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Does crypto belong in an ESG portfolio?

Doug Miller is a staunch believer in the power of technology to solve environmental problems.

As a masters student at London’s Imperial College, the American orchestrated a field study of office workers and energy consumption. He found that automating light switches was more effective and cheaper than relying on the last person leaving a room to turn off the lights.

In his current role at global non-profit organisation Energy Web, he has gone even more high-tech: engineering a certification system for digital assets that rely on clean energy. “I come at this purely from an environmental point of view,” he says. “Blockchain forms a key part of the clean energy transition.”

But asset managers with an environmental, social and governance brief may think differently. Blockchain is best known as the technology that underpins cryptocurrencies such as bitcoin — assets whose carbon footprint and utility in illicit transactions put them beyond the ESG pale. That may change, however, as — thanks to the efforts of Miller and others — blockchain percolates into more areas of the economy.

Cryptocurrencies owe their dubious environmental reputation to the huge amounts of electricity, often coal-generated, that computers need to create them. And because they are not subject to government regulation, they are a favoured medium of exchange for criminals and terrorists: the hackers who closed down Colonial Pipeline in the US in May, for example, received their ransom in bitcoin.

European asset manager Candriam said earlier this year that “cryptocurrencies have a long way to go to satisfy ESG criteria”, citing money laundering and the environmental impact of “mining” coins (performing the complex calculations that generate them).

Yet Miller is at pains to emphasise the difference between speculative currencies and the technology that supports not only them but other, more innocuous digital assets — such as the supposedly tout-proof tickets sold for the 2018 football World Cup. Central banks are also using the technology.

“There is a risk of conflating blockchain technology and crypto,” he says. “Helping energy companies manage their grid better is very different from [cryptocurrency] Dogecoin.” Energy Web runs just such a grid project with an Australian electricity group.

Last month, UBS Wealth Management said that, as well as healthcare and sustainability, “the digital transformation of sectors ranging from transport to manufacturing and financial services creates opportunities”.

In a paper evaluating cryptocurrency investments, the wealth manager’s analysts recommended that “investors focus on companies exposed to the evolution of distributed ledger technology, rather than engaging directly in cryptos”.

Distributed ledgers — of which blockchain is one type — are systems that rely on the collective agreement of users to verify transactions.

More recently, the technology has evolved in a way that cuts down on the number of users needed to approve transactions, making these systems more energy efficient. A recent study by University College London found that some new distributed ledger technologies — using the so-called “proof-of-stake” protocol rather than the older “proof-of-work” method — were up to three times more efficient than earlier systems.

“Our work shows that [newer blockchains] . . . could even undercut the energy needs of traditional central payment systems, raising hopes that distributed ledger technologies can contribute positively to combating climate change,” the paper concluded. Further impetus may come from the Crypto Climate Accord, which aims to decarbonise the crypto industry by 2030 (and which Miller played a key part in founding).

Crypto diehards also point to the fact that the carbon footprint of bitcoin mining is falling, especially since China this year banned private cryptocurrencies and shut down huge mining operations.

The impact is already showing up in data. In May, the Cambridge Bitcoin Electricity Consumption Index estimated that bitcoin’s global electricity consumption was about the same as Sweden’s. This month, it is on a par with Kyrgyzstan’s — a significantly lower level.

And conventional assets have issues of their own. “It could be argued that there is a much bigger but more subtle problem with fiat money as it pertains to the environment,” say analysts at Deutsche Bank in a recent report. Central bank-backed currencies, they argue, are “the ultimate tool in bringing forward consumption from tomorrow to today”, referring to national policymakers’ ability to print money through quantitative easing.

Still, there are significant risks around cryptocurrencies, especially for responsible investors. The use of digital coins in illicit activities remains rife. Chainalysis, a crypto monitoring company, says bitcoin remains attractive for criminals “due to its pseudonymous nature and the ease with which it allows users to instantly send funds anywhere in the world, despite its transparent and traceable design”.

Nevertheless, there are some hopeful signs for crypto fans. Chainalysis found that, in 2019, around $21.4bn worth of transfers were due to illicit activity, representing 2.1 per cent of all cryptocurrency transactions. Last year, such activities had fallen to about $10bn worth of transactions, or 0.34 per cent of the total.

Many continue to believe that, ultimately, cryptocurrencies will fade out after crashing and burning, due to their speculative nature and lack of inherent value. Regulation and central bank digital currencies are also threats.

“Bitcoin is a video game,” Jan Kregel, an economist and director of research at the Levy Economics Institute of Bard College in New York tells the FT. “There is potential for the crypto world to blow up and cause a bigger crisis than subprime.” The technology behind it, however, is probably here to stay.

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