Is it possible to make crypto sustainable? Here’s How You Can.
Cryptocurrencies have captured investors’ attention, as a result of skyrocketing values, and the need to analyze and identify their significant climate impacts has become necessary if we wish to fully understand the climate effect of investing in crypto. To put it bluntly, cryptocurrency is a notorious climate culprit. A Cambridge University study concluded that the global network of Bitcoin miners, who operate legions of computers that compete to unlock coins by solving increasingly difficult math problems, consume about as much electricity annually as the nation of Argentina. In terms of greenhouse gas emissions, these processes are equivalent to the emissions of the London metro area. That’s a significant amount of carbon pollution for a service that is still in its infancy and too volatile for widespread adoption. Even more, it’s a potential liability for companies that purport to be climate- friendly but own a significant volume of high-energy-intensity cryptocurrencies. If you’re looking to invest in cryptocurrency, the environmental impact is an important factor, not to be ignored. This poses the question: how do you identify which cryptocurrencies are sustainable, and how do you measure the environmental impact a company is having by purchasing or facilitating the purchasing of cryptocurrency?
How to identify sustainable cryptocurrencies
So, what is the first thing a crypto investor should look for to determine just how eco-friendly a coin truly is? It is necessary to first understand the process through which a coin is mined.
A quick crash course in crypto: Most cryptocurrencies operate on a blockchain, which is a distributed ledger that acts as a constantly updating account of all activity. Purchases, sales, trades, and the release of new coins are all tracked on the blockchain. This ledger is typically distributed across tens of thousands of computers. This means that the information isn’t kept in a centralized location, like how a bank operates. To confirm every transaction as legitimate, there must be a consensus reached across the blockchain through a process called mining.
Bitcoin, along with about 500 other coins or 80% of the crypto market, uses a mining process known as proof-of-work mining. This process requires miners to lend the computing power of their machines to solve encryption that gets increasingly harder and more resource-intensive over time. This lengthy and energy-intensive process acts as a security feature for manipulation. Although it is a security feature, the concept is also the reason crypto uses so much energy. Not all cryptocurrencies are created equal. While the environmental impact of coins such as bitcoin and other proof-of-work energy consumers is evident, there are methods to make cryptocurrency and other digital assets more sustainable. The single most important factor in identifying the sustainability of a coin is the protocol for a coin’s mining process. Unlike proof-of-work mining, a much smaller share of the crypto market uses a proof-of-stake model. This process requires miners to stake their shares of cryptocurrency to validate a transaction, rewarding those who provide accurate information and penalizing those who provide false information. A proof-of-stake network can require 99.95% less energy than a proof-of-work network. There are other alternatives to a proof-of-work protocol as well. As a basic rule of thumb, a proof-of-storage, proof-of-stake, or block-lattice cryptocurrency is going to be less energy-intensive than a cryptocurrency that relies on a proof-of-work algorithm. These are the five largest proof-of-stake cryptocurrencies.
Consider the Energy Source
Along with understanding the mining protocol of your cryptocurrency, it’s also worth taking into account where miners are drawing their energy from in the first place. Although backers of all cryptocurrencies, including Bitcoin, will often tout how environmentally friendly their particular coin is, the truth is often not as evident. For example, Bitcoin miners may believe that the currency is sustainable because 76% of Bitcoin miners claim they are using renewable energy to power their activities, however, only 39% of miners’ total energy consumption comes from renewables. Although a shift towards greater energy procurement from renewable sources would indeed reduce GHG emissions in the mining process, the intense energy demand for proof-of-work is still diverting energy away from other uses such as homes or commercial buildings. It is also difficult, if not impossible, to identify the exact location from where your coins are being received. Currently, around 65% of all crypto mining comes from China but this likely accounts for only the largest operations. It is much more difficult to pinpoint the locations of smaller bitcoin miners.
Identifying Companies Using Crypto
Crypto has seemingly permeated a diverse range of industries and product offerings, making it sometimes difficult to identify companies that may be participating in unsustainable crypto operations. An extremely important assessment to make when investing in a company through an ESG framework is understanding any potential environmental threats posed to a company as a result of its operations. In Deloitte’s 2020 Blockchain Survey, 55% of respondents stated that “blockchain will be critical and in our top-five strategic priorities” while 86% responded that “our executive team believes there is a compelling business case for the use of blockchain technology within my organization or project.” These responses make it clear that blockchain and crypto’s environmental impact will need to be added to an investor’s ESG framework when analyzing a company from now on. For the sake of creating a simple ESG framework, companies using crypto will be broken down into two categories. The first are those whose revenues are directly tied to the participation in and facilitation of buying, selling, and investing in crypto. The second are those indirectly involved in the blockchain through technology integration that is not directly tied to significant revenue streams. The first group of companies is easiest to identify and includes companies such as CoinBase, Riot Blockchain, Square, Paypal, and Robinhood. The second group can be much more difficult to identify and includes companies such as Tesla, Mastercard, IBM, and Amazon. To determine which category a company falls into, an investor may need to carry out their research. A company that falls into category one will almost always reveal within their business overview that crypto is a large part of their revenue model. If not, an investor may be required to search a company’s 10K or 10Q for mentions of “cryptocurrency” or “blockchain” involvement. Identifying companies in group two can be more difficult and may require more than a simple search of 10K or 10Q. This will likely require researching press releases from companies or media mentions of initiatives or investments in cryptocurrencies.
Creating Your Crypto ESG Strategy
After you have created two buckets of companies who are involved in cryptocurrency or blockchain, it is now necessary to identify your own ESG investing strategy. Start by asking yourself questions to better understand how you will approach investing in companies involved in crypto. Will you reject all companies that you have assigned to the first bucket? Alternatively, will you establish a threshold for a maximum percentage of revenue that can be directly attributed to crypto? It may also be the case that although a specific company attributes a significant percentage of their revenue to crypto, they carry out operations such as buying carbon offsets or making investments in renewable energy. As an investor, you must decide whether this is merely greenwashing or if it is providing significant advances to a carbon-free economy. These questions will allow you to create your ESG framework.