Bitcoin’s meteoric rise in recent months has no doubt been spectacular, hitting levels many doubters thought it would never see, and while there are many arguments both for and against the world’s biggest cryptocurrency, its ESG attributes are something which has, for the most part, been surprisingly ignored. However, contrary to the all-or-nothing narrative that often characterises pockets of exuberance within financial markets, like everything else, from an ESG perspective, Bitcoin has components that both work in its favour, and against it.
Environmental- A green coloured problem One of Bitcoin’s biggest issues is no doubt the sheer volume of electricity required to mine the cryptocurrency. What does this mean? Simply put, it is a security mechanism put in place to prevent the same coin from being spent twice because of a duplicate coin, whereby individuals verify the transactions that take place. Once these individuals verify 1MB of transactions, they are eligible to be rewarded with a certain amount of Bitcoin as thanks for their work, an amount which will steadily decrease as the supply of Bitcoin decreases over time, otherwise known as the halving cycle. To gain this reward, you must be the first miner to verify the transaction, which is done by coming up with the correct 64-digit hexadecimal number- in essence, it is trial and error.
And it is the computing power required to solve this trial-and-error method, that sees Bitcoin’s environmental problems begin to manifest themselves. The more Bitcoin you want to mine, the greater the ‘hash rate’ you require, and in turn, the more computing power you require, which then requires more and more electricity. At present, according to digiconomist, Bitcoin currently relies on 83.8 terawatt-hours of electricity, the same as Finland, has the same carbon footprint as Switzerland, and produces as much e-waste as Luxembourg.
The problems only start there. One bitcoin transaction has the same carbon footprint as 795,000 Visa transactions, the same power consumption as a US household uses in 26 days and produces as much electronic waste as 1.5 batteries. Considering that Visa alone processed 185.5bn transactions in 2019, and we can see that the argument for Bitcoin being a universal currency we rely on day-to-day while being secure be secure, comes at a cost that makes it something between a non-starter and unviable.
In this regard, regulation may prove a further drag on Bitcoin’s eventual success. A key milestone for many in the cryptocurrency’s widespread adoption is the proliferation of exchange-traded and over-the-counter products tied to its value, such as mutual funds, ETF’s and various forms of derivatives. However, with the regulation of such holdings in an environmental sense becoming ever more stringent, as managers are keen to appeal to a population that is becoming more sustainably aware, Bitcoin may prove a sticking point.
Social- A double-edged sword
The social implications of Bitcoin are somewhat less straightforward, and in many ways depends on one’s viewpoint regarding fundamental questions that have been asked repeatedly over centuries. Bitcoin’s big selling point as a decentralised currency sees it free from what some refer to as the manipulation currency value since the gold standard was abandoned in the 1970s. More conservative viewpoints, those who call for small government and markets which are free and fair in the purest form, align themselves with such arguments, while those left of centre may argue that Bitcoin’s decentralised nature enables it to become the currency of criminals, given transactions are untraceable and cannot be halted.
However, support for Bitcoin, or a lack thereof in a social sense, very much depends on how you interpret the same questions those centuries from now, will still be asking. Big or small government? Are markets truly free? High or low taxes on major corporations? Unlike many in society, today would have you believe, such questions have never been, nor will be clean cut.
Governance (or a lack thereof)
As a decentralized currency, Bitcoin’s score within the governance attribute is positive, due mainly to its unprecedented transparency; transactions are public, traceable, and permanently stored on the Bitcoin network. It is also important to keep in mind that Bitcoin represents much more than a payment method, it is slowly positioning itself as a confirmed asset and store of value in financial markets, as well as other facilities such as file storing capacities and the ability to verify property ownership. Bitcoin and its blockchain technology serve as a multi-use tool and represent a true forward step that many see as the future of finance.
However, with Bitcoin, we can see a trade-off between transparency and privacy. Bitcoin is considered pseudonymous due to the anonymity of the address owner’s identity and this is a limitation in many contexts. In the Financial industry, there is a need for the account holder to be identified and Bitcoin cannot do this as full records of transactions remain confidential. This can lead to problems, for one as it can facilitate illegal activities, among others.
How is the industry dealing with this? Well, to buy or sell Bitcoin, an individual must access an over-the-counter exchange broker such as Coinbase. Moreover, Coinbase, which act as middlemen in the transaction of cryptocurrencies, follows the know you customer (KYC) procedures against money laundering regulations. KYC thus allows Coinbase to identify individuals and their connection to one or more Bitcoin addresses, this way privacy and regulatory compliance are guaranteed while transparency is preserved. In turn, many will be sceptical of private bodies overseeing transactions that can be used to facilitate illegal activity.
The rise in Bitcoin’s price in the last year has drawn much attention, and when looking at the social and governance aspects of Bitcoin, there are certainly positives. However, while it continues to mature as a financial asset, its continued proliferation, and the impact this may have on the environment at a time when many are more conscious than ever of such issues, may prove a drag on its widespread appeal.
Moreover, this issue is only beginning to unravel, as more and more miners are incentivised by the riches it can bring as prices increase. In turn, while the decentralised model allows many to see their wealth held in a free and fair marketplace, the environmental threat it poses may prove a challenge if the green revolution continues at pace.
Bitcoin also typifies broader issues surrounding being able to quantify the ESG attributes of any asset, given the qualitative nature of what is positive or otherwise in all three categories, while also highlighting how such companies separate ESG attributes can indeed contradict one another. Bitcoin for instance, could be perceived to tick the social and governance boxes in dramatic fashion, however including it in any ESG index would no doubt be met with distain, nonetheless.
Either way, beneficial or not, the market will ultimately determine its fate.
Thank you to Craig McAuley and Maximilian Morte Von Jacobs for your in-depth analysis!