Cryptocurrency investing has not always gone hand-in-hand with ESG. Recent analysis suggests that these two major trends, which loom large over hedge funds and asset managers, are set for a head-on clash.
Cryptocurrency investing has not always gone hand-in-hand with ESG. Recent analysis suggests that these two major trends, which loom large over hedge funds and asset managers, are set for a head-on clash.
Though cryptocurrency has been criticised for its negative impact on the environment – particularly the energy-intensive bitcoin mining process – recent studies suggest institutional investors are more concerned with regulatory and security issues surrounding digital assets than their carbon footprint, with research from Fidelity Digital Assets highlighting volatility as the biggest worry, and a report commissioned by Nickel Digital Asset Management revealing crypto security as the biggest concern for allocators.
But it’s also clear that ESG factors remain vitally important to firms and clients, with Federated Hermes finding that 88 per cent of institutional investors view ESG factors as more important than financial metrics when evaluating a company’s attraction.
So, as the USD2 trillion-plus digital assets industry widens its appeal to institutional investors (Nickel Digital’s study reveals 43 per cent have a more positive view of cryptocurrency), how are market participants balancing this surging appetite alongside the ongoing push for green investment, just two months after the COP26 climate summit in Glasgow highlighted the scale of the climate challenge?
“It’s not the job of asset managers to be picking investments based on ESG criteria; I fundamentally disagree with it,” says Paul Frost-Smith, founder and CEO, Corinthian Digital Asset Management.
Though Frost-Smith concedes that his view is “not the consensus one”, his stance is founded on the view that ‘ESG-aligned’ remains an unclear notion across the industry, and sometimes represents open and empty promises in the form of tick boxes. He also believes it slows down or prevents much needed allocations to companies and projects in emerging and developing countries which are least able to meet the criteria.
Vetting companies
“The job of your asset manager is to make you the best returns they can, within the risk parameters that are laid down. It’s not to be vetting third-party companies to see if they’re ticking boxes on a form to say that they’re going carbon neutral,” he adds.
“By and large, with perhaps the exception of Algorand and Harmony, most cryptocurrency requires proof-of-work, and yes that undoubtedly consumes a large amount of power, a lot of which doesn’t come from renewable sources.”
Anatoly Crachilov, founding partner and CEO, Nickel Digital Asset Management, takes a different view, suggesting that the industry’s shift towards proof-of-stake, which is much more energy efficient, and away from proof-of-work, is evidence that ESG and cryptocurrency can work conjointly.
While acknowledging that it’s unlikely for bitcoin to switch to proof-of-stake due to resistance from the community, Crachilov argues that bitcoin drives the cost of renewables down.
“It can be energy intensive, but most of the mining today comes from renewables, not from burning fossil fuels,” he says.
Market participants note that as bitcoin miners moved beyond China – a significantly coal-based economy – to countries such as the US and Kazakhstan, they took the opportunity to switch to greener forms of energy, particularly solar energy, with crypto mining emerging as a major buyer of solar panels.
The Bitcoin Mining Council survey found that bitcoin mining’s electrical mix increased to 58.5 per cent renewable in Q4 2021. However, the data around the asset class can often be unreliable and contradictory, making it difficult to assess exactly how much damage is being caused through higher carbon emissions for example.
Ultimately, “until the world and protocols move towards proof-of-stake across the asset class as a whole, this is going to continue to be an issue”, Frost-Smith notes of the energy consumption question, “although things have improved since the Chinese mining ban.”
He believes that while the main concerns are often centred around energy consumption and pollution, on the social and governance side, it remains difficult for crypto assets to meet the criteria.
“Crypto can’t really tick the ESG box; you go into crypto for the higher returns and the diversification benefits. If you’re investing in hedge funds, you want returns and we’re all measured on our monthly performance. You just have to trade your way and at the end of the month, do your carbon offset, but at the end of the day hedge funds are for producing returns, not saving the environment or improving social norms,” he adds.
Social equality
While the environmental aspect in ESG is often the central focus when it comes to cryptocurrency, a recent study by Stanford University points to how crypto may serve as a powerful tool for social equality.
Digital assets evangelists have also hailed crypto as a non-discriminatory asset class which allows those with less traditional forms of investment and banking to access these opportunities. Citing the Stanford University findings, Melbourne-based crypto investment firm Apollo Capital, which invests on behalf of family offices and institutional investors mainly in Australia, noted in an analysis paper how the asset class is open and inclusive to unbanked sections of the population, particularly women, offering access to finance and markets where they previously may have been deprived.
While this time last year many might have assumed that ESG alignment and crypto would only ever collide in investment portfolios, there is perhaps a possibility for them to complement one another to a certain point after all.
Read the full Institutionalising Digital Assets: Powering the hedge fund crypto surge Insight Report here.
