An ESG Assessment of Crypto
By Rick Lacaille, Global Head of ESG, State Street
Cryptocurrencies get a bad reputation from environmentalists. And with good reason. According to the Cambridge Bitcoin Electricity Consumption Index, bitcoin consumes more electricity in a year than an entire country the size of Sweden, Norway or the United Arab Emirates.1
So does that mean the environmental case against cryptocurrency is closed or are there ways to mitigate crypto’s environmental impact? And what about other environmental, social and governance (ESG) priorities that investors might have. This article explores crypto’s environmental impact as well as a broader range of ESG priorities.
Crypto’s environmental impact remains negative for now but with potential for mitigation.
To understand crypto’s environmental impact, first you have to understand the relationship between virtual currency and the physical infrastructure, and the operating inputs it requires. As a digital representation of value, cryptocurrencies use distributed systems to store and transfer ownership securely through a cryptographic process based on complex computations.
Essential aspects include:
- The decentralized nature of cryptocurrency requires independent computers to agree on which transactions are legitimate to ensure accuracy. Depending on the currency’s design, different algorithmic consensus mechanisms can have different levels of energy efficiency.
- Transparency about historic transactions and the wide use of omnibus accounts by crypto exchanges removes the need to record derivative ownership transfers on the blockchain (so-called on-chain activity versus off-chain). As a result, there is no full transparency available.
- Cryptocurrencies are designed to operate globally on a 24/7/365 basis, but the speed of transactions can vary, depending on the currency’s design and other operational factors.
There are different methodologies to control how the network agrees to update to a blockchain ledger. These methodologies differ in terms of speed, scalability and so-called ‘Byzantine fault tolerance,’ in other words how resilient the network is to malicious actors and whether the interaction between participants is based on other trust mechanisms or not.
Cryptocurrencies which use so-called permissionless or trustless networks, such as bitcoin, adopted the so-called proof of work methodology (PoW) with anonymous miners. Miners, who could be anyone in any geography, compete to add a set of proposed transactions as a new block to the network by solving a mathematical challenge whose complexity is adjusted with respect to the computer power available. This model consumes increasingly large amounts of energy especially if the cost of energy is lower than profit from this mining activity, which may be derived from the voluntary fees paid to miners and a specific network reward.
Various estimates have been made about the impact of bitcoin on the environment. For example, a group of researchers from the University of Hawaii calculated that with widespread adoption, bitcoin emissions alone could push global warming above 2°C within less than three decades.2
However, determining precisely how much energy is consumed by the bitcoin is difficult. Whilst many aspects of providing services related to crypto (e.g., crypto exchange and trading) have increasingly been brought into the regulatory perimeter, in most cases mining is not regulated. Miners can enter and leave this market, their identities are not clear, and neither is the efficiency of their computer hardware. Energy consumption for bitcoin is estimated based on further estimation of the computer power in the network (hashing power) and a set of assumptions about how miners operate (Figures 1 and 2).
Other cryptocurrencies have adopted a different consensus algorithm generally referred to as proof of stake (although some are hybrid models that combine proof of stake with other approaches e.g., proof of history). Proof of stake (PoS) implies that the network choses a participant to make the next update based on the length of time and quantity a participant held the respective cryptocurrency and an element of randomness. While arguably less secure, this methodology is significantly more energy efficient and offers the higher transaction throughput and thereby operational efficiency.
The industry itself recognizes that cryptocurrencies like bitcoin and ethereum have an environmental problem. A campaign to switch bitcoin mining from PoW to PoS called “Change the Code Not the Climate,” estimates the move could reduce bitcoin’s carbon footprint by 99 percent. In the case of ethereum, efforts have been underway for six years to move from PoW to PoS. In theory, the move offers to cut ethereum’s greenhouse gas (GHG) emissions by almost 100 percent.3 But in practice, the switch is complex and has not been fully accomplished.
Efforts are underway in the crypto industry to make mining more sustainable by relying on renewable energy.4 However, current estimates of the share of renewable energy used to power bitcoin mining varies widely, making it hard to pin down. For example, CoinShares found that as of December 2021, renewables contributed under 30 percent of bitcoin mining while the Bitcoin Mining Council puts that figure closer to 60 percent. A recent Science Direct research paper found that the share of renewable energy powering Bitcoin decreased from 41.6 percent to 25.1 percent after China’s crack-down of crypto operations.5 Miners in China had access to renewable sources, but this was lost when mining was forced to move to countries such as the US and Kazakhstan.
The industry has also formed the Crypto Climate Accord (CCA) in 2021, to achieve net zero emissions from electricity consumption for CCA signatories by 2030 and to accelerate the adoption of and verify progress toward 100 percent renewably powered blockchains by 2025.
While it is uncertain whether bitcoin and ethereum will switch to PoS, it is clear that if cryptocurrencies are to be widely adopted, they will have to mitigate their environmental impact.
Crypto could have a significant positive social impact by promoting financial inclusion
When it comes to social impact, the case for crypto is far more positive. Cryptocurrencies can promote financial inclusion by driving innovation in financial services, like peer-to-peer micropayments, potentially providing accessibility to all (with an internet connection) and reducing costs by automating financial services at scale.
The World Bank estimates there are 1.7 billion people in the world today, or about a third of all adults, who are “unbanked,” and in some developing economies, that figure is as high as 61 percent.6 Without access to affordable financial services such as credit, savings, insurance and payment, those 1.7 billion are not fully able to participate in the economy and lack essential tools to grow household income and wealth.
