Other parts of this series:
In Part Three of this series, we explored the identification of cryptocurrency red flags and how the financial industries’ regulatory environment protecting the consumer is not always in their best interest. In this blog, we analyze the challenges and best practices of indirect cryptocurrency emissions reporting, the impacts this emerging technology will have on our social landscape, and the deficits of this new governance structure.
The ESG issue and opportunities
As pointed out in a recent MSCI publication1, investors are increasingly subject to ‘Creeping Cryptocurrency Exposure’ through direct and indirect investment in companies that hold digital assets. As companies are increasingly pushed to include ESG-related risks and opportunities in their financial disclosures, it is important for all investment portfolios to understand the impacts of decentralized finance (DeFi).
‘E’ for Environment
Emissions Reduction and Cryptocurrency Mining
Since the IPCC’s Sixth Assessment Report spurred alarming headlines like ‘Code Red for Humanity’ 2, the environmental footprint of decentralized finance has come into focus: blockchain mining and transactions use a tremendous amount of power compared to credit card payments, with Bitcoin alone accounting for 0.5% of the entire globe’s electricity consumption3.
Key factors driving fossil fuel consumption are how and where mining occurs: proof of stake (POS) has been shown to leave a lesser footprint than proof of work (POW), as does cryptocurrency mined in places with greater renewable energy adoption4. Additionally, a given currency’s transaction speed positively influences payments’ energy consumption.
The transition to clean energy has gained momentum, including a commitment by Ether developers (among the most popular digital currencies) to introduce more sustainable mining. In 2021, the Crypto Climate Accord was formed, inspired by the Paris Agreement. 250 institutions and individuals signed on to commit to net-zero by 2030 through developing green technology and purchasing carbon offsets. Well-known supporters include KPMG, Ripple, RSK, and Curate, among others (it is worth noting that carbon offsets are typically considered a last resort by climate activists and organizations like the Science-Based Targets Initiative, suitable only for residual emissions unable to be avoided).
Cryptocurrency and Emissions Disclosures
Regulators globally are considering mandatory emissions reporting, and investors are now pushing to understand companies’ carbon footprints. Non-financial companies must understand their direct and supply chain-driven emissions, and asset managers may soon be expected to quantify the total environmental impact of their portfolios and products. This could certainly encompass mining and payments, as well as any financed emissions through cryptocurrency held. There are currently classification challenges with reporting cryptocurrency holdings, as well as evolving regulation regarding sustainability and climate reporting, making crypto-driven emissions reporting even more complex.
However, legislation is rapidly evolving to address all these challenges. For example, the EU recently introduced a classification system for reporting sustainable initiatives and is working towards a Digital Finance package. Similarly, SEC chairman Gary Gensler has stated that climate disclosure regulation is coming; it could thus require all cryptocurrency classified as a security, using the Howey Test, to disclose emissions5. While cryptocurrency emissions may seem difficult to achieve, companies must work towards a solid foundation of both cryptocurrency holdings transparency and climate risk reporting as regulation evolves.
‘S’ for Social
At their best, features of decentralization such as anonymity, transparency, and cybersecurity may contribute to alleviating social inequalities through their equalizing effect. DeFi has been prophesized to resolve issues such as banking the unbanked, solving world hunger, and freeing consumers from hyperinflation. For example, although the Global Remittance Market, a $700 billion industry, allows for cross-border transactions via electronic payment, drafts, and checks6 it still consists of significant fees, slow transactions, potential errors, and often requires customers to physically travel to local financial institutions. With the utilization of cryptocurrencies, these transactions cost a fraction of the fees, which are provided to other users of the blockchain, take seconds or minutes, and the transfer cannot be disputed once part of the immutable ledger.
