accord is a welcome development for sustainable investors and other stakeholders. The Accord represents a private sector collaborative effort to decarbonize the crypto and blockchain industry with the ultimate goal of achieving net-zero emissions from electricity consumption associated with all their respective crypto-related operations by 2030.

While the focus of this research article is limited to environmental impacts, cryptocurrency investors should be aware of potential social and governance risks and opportunities sourced to cryptocurrencies (e.g. evaluation, risk management, ransomware, fraud, human rights abuses, etc.). According to research recently published by MSCI, there are at least 52 public companies that have exposure to cryptocurrencies.

Investors drawn to cryptocurrency should keep in mind that it is a new, highly speculative investment with limited history. For sustainable investors, options and considerations include advocating for improved disclosures, transparency, and a shift to renewable energy sources, considering lesser energy-consuming cryptocurrencies, and/or offsetting emissions through the purchase of carbon credits.