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Cryptocurrencies and ESG: Challenges and the Potential of Digital Assets for a Green Transition
Overall, the increasing interest and popularity of cryptocurrencies has brought light to the various impacts they have, specifically environmentally. However, if both cryptocurrencies and ESG seem incompatible, there is nevertheless potential for digital assets and blockchain to assist a green transition and address ESG concerns. 
28 February, 2022

ESG and cryptocurrencies are two of the most popular trends right now. In 2020-2021, the price of cryptocurrencies increased vastly – a single Bitcoin was worth more than £45,000 in October 2021 – but there was also a greater awareness of the impact that investments in these can have on the environment. Indeed, with COP26 dominating the news agenda throughout the world, businesses are under unprecedented pressure to operate more sustainably. So, given the major environmental concerns surrounding cryptocurrency and the increasing importance of ESG, are these two developments compatible

1.     Cryptocurrencies and the environment

With increased focus on fighting climate change, the energy usage of cryptocurrencies has come under close examination. Indeed, mining cryptocurrencies – the process of confirming transactions – is extensively energy efficient and produces massive volumes of CO2. According to the University of Cambridge Centre for Alternative Finance, Bitcoin mining consumes more energy than the Netherlands or the UAE. Bitcoin consumes about 0.4% of global energy and up to 150 TWh of electricity every year. The energy consumption of cryptocurrencies is the first clash with ESG principles aiming at mitigating the effects of climate change.

2.     Proof-of-work and proof-of-stake

To understand those energy consumptions, the model that cryptocurrencies use matters. Cryptocurrencies can be classified into two types: those that employ proof-of-work (POW) or proof-of-stake (POS) for ledger validation. POW model :employed by most cryptocurrencies, it is a consensus mechanism that requires computers to solve complicated mathematical problems while also using a lot of energy. Instead of the raw processing power that POW requires, the POS approach uses hard drive storage. Unlike POW, which pays miners with the highest processing power with coins, POS decides that miners who own a bigger percentage of the currency can mine more coins. Bitcoin and Ethereum both use the POW model. While the latter wants to switch to POS, Bitcoin will remain POW. In fact, the Ethereum protocol declared that it would soon complete the move to POS. If the migration to POS is successful, Ethereum’s energy consumption could be reduced by up to 99.95%. In comparison to the estimated 5.13 gigawatts currently utilised per year to mine Ethereum for its POW model, a POS Ethereum could possibly consume as little as 2.62 megawatts per year.

3.     Crypto and social considerations

More than the energy usage, cryptocurrencies and ESG collide on their social plan. Diversity, human rights, consumer protection, and financial inclusion are all examples of the “social” part of ESG. It is plausible to claim that the pseudo-anonymous structure of most cryptocurrencies protects the vulnerable from oppressive governments, and that the possibility to possess bitcoin by anybody with an internet connection promotes financial inclusion. But the necessity of owning a smartphone and having access to the internet does little to assist the poorest. Even individuals who can afford cryptocurrencies confront significant price volatility and the costs of transferring cryptocurrencies into real-world money to purchase goods and services. 

The privacy benefits of cryptocurrencies are true, but they also promote illegal conduct, such as tax fraud and evasion of exchange regulations. Consumer protection is perhaps the most serious contradiction with social issues. For most investors, assets with the volatility of cryptocurrencies are just not suitable investments. Cryptocurrencies are bought and sold on “exchanges” that aren’t regulated  and leverage is provided by a shadow bank that isn’t regulated as a bank.

4.     Crypto and governance 

Applying corporate governance concepts to cryptocurrencies is theoretically difficult. The governance of cryptocurrencies may bring significant issues for boards and investors. Most cryptocurrencies are decentralised.. However, the lack of a governance framework does not imply that there is no governance. Informal communities of software developers, cryptocurrency miners etc. support and promote decentralised cryptocurrencies. While the topics these people debate are frequently technical, their judgments and decisions have the potential to drastically alter cryptocurrency economies.

Moreover, there is an issue of anonymity. Bitcoin is appealing to people who want to circumvent the network of regulations and fines that control traditional currencies and financial markets due to its loose regulatory and enforcement structure.

5.     Green crypto? Potential for green transition? 

All this being said, can the technology behind cryptocurrencies be used to help a green transition? Indeed, blockchain is being used by MENA countries to advance their sustainability agendas. Some companies are driving innovative projects centred at this junction of technology and sustainability, taking advantage of a unique potential for blockchain and crypto’s rise in green efforts. Traditional energy providers, such as Saudi Arabia’s oil giant Aramco, have transitioned to blockchain to boost efficiency and sustainability as the country continues on its path to make renewable energy 50% of its energy production by 2030. Smart city efforts like Dubai’s Sustainable City — the UAE’s first net-zero energy development — and other up-and-coming smart cities are also relying on blockchain to fuel their operations. As a result of the pandemic’s increased awareness of ESG considerations, sustainability-focused funds have grown to about US$2 trillion in assets under management. However, much of the money is still concentrated in Europe and North America. MENA’s blockchain and digital asset innovation, however, has the potential to accelerate green efforts around the world, with a global yearly financial shortfall of US$2.5 trillion to be crossed to accomplish the UN Sustainable Development Goals. 

To develop ESG projects, many local businesses are already embracing blockchain and digital assets. The world’s first token created from the tokenization of a Tesla charging unit was just released in Bahrain, and it is an example of how green technology may be developed while encouraging the usage of digital assets. This is only one example of how digital assets can help ESG projects overcome funding challenges. Tokenization can improve access to assets that were previously inaccessible to institutional and ordinary investors by digitising and fractionalizing big hard assets. 

Moreover, efforts are being made to enhance cryptocurrency’s environmental records. The Crypto Climate Accord is one such endeavour, a private sector initiative inspired by the Paris Climate Agreement with the goal of “decarbonizing the cryptocurrency and blockchain business in record time.” Regulators, on the other hand, remain cautious when it comes to governance. 

Overall, the increasing interest and popularity of cryptocurrencies has brought light to the various impacts they have, specifically environmentally. However, if both cryptocurrencies and ESG seem incompatible, there is nevertheless potential for digital assets and blockchain to assist a green transition and address ESG concerns. 

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