The benefits of promoting financial inclusion are well known. The McKinsey Global Institute calculated that widespread use of digital finance could boost annual GDP of all emerging economies by US$3.7 trillion by 2025, a 6 percent increase versus a business-as-usual scenario, and create an addition 95 million jobs across all sectors.7
In Nigeria, where one in three adults lack access to financial services, the government launched a central bank digital currency (CBDC) pilot program in October 2021, called eNaira to promote financial inclusion. As of December 2021, 666,000 speed eNaira Wallets were created, more than 35,000 total transactions worth US$500,000 were registered, and there are expectations that 90 percent of the population will be able to use eNaira. While a CBDC is not a cryptocurrency, it illustrates the potential of digital currencies to deliver significant economic and social benefits.
El Salvador approved a proposal to make bitcoin legal tender in June 2021. The statement from President Nayib Bukele at the time said that bitcoin was made legal tender to “bring financial inclusion, investment, tourism, innovation and economic development to El Salvador.” So far it has been difficult to assess the impact crypto is having there. In January, 2022 a government endorsed report calculated there were at least four million users (about the entire population of El Salvador) but a few months later, a report by the Chamber of Commerce and Industry of El Salvador reported that 86 percent of businesses contacted had never used bitcoin in a transaction.8
There are also potentially large benefits from cryptocurrencies facilitating cross-border transfers for small values at low cost as they do not require currency conversions. Companies like Bitpay are already multiplying in this space. A report by Oliver Wyman and J.P. Morgan found that digital currencies could save global corporations over US$100 billion a year in transaction costs when it comes to cross-border payments.9 And this does not take into account the benefits for small businesses or entrepreneurs to facilitate cross-border economic activity.
While there is a case for cryptocurrencies to promote greater global financial inclusion, it will take time and wider adoption before the evidence materializes. However, the developing use of digital currencies including crypto seems set to offer a naturally competitive way of reducing some of the negative aspects of the financial system for the poorest in society.
Without regulation, cryptocurrencies can introduce risk into the financial system
By design cryptocurrencies are decentralized, so there is no single body overseeing crypto strategy or direction. For many proponents, that is indeed the beauty of such systems, but this beauty might come at a wider cost. Cryptocurrencies can add risk to the financial system, including by facilitating criminality, lack of education, lack of transparency, and lack of regulation and oversight. As crypto becomes part of the investment landscape, proper risk governance will be key if it is to be widely adopted.
Cryptocurrencies can be used for nefarious purposes and ransomware. Chainalysis, a crypto analytics firm, found a massive spike in the amount of cryptocurrency ransomware attackers from over US$412 million in 2020 compared to just US$93 million in 2019.10
While crypto has a reputation for providing cover for illegal activity, so far those who have tried to measure the extent of illicit activity find that it may only make up a relatively small portion of total activity. According to another study by Chainalysis, the share of illicit activity to total crypto activity from 2017 to 2020 was less than one percent. In comparison, the estimates of illicit activity in the economy as a whole was on the order of two to four percent of global GDP.11 However, a 2022 report by Chainalysis found that cryptocurrency-based crime was at its highest level in 2021, yet transactions involving illicit activity represented just 0.15 percent of cryptocurrency transaction volume in 2021.
Whether those figures are correct remains subject to debate. Even if they are, cryptocurrencies will retain their attractions for criminals and others wishing to hide their tracks. That implies introducing better KYC regulations, periodic reporting and potentially a framework, which includes penalties for violation of disclosure requirements. In the end, finding the right balance between the attractions of anonymity and increasing trust in cryptocurrencies through disclosures will be key and a delicate balancing act.
As things stand today, an ESG investor would have a tough time making the case for investing in cryptocurrencies. Both the negative environmental and governance impacts go a long way to cancel out any potential positives for increasing financial inclusion. However, that may not always be the case. The industry recognizes it has an environmental problem and has options for reducing its carbon footprint. At the same time, governments are accelerating efforts to provide regulatory and oversight frameworks that foster trust and reduce risk in the financial system. Over the longer term, widespread adoption of cryptocurrencies will very likely depend on how well ESG considerations are addressed.
The developing use of digital currencies including crypto seems set to offer a naturally competitive way of reducing some of the negative aspects of the financial system for the poorest in society.
 Mora, C., Rollins, R.L., Taladay, K. et al. Bitcoin emissions alone could push global warming above 2°C. Nature Clim Change 8, 931–933 (2018). https://doi.org/10.1038/s41558-018-0321-8.
 Ethereum’s energy usage will soon decrease by ~99.95% | Ethereum Foundation Blog
 3rd Global Cryptoasset Benchmarking Study - CCAF publications - Cambridge Judge Business School
 Revisiting Bitcoin’s carbon footprint - ScienceDirect
 MGI-Digital-Finance-For-All-Executive-summary-September-2016.ashx (mckinsey.com) - https://www.mckinsey.com/~/media/mckinsey/featured insights/Employment and Growth/How digital finance could boost growth in emerging economies/MGI-Digital-Finance-For-All-Executive-summary-September-2016.ashx.
 Six months in, El Salvador’s bitcoin gamble is crumbling - Rest of World
 Unlocking $120 Billion Value In Cross-border Payments (oliverwyman.com)
 The Chainalysis 2022 Crypto Crime Report