How to fill in the ESG pitfalls of cryptocurrencies

In February Elon Musk gaveth to cryptocurrencies, when he announced that Tesla had bought $1.5 billion of Bitcoin. Three months later he tooketh away, halting the acceptance of Bitcoin for purchases of Tesla vehicles – and blaming the digital currency’s environmental impact for the halt.

The value of Bitcoin, the most popular cryptocurrency, surged on the news that Tesla had bought it and would accept it as a payment method. The value of a single bitcoin soared from $48,717 on February 8, when the news was reported, to $57,539 a week later, breaking above $50,000 for the first time.

Then on May 13, Musk sent out a tweet to announce that Tesla would halt purchases using Bitcoin.

“We are concerned about rapidly increasing use of fossil fuels for Bitcoin mining and transactions, especially coal, which has the worst emissions of any fuel,” read his tweet.

Tesla & Bitcoin pic.twitter.com/YSswJmVZhP
— Elon Musk (@elonmusk) May 12, 2021

It sparked a tumble in prices that lasted 10 days. On May 23 Bitcoin prices hit $34,770, its lowest in four months.

Musk was not the only one sounding the alarm over the Bitcoin’s energy-intensive algorithm. In February, US treasury secretary Janet Yellen said the cryptocurrency is an “extremely inefficient way of conducting transactions, and the amount of energy that’s consumed in processing those transactions is staggering”.

Naturally, this is likely to affect many asset owners’ views on cryptocurrencies.

Environmental, social and governance (ESG) practices have become increasingly important for investors across the world.

Indeed, a chief investment officer at a North Asian pension fund told AsianInvestor that their organisation is not currently interested in cryptocurrencies, partly because of the “huge amounts of fuel consumption” needed to power the asset.

US treasury secretary Janet Yellen said in February that Bitcoin was "extremely inefficient" and that its energy consumption was "staggering"

An example of a Bitcoin mining facility

HOW BAD IS BITCOIN?

Is Bitcoin as bad as all that for the environment?

Industry insiders and experts admit the cryptocurrency is very energy inefficient. The asset consumes around 115 Terawatt Hours (TWh) per year, according to the Cambridge Centre for Alternative Finance (CCAF). That is the equivalent of the annual energy consumption of countries like Sweden and Ukraine.

But that does not mean that all digital assets or even cryptocurrencies are environmentally unsound. For a start, some blockchains, the technology that underpins cryptocurrencies and other digital assets, do not use Bitcoin’s energy-intensive “proof-of-work” protocol.

Ethereum, the second-largest cryptocurrency by market capitalisation, has said it is looking to change its network from a “proof-of-work” to “proof-of-stake” protocol (see sidebar), which requires 1,000th the amount of energy used by Bitcoin, Johannes Sedlmeir, who researches applications of blockchain technology at the University of Bayreuth in Germany, told AsianInvestor.

“There is still a lot of redundancy and therefore also inefficiency [with proof-of-stake] ... But compared to the energy that’s consumed for proof-of-work, this is negligible,” he noted.

He added that while proof-of-stake technologies consume more energy than more centralised systems, they provide benefits too.

“If you compare the savings potentials that you can get from automation that centralised systems couldn’t provide so far, then probably, in the end, proof-of-stake-based cryptocurrencies can be sustainable and are not necessarily a waste of resources,” he said.

These savings include improving supply chains through more targeted recalls, which leads to a lower consumption of resources, he added.

BLOCKCHAIN-BASED ESG

Asian asset owners have been reluctant to invest directly into cryptocurrencies, but several have been willing to gain some exposure to the underlying technologies and platforms that support digital assets.

For instance, Singaporean sovereign wealth fund GIC has reportedly invested in crypto exchange Coinbase’s 2018 fundraising round, while Korea’s state-run National Pension Service (NPS) reportedly had exposure to several cryptocurrency exchanges.

“Some may ask, what’s the difference between an ESG bond and a normal bond? The underlying [idea] is the same: it’s a bond."
- Benjamin Soh, managing director of STACS

Digital bonds, which allow the inclusion of ESG factors, have also been rising in popularity since the World Bank issued the first blockchain bond in 2018 for A$110 million ($83 million). That deal gained institutional investors including the Commonwealth Bank of Australia, which was also the bond’s arranger, plus First State Super, the New South Wales Treasury Corporation and Northern Trust.

Further developments in this space are afoot. In September 2020, Singapore state investor Temasek Holdings, along with HSBC and the Singapore Exchange, jointly piloted one of Asia’s first digital bonds for commodities trader Olam International, pricing S$400 million ($303 million) of the debt.

Digital bonds are created with blockchain technology, which allows issuers to include smart contracts that are programmed to automatically include ESG-friendly factors and exclude carbon-intensive ones, for example.

A recent partnership between Germany’s Deutsche Bank and Singapore fintech company STACS led to the completion of a proof-of-concept using distributed ledger technology (DLT) to enhance end-to-end bonds lifecycle management.

The project was developed to ease the handling of digital assets, improve their ESG transparency, and enable smart contract issuances.

“Some may ask, what’s the difference between an ESG bond and a normal bond? The underlying [idea] is the same: it’s a bond. But there are certain functions or features that we can programme into the smart contract to ensure that the ESG bond is really paying process to ESG use cases,” Benjamin Soh, managing director of Singapore fintech firm STACS, told AsianInvestor.

SUSTAINABILITY SPREAD

“We could also programme the smart contract to have the bond function with financial incentives. So, if KPIs are met, we could decrease interest rates as a financial incentive to the corporates,” he said.

Investors might well not like this, as it would effectively reduce their returns on the deals. But Soh believes this would only be a short-term issue.

“In the short run, there’s this question about profitability and sustainability, but in the medium term that’s not going to be a choice at all. Because of regulations, because of the way the world is moving, everybody will be focused on sustainability. If a company is not sustainable, as an investor or as a company, then people will not buy their goods, people will not invest in them,” he said.

This article was first published in the summer 2021 edition of the AsianInvestor print magazine. Click here to return to the AsianInvestor website.