Lisa Wang, founder, and CEO of SheWorx, points out that Initial Coin Offerings (ICO’s) are a quick way for women-led start-ups to raise capital in a way that “fundamentally erases…bias” associated with typical fundraising7. In practice, however, a male-dominated culture has evolved around cryptocurrency trading; for example, research has found that only 4% of cryptocurrency investors are Black women, and 19% are white women8. The hyper-masculine culture around cryptocurrency investing was punctuated by the official 2018 North America Bitcoin Conference, where 84 of 87 speakers were male, and the “official conference party” was held at a strip club. The volatile nature of cryptocurrency investing may also discourage those who are already subject to greater financial insecurity from investing9.
The volatility associated with cryptocurrency has also been criticized to spur gambling addictions. The National Gambling Helpline in the UK reports 20 calls per week about cryptocurrency trading; gambling rehabilitation facilities are also starting to see patients with trading addictions. Some cryptocurrency firms have leaned into retail investor hype; the Guardian showed that cryptocurrency firms were behind 40,000 advertisements in 202110, and a Google search for “Cryptocurrency marketing” will return dozens of services willing to build your cryptocurrency brand.
To realize the social benefits of cryptocurrency, companies must look for ways to champion blockchain and cryptocurrency projects led by diverse and underrepresented groups through accelerators and investments. Companies must also plan to educate investors and other company stakeholders to bridge skill gaps forming behind this rapidly evolving technology. Additionally, companies may rethink coin issuance and marketing, being cautious to evaluate marketing statements through the level of rigor applied to financial advice where applicable.
‘G’ for Governance
A key feature of DeFi is that no governing body is wholly responsible for a given cryptocurrency but rather the entire ecosystem – as such, governance decisions are made by informal stakeholder groups including developers, users, and miners. There are two types of decentralized governance in use11:
- On chain governance, used by Bitcoin, implements changes through a stakeholder vote where all parties on the blockchain must verify an update. Decision-making records are publicly accessible.
- Off chain governance, used by Ethereum, implements changes “through an informal process of social discussion,” or the involvement of a single third party on a “side-chain.” Unlike on-chain governance, this process is not publicly accessible.
While off-chain transactions are faster and cheaper, on-chain transactions more closely uphold the tenet of auditability associated with cryptocurrency trades12. Additionally, these mechanisms can favor developers’ decisions over digital wallet-holders. Ether is currently exploring new governance mechanisms, like voting mechanisms for ether users and increased transparency into developer conversations13.
Especially where cryptocurrencies are not regulated as securities, it is important for investors to understand the governance structure overseeing their investments. The governance structure of a cryptocurrency is unlike any business the world has ever known because there is no single point of responsibility for the ecosystem’s decisions. For example, if a Bitcoin transaction violates GDPR because an EU citizen’s personally identifiable information is not properly protected, Satoshi Nakamoto will not be asked to answer to the breach nor will the ecosystem be fined in the same manner as a Fortune 500 company engaging in inappropriate data privacy practices.
Cryptocurrencies typically govern new functionalities through a development team responsible for introducing changes which are then voted upon by coin holders rather than a Board of Directors. If new functionality causes issues, it is unclear whether developer teams or token holders should be held liable, if anyone at all. As regulatory scrutiny and our understanding of these ecosystems evolve, accountability will be assigned. Before this maturation occurs, each ecosystem user must be familiar with different governance structures, legal implications, and risks and industry best practices identified by trusted advisors as fundamental to cryptocurrency strategy.
Cryptocurrencies and the blockchain / distributed ledger technology behind the curtain are here to stay. Governments across the world are experimenting with regulation to maintain healthy innovation while ensuring the safety of consumers. Often compared to the explosive innovation of the Internet, which began as a scientific tool used to share laboratory results, blockchain technologies’ future use cases in financial services and payments are still unknown. Accenture stays appraised of the latest regulation and leads within the distributed ledger technology field — please reach out to the authors to discuss how we can partner in this space.
- https://www.weforum.org/agenda/authors/rahul-singh and https://www.msci.com/www/blog-posts/creeping-crypto-cryptocurrency/02793697305