By Lionel Rebibo, CEO of Trakx
June 25, 2022
Environmental, Social and Governance – or rather ESG. This term was born in 2005 at The Who Cares Wins conference. Attendees included representatives from leading financial institutions and government bodies and regulators, who collectively examined the role of ESG value drivers in asset management and financial research. While the term ESG may have been created, make no mistake, ESG has been part of everyday investing for decades and our everyday lives for centuries.
So what is ESG investing? In its simplest form, investors exclude purchasing financial instruments in organisations that exhibit poor ethical behaviours where ethics can be applied to all three.
Take the environment to start. This includes organisations that pollute the environment, use up precious natural resources, or have policies and practices that go against our will to protect the climate (think big oil, electricity and manufacturing).
Then consider social. This could include organisations that make products that are harmful to the environment or to the human body, or have labour footprints in regions with “harsh” labour conditions (think big tobacco, minerals and mining).
The more recent addition is governance. Governance has become a major driver in investing due to global attention paid to diversity, business ethics and overall corporate behaviour.
I believe that investors have always considered ESG as three individual and collective factors in their investment thesis. It has just become more prominent today given the environment and especially with the increase in media scrutiny (and the internet).
A few facts to show just how prevalent ESG has become:
- According to an HSBC sustainable financing and investing survey 2021, 59% of investors have a general ESG policy in place, up from 52% in 2020.
- HSBC also noted that 85% of large investors ($25B+ in assets) have implemented a company-wide approach, versus 34% of smaller institutions (< $1B in assets).
- In 2021, there was an estimated $35 trillion in ESG assets, expected to reach $41 trillion by the end of this year and over $50 trillion by 2025 (Bloomberg Intelligence).
- Further, Global Sustainable Investment Association estimates that ESG-related assets account for one in three dollars managed globally.
I think you get my drift…now enough about ESG when we talk about traditional finance and let’s talk ESG as it relates to crypto!
Crypto hit the scene more than a decade ago and we’ve witnessed its rapid rise throughout the world. When people think crypto – they tend to think Bitcoin, mining and the environment. Of course, crypto is much larger and touches an entire ecosystem addressing blockchain technologies, digital assets, and more. Since the start however, there has been this negative association that crypto and the way in which mining is done, negatively impacts the environment. Let’s take a further look to see why.
As originally conceived, cryptocurrencies were mined using energy-computing power to create transactions on the blockchain. Both Bitcoin and Ethereum, the two largest cryptocurrencies by market capitalisation and transaction volumes, still use these Proof-of-Work (PoW) consensus protocols. Under these protocols, miners solve complex mathematical functions (hash functions) in order to qualify to include transactions in the blocks that form the blockchain. Other more recently developed blockchains use Proof-of-Stake (PoS) consensus algorithm, whereby blocks are created and validated by validators. These algorithms are much more efficient in terms of energy consumption to validate transactions. Ethereum, the largest smart-contract blockchain,is scheduled to switch to PoS in August/October 2022.
Crypto companies have been creative in trying to come up with environmentally-friendly alternatives to mining without being mandated by government or industry.
They have come together to form associations and industry think-tanks to positively impact the environment faster than most industries and in many cases without the government directing or mandating them to do so. Over the past decade or so, the narrative has shifted and investors are starting to bet on cryptocurrency becoming more ecologically friendly. In our September 2021 blog titled, Are Cryptos Going Green?, we explored the many ways in which the industry has evolved, from Proof of Work to Proof of Stake protocols, to Green Layer 2 solutions built on top of the blockchain, to enhancements in coding. The conclusion here was the same nine months later - the crypto community is adapting to a more energy conscious public demand and working to build a more sustainable 21st century asset.
We’ve talked a lot about the environment, but there is more to ESG.
Let’s start with Social. When we think about social in the context of ESG, we are talking about a lot of things. Gender equality, race and ethnicity, executive pay scales, labour and workforce conditions to start. We also think about business ethics and corporate values, and a company’s impact on society as a whole. Here too, I believe digital assets, which include cryptocurrencies, tokens, protocols, blockchains, etc. provide social value.
Crypto is about inclusion, which is the driving force behind my thesis. It opens up a financial world to people that may not have access to financial institutions or the services they provide. Crypto can be used as a form of currency for those without access to traditional currencies, and can even be used as a storage or savings tool to combat inflation or recessions. Crypto is transparent and open, which means that anyone, irrespective of race, ethnicity or gender can become participants in the crypto revolution. Crypto as a new industry, or rather industries, has led to job creation and let’s not forget, it has become a popular payment option for consumers around the world! Our views now haven’t shifted much from our October 2021 blog, The Social Missions of Cryptos.
And lastly governance. I go back and forth on this one. You can talk about decentralised networks and the risks without regulation. Then you can make a case that in a decentralised environment, you have greater transparency as no one has complete control and that crypto protocols’ remain open to anyone. Governance can mean a lot of things. From a network and protocol perspective it’s about decentralisation vs. centralisation and I’ve already stated my views on this – both will co-exist and thrive. But then think of governance from a corporate perspective – the industry is still in its infancy stage and companies are doing the right things to foster strong corporate governance practices.
In our November 2021 blog, Digital Assets for a Better Community Governance, we discussed the history of DAO, so I won’t rehash what you probably already know. But there were two key take-aways. The first: the code of the DAO is open-sourced and developed in a decentralised manner. It creates more efficient systems by reducing the need for human inputs, which in turn, reduces the overall operational costs and the risks related to human behaviour. Second, DAO’s are emerging as a new model of community governance in that individual users not only built, operated and funded a community, but they owned it. Now think about investing in ESG. Investors purchase stock in companies and own a part of what they purchased. With cryptocurrencies or ESG tokens or protocols, you have direct ownership as well.
So what do I mean when I say ESG in a Perfect Crypto World?
ESG isn’t going anywhere anytime soon and frankly, will become even more important to the investing public as time evolves. The growth of ESG investing is staggering as I noted earlier and makes up a very large percentage of institutional investment on a global scale.
In a Perfect Crypto World, we have industry coming together to protect the environment, drive meaningful reform in social practices and uphold the highest standards of governance. At Trakx, the Top 10 PoS Index and Top 10 DeFi Index are solutions to get an exposure to ESG protocols, on the energy and governance aspects. We are also planning to launch an ESG Index that will gather the best ESG rated protocols. Stay tuned for more on this topic and I hope you enjoyed the read!
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