Environmental, social and corporate governance (ESG) and cryptocurrencies are two of the most prevalent, if not the hottest, investing trends in the world right now. But are they diametrically opposed?
I’ve always considered myself a somewhat mission-agnostic investor. Yes, I’d like to avoid investing directly in criminal or immoral activity when possible, but I emphasize simplicity when I deploy my money in financial markets. That sets me apart from many investors my age, who want to make sure they put their money to work in ways in accordance with their values.
The most common knock against tokens like bitcoin from an ESG perspective is that processing power – and therefore energy and resource use – are intrinsically linked to the value of the asset. The energy it takes to mine and transact with cryptocurrencies makes them environmentally unsound, according to this argument.
But not every advisor buys it.
Crypto and the environment
“I’ve always felt that the environmental argument against cryptocurrencies is weak,” said Scott Eichler, founder and principal at Standing Oak Financial, a Newport Beach, Calif.-based registered investment advisor (RIA). “There’s something to the idea that, in some ways, the energy use gives cryptocurrencies their value, creating a barrier to entry.”
That argument has woven its way through a lot of media and political discussions, even as many cryptocurrency operations have concentrated around hubs of relatively clean and inexpensive industry. Also, over time the digital assets industry itself has moved gradually from a more energy-intensive proof-of-work model to a proof-of-stake model to confirm transactions.
Proof-of-work and proof-of-stake
The distinction between the validation models really comes down to differences in how to use computers to solve math problems. What’s more important is that the move itself promises to lead to a future of cleaner cryptocurrencies because proof-of-stake validation is up to 99.9% more efficient than proof-of-work, according to the Ethereum Foundation.
Proof-of-work depends on a lot of computing power from a network of cryptocurrency miners to confirm transactions, while proof-of-stake distributes responsibility between all of the holders of a cryptocurrency.
Bitcoin and Ethereum were founded on proof-of-work to validate transactions; while the latter plans on moving to proof-of-stake, Bitcoin will remain proof-of-work. Other platforms, like Cardano and Solana, were founded in the proof-of-stake realm and already offer a cleaner digital asset investment alternative.
That ongoing debate only covers one facet of ESG, around environmental sustainability. There are other dimensions to the crypto ESG debate worth exploring, too.
Crypto and social considerations
Advisors and investors once pursued values-driven investing strategies as a method to avoid what they viewed as morally or ethically bad actors. For example, members of certain religious or social groups might want to avoid companies involved in alcohol, tobacco, gambling, firearms, pornography or other potential vices.
Today, a growing cohort of investors seek investments for positive reasons to create change in the world.
“Capitalism is about building everybody up, so our version of ESG is focused on finding investments that are not just good for investors or the CEOs, but also focus on the employees and the greater community,” said Eichler. “The other side of cryptocurrencies is their social impact, where many proponents argue that it provides access to financial resources for the underserved. I think that’s way overstated.”
Eichler argues that to use cryptocurrencies, people need access to the internet, funds with which they can obtain cryptocurrencies, and some kind of understanding of how to obtain, hold and transact with crypto – barriers he says place digital assets out of reach of much of the world’s population.
Instead, Eichler points out that people with wealth and power will be more likely to access the technology and energy needed to mine, store and transact cryptocurrencies. Thus, this new asset class may end up exacerbating the very economic and financial inequalities its proponents promise to combat.
And from a reputation standpoint, Eichler also worries that many cryptocurrencies have, in the past, been used for illicit transactions in the drug and sex trades, likening it to a series of studies finding that 80% to 90% of U.S. paper currency has traces of cocaine on it.
“With cash, you can clearly see how it has been used for nefarious purposes, we have tangible evidence, but I don’t think we’re as adept at uncovering this kind of evidence in digital assets,” he said. “My suspicion is that we’re going to get better, but it worries me because it’s relatively new and we just don’t know for sure.”
A group of attorneys at Katten, a national business law firm, expounded on social concerns around cryptocurrencies in “Crypto, Meet ESG; ESG, Meet Crypto,” an analysis from July, voicing concerns for digital assets’ use as payments in ransomware attacks like the breach that shut down the Colonial Pipeline, and the potential link between Chinese cryptocurrency mining and human rights abuses.
“While the impact of China’s desire to halt crypto mining activities remains to be seen, the expressed human rights concerns of the Xinjiang region must continue to be considered as the region remains responsible for a large portion of new cryptocurrency. Again, China has denied all allegations,” the attorneys wrote. [China went on to ban crypto trading and mining altogether in late September.]
Crypto and governance
The Katten lawyers also expressed concern surrounding the corporate governance factor in cryptocurrency investing. While cryptocurrencies themselves, by virtue of disintermediation, do not have traditional corporate governance, the multitude of companies now thriving in the digital assets sector do.
The authors were explicitly concerned about the relative lack of diversity in the blockchain and cryptocurrency spaces, citing studies that show between 4% and 10% of the employees in the sector are women and the sector is dominated by white and Asian men.
Eichler noted that with a cryptocurrency, governance exists in the technology, the code itself, but questioned whether they are truly disintermediated. With crypto enthusiasts naming disintermediation and decentralization both as major points of attraction for digital assets, perhaps some of the talk around eliminating the middleman is more theater than reality.
“Have we removed the trusted third party, or have we just moved them to the side?” Eichler asked. “Learning about Bitcoin and Bitcoin Cash and all the hard forks that have occurred makes it clear that you’re always depending on a development team who is updating the code, and you have to trust those people to augment the code in a way that is helpful and not too deeply.”
“So there is still a third party that you have to trust. That could be a problem,” he continued. “Are we just going from a trusted third-party intermediary that can be easily identified to one that we can’t identify?”