Ben Ashby, Partner, Good Governance Capital, surveys the ESG risks of the crypto-currency space.
Who remembers MySpace? What about Betamax? Both were the future – once. Today, Bitcoin has a valuation that recently topped US$60,000 and growing ranks of advocates who see it as digital gold, or a hedge against fiat currency inflation.
It’s more likely that Bitcoin’s future is as a kind of monetary MySpace. The rise of central bank digital currencies (CBDCs) threaten to make it so-called Dodo code, obsolete software rendered extinct by evolutionary change. Bitcoin’s biggest weakness, though, is its appalling environmental, social and governance credentials. This has the potential to make it the digital equivalent of a stranded asset – like a coal project on a bank’s balance sheet – and hasten its obsolescence.
A high-carbon currency?
The energy intensity of Bitcoin-related activities is not disputed by its advocates, but the magnitude and nature of its energy use is still poorly understood. Bitcoin and its crypto sister currency Ethereum are power hungry by design. For many Bitcoin enthusiasts, this vast energy usage is a ‘feature not a bug’ because they believe that is how Bitcoin derives its value. This appears to be an example of the ‘sunk cost fallacy’ in its most basic form.
Based on data from a recent study by the University of Cambridge, Bitcoin’s estimated electricity use is equivalent to that of Ukraine, a country of 44 million people. However, that is just a guess as to the average, though: Cambridge believes it could be much higher at peak times. Other studies suggest a far greater impact which is only likely to increase in the future.
Some argue that, because Bitcoin mining is so energy intensive, it is forced to chase cheap renewable electricity. Estimates of this renewable electricity component range from 30-70%.
However, claims towards the upper end of this range just do not stand up to scrutiny. Bitcoin mining does not largely occur in countries with a high proportion of renewable energy generation. And although 36% of global electricity comes from low-carbon sources, only around 10% comes from variable renewables, such as wind or solar. That implies very high odds that most Bitcoin is mined using less green sources of electricity.
So it is more likely that the utilisation of renewable electricity in Bitcoin creation is closer to 30% than 70%. In any case, given the known energy intensity of the creation process, the burden of proof falls on Bitcoin miners to demonstrate their green credentials.
There’s a problem, though. With its current underlying blockchain architecture we don’t believe that it’s possible to reliably audit the carbon footprint of Bitcoin mining as it’s not possible to determine accurately from where the electricity used to mine Bitcoin was generated. It’s also unlikely that the concerns of many ESG-focused investors will be assuaged by the use of carbon offset schemes, as some investors are suggesting. Unlike industrial activities that use offsets, there is no intrinsic reason why this mining activity has to happen.
Social and governance
Many societies have made democratic decisions about what taxes should be and what activities should be illegal. We understand cryptocurrency users’ desire for privacy, but they don’t have the right to put these social norms at risk.
In traditional finance, there has been a constant increase in anti-money laundering and know-your-client regulation over the past few years. It is likely that regulators and legislators will also turn their attention to alternative payment systems, for which anonymity and the lack of central control are key features.
The Financial Action Task Force, an international body that coordinates global action against money laundering and terrorist financing, has gone further and announced a public consultation on virtual assets. This seems to indicate that the burden of proof will fall on users and providers of these activities. This growing regulatory movement against cryptocurrencies was recently recognised by the World Economic Forum, which said it expects “dramatic changes in regulation.”
Finally, no advanced country is going to allow their monopoly on money to be threatened. This has already been made expressly clear in the Eurozone and we expect other major countries will follow.
Back to the future
One of the key claims of crypto advocates is that they are forward-looking, embracing the future of money. So it’s ironic that they don’t seem to have grasped that this future conflicts with efforts to limit climate change. That makes it highly unlikely that regulators will allow anything based on the most common forms of blockchain, such as Bitcoin and Ethereum, to persist in their current forms. The evolution of less energy-intensive substitutes also seems probable.
The questions we should be asking are more about when governments will take action on cryptocurrencies and what form it will take, rather than whether they will act. Will it be an outright ban like the one proposed by India or the imposition of a levy that perhaps combines features of a Tobin and carbon tax?
In any event, the prospect of CBDCs could render the whole debate about Bitcoin redundant. This is a key point that is often overlooked: cryptocurrencies are still an infant technology and might yet prove to be a dead end. But crypto enthusiasts, like MySpace boosters in their time, believe they have perfected digital currencies first time and that Bitcoin is future-proofed. Ironically, these self-proclaimed forward thinkers can’t see that Bitcoin may well be a digital stranded asset – and already a relic of the past.