Crypto cannot easily be painted green

Can crypto ever be green? Until recently, this was a question that preoccupied idealists above all. The crypto kids who dived into bitcoin a decade ago were so focused on fomenting a financial revolt against the system that they generally weren’t overly concerned about carbon emissions.

The type of mainstream investors who worry about environmental, social and governance issues today avoided digital assets due to other types of filth; As a report by ChainAnalysis shows, fraud and cyber theft continue to plague the ecosystem.

No more. As 2022 progresses, even heavy asset managers like Fidelity are starting to use crypto to create exchange-traded funds. And, as Goldman Sachs noted this week in a research note, top investors are increasingly including cryptocurrencies in portfolios as a hedge against inflation, alongside gold.

In fact, Zach Pandl, Goldman’s co-director of global currency, rates and emerging markets strategy, acknowledges that bitcoin already accounts for 20 percent of the “store of value” investment sphere (comprising primarily bitcoin and gold). He projects that if that ratio were to increase to 50 percent, the price of bitcoin would double from its current level to $ 100,000.

However, as Pandl also points out, there is a “major roadblock”: physical dirt. More specifically, the process of “mining” bitcoins (that is, creating consensus on a shared computer ledger to make a digital asset) requires staggering amounts of electricity. In fact, bitcoin mining now appears to consume more electricity annually than Finland or Belgium, according to the Cambridge Bitcoin Electricity Consumption Index. Kosovo just banned it for this reason.

Worse still, most mining has historically taken place in China, which is heavily reliant on coal. Hence that tricky question for top investors concerned about inflation in 2022: can you dabble in cryptocurrencies without getting your hands dirty in the real world?

The short answer is “yes, but not easily”. First, the good news: In 2021, this once lawless corner of finance began organizing to go greener. Notably, a coalition of some 200 crypto entities recently joined forces with the Rocky Mountain Institute, a Colorado-based environmental lobby group, to create a Crypto Climate Agreement.

The signatories to the agreement apparently agreed to reduce carbon emissions from electricity use to net zero by 2030, in part through carbon offsets, but also by shifting all blockchain technology to renewable energy sources by 2025 and using tracking tools. energy such as so-called green hashtags.

Last month, the CEC took a step that would have been unimaginable five years ago. He created a serious 32-page template on how to conduct the kind of credible crypto environmental audits that could put a traditional pension fund at ease. Yes, really: the (green) suits have arrived.

Meanwhile, the CEC’s pious promises are being bolstered by two other industry trends. First, Beijing’s decision to clamp down on the industry last year has forced many miners to relocate from China. This makes cryptocurrencies less reliant on coal-fired electricity, as many of the new mining operations choose to adopt renewable energy sources.

Second, industry players are turning to more energy efficient technologies for reasons that go beyond simply “going green.” The key issue is that the so-called “proof-of-work” process used to create consensus on the ledger for bitcoin is too cumbersome for large-scale transactions. Therefore, many of the newer digital assets, such as cardano or solana, have adopted a different process, created in 2012, known as “proof of stake”.

Purists argue that PoS could be less secure than PoW. But it also consumes much less energy. And some digital assets, like chia, have further reduced energy use by adopting a “proof of space and time” algorithm. Taken together, these moves could further reduce the sector’s carbon footprint, particularly since Joe Lubin, a leader in ethereum (the second-largest digital asset) says that ethereum will move from PoW to PoS in the coming months.

However, as Goldman says, obstacles remain. One big problem is that bitcoin remains attached to the PoW consensus and represents roughly half of the $ 2 trillion crypto universe. In fact, Sustainability Fund Monitor suggests, using data from 2017, that bitcoin now accounts for the vast majority of electricity consumption (11 times that of ethereum, for example).

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A second problem is that the industry is so murky that it remains to be seen how much transparency the CEC can actually create, particularly among non-signatories. Or, as the Sustainable Funds Monitor observes: “In the end, the lack of transparency and data makes it extremely difficult to pinpoint that one currency is ‘greener’ than others.” Finally, basket products created by financial institutions could significantly worsen the ESG challenge by mixing assets.

Of course, a cynic (or a crypto enthusiast) might scoff that this problem is no different from other asset classes; Gold, for example, also has a dirty carbon footprint. That is a fair point. But perhaps the key message for investors is this: yes, it might make sense to include cryptocurrencies as a hedge against inflation, but no, it does not offer a free lunch. Digital gold may be going mainstream, but it hasn’t been cleaned of all the grime yet.

gillian.tett@ft.com

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