Global Green Guide: Do cryptocurrencies have a place in the sustainable investment movement?

Amy Ulliott looks at a somewhat inevitable collision course between cryptoassets and a more green-conscious approach.

In 2008, the global economy collapsed and sparked a chain of events that would alter the world’s financial markets forever. Financial regulations were thrown out and rewritten, household names in the banking world disappeared overnight and how people viewed finance and money was permanently changed. In amongst the chaos, a new idea emerged, which has increasingly dominated headlines and discussions in the last 14 years – cryptocurrency. Where Bitcoin forged a path, many others have followed, and the digital currency market is now overflowing with cryptoassets.

Since its inception, cryptocurrency has (to put it mildly) divided opinion. However, in recent years, one notable factor has risen in prominence in the crypto debate – its energy consumption. Certain methods of mining cryptocurrency and the sheer amount of electricity required to power these processes have made headlines in recent months and years and encouraged critics and enthusiasts alike to debate whether cryptocurrency can find its place in the sustainable investment movement.

Cryptocurrency processes – a short summary

Cryptocurrency mining is regularly powered through one of three models: proof of work (POW), proof of sale (POS) or proof of authority (POA). Under the POW method, which is by far the most energy intensive, computers are used to calculate complex mathematical problems to either create or ‘mine’ cryptocurrencies or process a transaction. These computing processes (or ‘work’) are then used as a method of verification for the blockchain transaction, which is confirmed by other participants in the blockchain.

The POS model validates a transaction in the blockchain based on the amount of coins a miner holds, i.e. coin owners offer their coins as collateral in order to validate blocks within the blockchain; while the POA method is more reputation based and relies on verification from block validators that have been arbitrarily selected as trustworthy entities. Both of these methods are generally acknowledged as more eco-friendly than the more widely used POW model.

The current situation

As previously reported by the Cambridge Bitcoin Electricity Consumption Index, the energy use of Bitcoin, which utilises a POW method, is approximately 0.6% of the global energy consumption, which is roughly equivalent to the annual energy usage of countries like Norway or Ukraine.

Neil Robson | Partner, Financial markets and funds | Katten

“Where a cryptocurrency relies on a consensus mechanism (such as POW) over a distributed network, there is an enormous environmental cost” states Neil Robson, a financial regulatory and crypto expert based in Katten’s London office. “The negative environmental impact that some crypto have, such as Bitcoin, is bound to become a bigger issue as cryptocurrency gains more popularity”.

This massive energy usage has recently caused several governments and legislative bodies to take drastic action to counteract the negative climate impact. In late 2021, China banned all cryptocurrency transactions and crypto mining, the largest in a growing group of countries to do so; Russia has recently proposed a similar ban due to its effect on the country’s green agenda, and Swedish regulators have suggested a ban on Bitcoin mining to ensure Europe can meet its obligations under the Paris Climate Agreement.

However, the approach to cryptocurrencies globally has been far from consistent. As highlighted by James Burnie, a financial services regulation and fintech partner at gunnercooke, “Different local lawmakers have different priorities, cultures and philosophies. In the EU there is a focus on the importance of the individual, in the US there is a focus on the corporate and in China the focus is on the importance of the state. Therefore, there is a lack of a single unified stance on how cryptoassets should be dealt with. When this is overlaid by the fast-changing nature of cryptoassets, it means that those who create and understand the technology tend to innovate, whilst regulators are left to catch up”.

It would also be reductive to suggest that sustainability is the only issue facing the crypto market. Undeniably, the other prominent narrative around cryptocurrencies is the volatility of the assets themselves. Large volumes of crypto scams and wildly fluctuating prices have led to some arguing that a cryptocurrency’s value is solely driven by supply and demand, with no intrinsic value in and of itself. Celebrity endorsements have also added to the chaos, with recent examples leading to allegations of misleading marketing and, at worst, class actions alleging intentional ‘pump and dump’ schemes.

Similarly, the idea that cryptocurrency’s impact on the environment is contained to its energy usage ignores the other side of the proverbial coin. As reported by the BBC in late 2021, cryptocurrency mining processes produce 30,700 tonnes of electronic waste (also known as e-waste) a year, the majority of which ends up in landfills. This averages out to 272g of e-waste per transaction and is equivalent to the small IT equipment waste of a country the size of the Netherlands.

So, is there a green solution?

Several jurisdictions around the world have attempted to offer up solutions to the crypto sustainability issue with varying degrees of success.

