The popularity of ESG investments has rocketed in recent years, while cryptocurrencies are coming to be viewed as a hedge against inflation in this era of ultra-low interest rates. The question for investors is: can the two ever be compatible?
Crypto fever is starting to infect wealth management, as some private banking institutions have responded to demand from their clients. In March, Morgan Stanley became the first big US bank to offer its wealth management clients access to bitcoin funds. JPMorgan Chase followed suit in August, even though its chairman and CEO, Jamie Dimon, admitted that he considered bitcoin to be “worthless”.
The argument that crypto, unlike a physical asset such as gold, has no intrinsic value is just one of the reasons why most other players in the sector have steered clear of the asset class so far.
If crypto is ever to be added to ESG portfolios, it will be subject to much scrutiny, particularly regarding the environmental element. It has been well reported that bitcoin mining – the computational process of producing new coins – consumed more electricity last year than the whole of Argentina did.
The booming popularity of bitcoin mining in Kazakhstan, for instance, has led to energy shortages in recent weeks. These have been caused by a ban on the activity in neighbouring China, which prompted miners there to move their operations across the border.
It will take a few more years to mature, but cryptocurrencies will inch closer to being environmentally friendly
On the flip side, there are miners who actively offset their greenhouse gas emissions. Some are exploring the possibility of using renewable resources, while others are focusing on clean energy goals. One such project is blockchain company Efforce, led by Apple co-founder Steve Wozniak. Holders of its cryptocurrency token, WOZX, are entitled to a share of profits from energy-efficiency projects.
Ecological concerns about crypto are not shared by the socially conscious investors who’ve spoken to Daniel Wolfe. He’s the co-founder of Simoleon Long-Term Value, a fund with a minimum investment level of $100,000 (£75,000) that specifically provides exposure to cryptocurrencies and blockchain-related assets.
“The need to increase the use of green energy sources is critical, regardless of the amount of electricity being consumed, but we shouldn’t conflate issues concerning mining with cryptocurrencies in general,” Wolfe stresses. “When people talk about cryptocurrencies and sustainability, they’re usually referring to bitcoin. Its proof-of-work consensus mechanism, which is used to validate transactions, does require large amounts of computing power.”
Can crypto go green?
But some crypto assets are starting to rely instead on what’s known as a proof-of-stake model, he adds. This is a less energy-intensive process that’s also faster and cheaper. Ethereum plans to switch to proof of stake in 2022, for instance, although no date has yet been set for bitcoin.
In effect, miners are competing to produce coins under the proof-of-work system. Under proof of stake, miners must pledge coins in order to take part. As a result, there are fewer participants.
“There’s a clear movement: developers of new crypto projects are becoming conscious of their environmental impact, so they’re shifting from proof of work to proof of stake,” notes Philip Radford, director at Saffery Champness Registered Fiduciaries. “While the answer isn’t just to use renewable energy to power their networks, this is certainly a good starting point.”
Beyond the environmental concerns, there are other ESG issues that wealth managers and their clients will need to consider when approaching crypto investment opportunities.
Jeremy Cheah, associate professor of decentralised finance at Nottingham Trent University, points to the matter of governance. Cryptocurrencies have no CEO or board, but their creators have been known to publish white papers setting out a digital token’s real-world use, thereby helping potential investors to gauge how sustainable it might be. Nonetheless, the general lack of accountability means that the sector remains shrouded in mystery.
“Investors should not feel restricted – there is huge upside for ESG and cryptocurrencies,” says Cheah, but he adds: “The question is whether they understand all the risks or not.”
Other ESG considerations
Another ESG weakness of crypto concerns the sector’s diversity – or lack thereof. For instance, a report published in 2019 by campaign group Diversity in Blockchain criticised a dearth of female and ethnic minority representation in the cryptocurrency sector, particularly at leadership level.
Appropriate regulation could ensure better governance standards and make this industry more diverse and inclusive. In theory, it could also help to make crypto markets less volatile. For instance, the price of bitcoin plummeted by 20% after the emergence of Covid’s omicron variant was first reported.
Mitigating such risks, along with reducing the energy consumption of the mining process, should strengthen the appeal of crypto as a long-term investment opportunity, according to Cheah. Moreover, if the associated transaction fees, which are received by miners, can be lowered, this will incentivise investors to buy sustainable cryptocurrencies.
He adds that, while crypto clearly has its downside risks, not all ESG projects will provide good returns in the short to medium term. Investments in crypto and ESG are therefore compatible in the sense that both have the potential to deliver gains over the longer term.
Radford stresses that blockchain is still “a young technology. It will evolve and take a few more years to mature, but cryptocurrencies will inch closer to being environmentally friendly.”
The number of use cases for blockchain-based sustainability, such as using digital assets to raise ESG finance or trading carbon credits on digital markets, will only grow. This should encourage more investors and wealth managers to consider exposing their ESG portfolios to cryptocurrencies.
Wolfe says that his advice for investors who have been “convinced about the transformative nature of blockchain and crypto assets” would be: “Don’t let current ecological concerns hinder your investments.”
The popularity of ESG investments has rocketed in recent years, while cryptocurrencies are coming to be viewed as a hedge against inflation in this era of ultra-low interest rates. The question for investors is: can the two ever be compatible?
Crypto fever is starting to infect wealth management, as some private banking institutions have responded to demand from their clients. In March, Morgan Stanley became the first big US bank to offer its wealth management clients access to bitcoin funds. JPMorgan Chase followed suit in August, even though its chairman and CEO, Jamie Dimon, admitted that he considered bitcoin to be “worthless”.
The argument that crypto, unlike a physical asset such as gold, has no intrinsic value is just one of the reasons why most other players in the sector have steered clear of the asset class so far.
