Crypto Investments with Sustainability in Mind

Market Insights Oct 20, 2022

Views from Lionel Rebibo

The digital asset and cryptocurrency space is now moving out of its infancy and into adolescence, but how do we understand the operational effectiveness for these crypto indices? In traditional finance, Environmental, Social and Governance (ESG) metrics are commonly used to help gauge both the sustainability and longevity of a business. At Trakx, we believe that ESG metrics will be imperative to understand the health of crypto exchanges and tokens. We will be defining what ESG means for crypto and how to measure it based on our research.

Crypto and ESG

Perception vs. Reality

Crypto has something of a bad reputation with traditional ESG perceptions. The broader community commonly associates blockchain protocols like Bitcoin with bad environmental practices and the media often discusses this point at length, creating equivalencies between Co2 consumption and the carbon footprint of large nations. However, there are some inaccuracies with these calculations.

To fix these errors, let's look at the hashpower of Bitcoin’s network. This power draw has the same carbon footprint as approximately 300 commercial airliners in the sky. This number sounds bad, but pales in comparison to the roughly 8,000 airliners that are currently in the sky right now, in the middle of the week with no holidays.

In terms of global Co2 emissions, Bitcoin mining actually only accounts for 0.1% of this total. Additionally, Bitcoin tends to follow global trends for energy consumption for the entire energy market, with 40% of the total power consumption of Bitcoin composed of renewable energy sources.

As a whole, Bitcoin miners are largely energy agnostic. Their priority is to find the cheapest source of electricity as this reduces their overhead costs for running a data center. Mining operations are very mobile and can be installed virtually anywhere, allowing Bitcoin miners to invest in stranded energy sources to take advantage of cheap excess power like hydroelectric or flared gas.

In this way, Bitcoin is actually able to capitalize on energy sources that other industries find harder to exploit, which means Bitcoin is naturally becoming more environmentally friendly by virtue of how it operates.

What about the social and governance aspects of ESG? Here, crypto and Bitcoin by extension fare particularly well. Bitcoin by its design is intended to give money back to the people, acting as a decentralized value proposition against traditional centralized financial structures. These aspirations are noble, but of course there are some outliers. Terra USD is an excellent example of decentralized finance being mismanaged and resulting in a complete crash of the token’s value.

In conclusion, cryptocurrencies are not as ESG averse as many assume, and will continue to move towards cleaner energy models as renewable resources become more prevalent. Still, understanding the potential issues and identifying problematic practices will remain important for this industry. Our Trakx ESG index will be particularly useful for our clients to ensure the safety of investments for the future.

ESG Crypto Assessment

Green Crypto Research is a non-profit organization based in Zug, Switzerland, that specializes in evaluating the sustainability of digital assets and crypto tokens. Founded in May 2021, Green Crypto Research has developed the world’s first standardized ESG rating for crypto assets.

As a partner with Trakx, Green Crypto Research has rated 24 different blockchains and 38 digital asset tokens, with a focus on crypto assets in the top 100 based on market capitalization. Prior to the development of their ESG crypto metric, the worlds of crypto and ESG rarely intersected.

The methodology to achieve this ESG rating is based on a technological assessment that leverages both qualitative and quantitative data points. Each assessment consists of 90 to 100 data points, which are scored on a scale of 1 to 10. These scores are made relative to other crypto assets, allowing for easy comparison across assets that have a similar structure. Each of these assets receive a full rating every 6 months, or based on a current event such as the Ethereum merge.

In order to avoid outliers, cryptocurrencies are put on an outlook positive or negative for 3 months to determine if the data is sound. This allows for errors and outlier data to be mitigated. In addition, crypto tokens and crypto blockchains are scored separately for ESG metrics given that tokens can exist across different blockchains. Tokens are scored both on their own individual rating and the rating on the blockchain they are traded on, with the blockchain of each token comprising one third of the ESG score.

Quantitative measurements include key metrics like energy consumption, pollution and waste, and the aspirations for net zero carbon emissions. For social and governance metrics, the social impact and asset distribution are measured using a grading scale, as well as barriers to entry for new investors, network diversification and governance issues.

This data is aggregated from multiple sources, starting with facts provided by the crypto asset such as their homepage and social channels. This data is then fact checked against research and media reporting across multiple channels, as well as models and calculations curated by Green Crypto Research that is used as a benchmark.

ESG Rating of Ethereum

Prior to the merge, Ethereum had a C rating for their ESG score due to their proof-of-work model. With the merge and the move towards proof-of-stake, Ethereum has moved up to achieve a B rating on their relative ESG score.

The primary driver of this change is the reduced energy demand to run the Ethereum network. Environmentally, Ethereum has a much more sustainable model and produces far less pollution than its previous model. However, based on our analysis over 6 months, Ethereum has not made further aspirations towards net-zero emissions. This in addition to the high barrier to entry for new investors is largely the reason for the B rating.

Difficulties with Determining Crypto ESG

Developing an ESG rating for crypto assets is a difficult task, for a few key reasons. The lack of standardized and transparent data regarding sustainability means that each asset requires case-by-case analysis. Additionally, because crypto assets are a relatively new field of finance, there are very few academic research papers and resources on the sustainability of crypto to draw from. Finally, because of the newness of crypto markets, there is limited scalability relative to other financial markets.

Crypto ESG Findings

When Bitcoin was founded in 2009, sustainability was not as important a factor as it is today. Criticism of the ecological footprint of cryptocurrencies only emerged recently for both traditional finance and crypto assets.

Today, some younger crypto assets have implemented sustainable practices since their inception and have incorporated it directly into their business strategy. Still, the number of cryptocurrencies actively addressing sustainability issues within their structure is limited.

The bulk of sustainability efforts from cryptocurrencies is focused on their overall power draw and turning to renewable energy sources to power their operations. This ties into the natural inclination of crypto tokens and blockchain networks seeking out cheaper and cleaner energy avenues simply as a result of their overhead costs, with continued focus being placed on taking advantage of renewable power.

Sustainable standards are not yet state-of-the-art in the crypto world, but this is changing rapidly. To assist this, standardized data and ratings will be key to defining what goals should be set and what practices will work best. The crypto world has evolved dramatically since the inception of it in 2009, and newer crypto assets will likely factor in sustainability directly into their business model as this industry continues to develop.

Trakx ESG Index

Tradable since August 2022 on, Trakx ESG Index replicates A rated crypto-assets in terms of Environment, Social and Governance. Trakx relies on Green Crypto Research to score the largest assets in all three areas. This index essentially captures the growth of best in class protocols, focusing on strong environmental, social and governance practices. Trakx ESG factsheet is here.

Carole Laizet

Senior marketing manager with 15+ years of experience in the Financial Industry (traditional Banking as well as Crypto Assets). Responsible for market research