“In terms of using green energy sources for POW, a great example is Iceland”, states Robson. Nearly 100% of the country’s electricity stems from renewable energy sources, with excess created every year to attract energy-intensive businesses to the region, including cryptocurrency miners, which have long been drawn to Iceland for its abundance of cheap geothermal energy.

However, as Robson points out, “Just last December, Iceland began turning away new Bitcoin miners due to issues with energy allocation and problems in its power station, so it appears that using green energy sources for POW mining may not be a long-term option”.

Kazakhstan has also followed a similar trajectory, initially welcoming cryptocurrency miners but shutting down mining centres or cutting of electricity supplies to miners in January 2022 due to nationwide electricity shortages.

James Burnie | Partner, Financial services and fintech, gunnercooke

The cryptoasset market has also seen an increased presence of sustainable cryptocurrencies in recent years. Burnie comments, “So far, the issue around sustainability has predominantly centred around Bitcoin. However, some new cryptoassets, such as Avalanche, have made sustainability a core part of their USP and are actively geared towards those who are focused on ensuring sustainability”.

Other notable examples of sustainable cryptocurrency include Cardano, which utilises a POS system; SolarCoin, which creates one coin for every megawatt hour generated from solar energy; and Bitgreen, which rewards users for environmentally friendly behaviour.

“As the techniques behind making these cryptoassets sustainable become increasingly used and accepted”, continues Burnie, “then sustainability may become less of a criticism to cryptoassets. Indeed, as there can be inherent inefficiencies in non-blockchain solutions, it may be that, in some cases, using a cryptoasset becomes more sustainable than the traditional method”.

Can regulations play a role?

Additionally, it seems increasingly likely that the future of crypto will be within a regulated landscape and, if current trends are an indicator, a landscape that focuses ever more on sustainable investments.

As Robson suggests, “Given the green incentives published by countries such as the UK, US, EU and China, it’s important to highlight that we are seeing a shift in what investors are looking for. ESG assets have become incredibly popular in the past few years and the transition to sustainable finance is only going to get bigger in the coming years”.

Burnie adds, “There is an issue here of perception. If consumers are faced with two alternatives, one of which is sustainable and the other not, then they may decide to use the former preferentially”.

Similarly, notable players in the traditional financial market have become increasingly vocal about the potential for cryptocurrency regulations. In 2021, HM Treasury and the Bank of England announced they would be creating a taskforce with the aim of looking into the possible creation of a UK Central Bank Digital Currency (CBDC), a form of digital currency issued by the Bank of England.

In January 2022, HM Treasury released the results of its consultation on cryptoasset promotion, confirming that the UK government will introduce measures to bring a broader range of cryptoassets within the scope of the UK’s financial promotion regulation. The FCA also got involved in early 2022, setting out its intentions to strengthen financial promotion rules relating to high-risk investments, including cryptocurrencies.

Given the volume of proposed changes on the regulatory horizon for cryptoassets and the wider shift in the financial markets towards a more green-conscious approach, the two seem on an inevitable collision course.

Robson suggests, “It’s worth noting that, alongside increased regulation, the UK has recently committed to a net zero economy by 2050, and we are seeing this commitment trickle down into the financial sector. For example, the UK is proposing to impose an obligation on certain UK firms to make public ESG disclosures. These include possibly requiring asset managers to disclose carbon emission data and carbon intensity metrics of the investment portfolios they manage. If this proposal is successful, and crypto becomes fully regulated, we may see crypto mining emissions being included in these portfolios in the years to come”.

Burnie adds a slightly different take: “An interesting point is regarding the assumption that crypto will have to adapt to the existing regulatory framework, whereas in fact it may be in some cases that the existing regulatory framework should adapt to crypto. It may be that these firms shape the future of regulation to come as regtech solutions are developed using this technology as part of ensuring better outcomes for markets and consumers”.

Overall, the reality is that the discussions around climate change are set to become increasingly prominent throughout the financial world, and with ESG assets predicted to exceed $53tn by 2025, the cryptoasset market will have to consider its environmental footprint when looking ahead.

As Robson concludes, “The focus on climate change and the need for sustainability has brought intense scrutiny to cryptocurrencies’ energy usage. Cryptocurrencies and their underlying blockchain technology will need to evolve in line with market needs if it wishes to be successful in the future, though it remains to be seen how sustainable or green crypto will be as an industry in one, three or five years’ time”.


Author

Amy Ulliott

Amy Ulliott is editor of The Legal 500 Caribbean and Nordics