By Juuso Roinevirta, Head of Growth, Tesseract

Bitcoin and other cryptocurrencies are often associated with terms such as climate change, illicit use, and money laundering. In this article I intend to give an overview of the ESG characteristics of Bitcoin and other digital assets. Let us dive in!

The E

The E in ESG stands for environment. Concepts that fall under the environmental criteria include, among many others, issues related to climate change, resource depletion, waste, pollution, and deforestation. (CGLytics n.d.).

Bitcoin is notoriously known for its high energy consumption. Often, its energy consumption is compared to that of countries; for example, near year-end 2020, the Bitcoin network consumed as much energy as Sweden. (Huber n.d.). Another common comparison is to compare the energy used by common payment processors such as Visa. As of May 2021, a single Bitcoin transaction consumed around 800,000 times more energy than a single Visa transaction. (Statista 2021).

Too often crypto-enthusiasts retort with a philosophical or a blanket statement similar to “What about the U.S. army?” or “Well, it is different”. While both are good points to raise, they do not contribute to the discussion. Bitcoin’s energy consumption is real, and even if most of it came from clean energy sources (this is up for debate with estimates ranging from 39 to 73 percent), there is still a good share of coal burning and natural gas use. (Cuen 2021).

So why is Bitcoin’s energy usage not a problem? Well, it is – in the short term. In the long term, however, Bitcoin – and the concept of Proof of Work1 – is good for the environment. Here is why: the current energy system is extremely centralised. Large areas are often served by a single energy producer, such as a coal, nuclear, or gas plant. The energy generated in this plant, often quite far away from the energy’s consumers, is then transferred via the energy grid to its users. This leads to two problems. First, a huge amount of energy, approximately 6% of energy produced, is lost in transmission and distribution. (Wirfs-Brock 2015). Secondly, renewable energy sources, such as solar, wind, or wave power cannot be used to predictably supply a consistent amount of energy to a large area. This is because of the changes in environment, such as sun’s position on the sky and cloud coverage, affect the energy output of renewables quite much.

Therefore, arguably, it would be more efficient to have small power plants distributed all across the world. These small power plants could then distribute energy to their immediate area, decreasing energy lost in transmission and distribution. However, building super-small coal plants is not feasible. But building small scale renewable energy plants is. So why doesn’t everyone build their own renewable energy plants? One reason is the unpredictability of output. With solar, for example, the most energy is generated when it is not needed. This is known as the “Duck Curve”; energy demand dips in the morning and rises in the evening. (NuScale Power, LLC n.d.).

So how could Bitcoin help? I am glad you asked. For renewables to be a feasible option to power 100% of our consumption we must overproduce during the low-consumption hours. The cost of capital can be reduced significantly by finding an alternative use for that otherwise “excess” energy that cannot be stored in batteries. One great option is to sell it to Bitcoin miners when it is not used. Combining this demand smoothening strategy with the existing extensive power grid network we could be a step closer to a clean energy future. The current infrastructure is important, as it will allow interarea power exchange when, for example, one suburb is under cloud coverage and it is not windy, either.

That all sounds great, but what about the short-term? The short-term solution is not immediately clear, and there probably is not a single good answer. What I believe we should do is get together and discuss these issues as they are. Not ban mining completely nor forget its environmental impacts. Geolocation, or the building of Bitcoin mining plants near energy sources, has been happening for years. Some renewables producers have realised the potential of striking deals with miners to gulp their excess energy during peak production hours and made both their and the miners’ operations more profitable.

With the right economic incentives, which are, in the end, controlled by governmental bodies and the right legislative framework, Bitcoin mining can help in global transformation to cleaner energy. Discussing the issues and implementing solutions is up to the industry, governments, and activists all around the world. Some industry advocate groups have already spawned, perhaps most notably the Michael Saylor driven Bitcoin Mining Council which aims to, among other things, pursue ESG goals. (Chawaga 2021).

The S

The social impacts of digital assets are hard to quantify. From international remittances and inflation hedging to donations and activist group funding to illicit trade and money laundering, the use cases for digital assets are huge.

Perhaps the most prominent use cases are the illicit ones: scams, extortion, illicit trade, and money laundering. While only a small amount, approximately 0.6-2.4%, of all digital asset transactions are related to illicit activities they are extremely prominent in media. (Chainalysis 2020). Digital assets are actually used in fewer illicit activities than traditional ones, of which 3.6% are related to illicit activity.[1] .

What is more is that it is much, much easier to track illicit activity in digital assets than in the traditional banking system. This is because the transactions are public.[2] As long as the right restrictions and controls are put in place between the exchange of digital and traditional assets, it should be easy to control illicit activity. At Tesseract, for example, we are subject to AML and KYC requirements like any other bank, and we will not touch assets that have any history of illicit use. We are actually required to notify the authorities when we detect these types of capital flows – something that really helps in the enforcement of AML directives. With the largest taboo dealt with, let me talk about some of the good things digital assets are bringing to the society. Due to the censorship resistant nature of digital assets, they are a prime candidate for enabling freedom of capital movements even under authoritarian regimes. Censorship resistance means, in practice, that anyone with an internet connection can control their digital assets. The service is not dependent on bank access, opening hours, location, nationality, or any other factor. A simple internet connection is enough to grant complete control over one’s assets. Importantly, especially in the case authoritarian regimes, nobody can take away your ownership of a digital asset because it is not controlled by a third-party, like a bank. Instead, the one who knows the private key, a kind of a password, has absolute control.

The lack of barriers to entry also provides extreme opportunities for the 1.7 billion unbanked people of the world. (World Bank 2017). With only a smart phone and an internet connection these people will have access to an increasingly complete financial system that might have been out of their reach otherwise. With new applications being built on top of Ethereum, Bitcoin, and other blockchain technologies, the universe of financial applications – and therefore opportunities – is growing quickly. Some decentralised Ethereum protocols allow, for example, anyone to take out a collateralised loan, exchange tokens, or earn interest on their savings. Without the need to rely on the services of a local, perhaps underdeveloped and discriminatory bank, now anyone can access a comparable suite of financial products online.

The G

Governance, or the G in ESG, relates to issues such as corruption and diversity. Applying some of the dimensions of governance, for example executive compensation, to the digital asset space is hard as, often, there is no single “governor”. Digital assets, usually decentralised by nature, are controlled collectively by the people using them or the miners maintaining the network.[1] Accordingly, the governance issues are non-existent because, by the ethos of digital assets, everyone is incentivised to do what is best for the overall community by serving themselves first.

I could, however, highlight a couple of positive things that emerge from the decentralised governance model of many digital assets. Firstly, as alluded above, is the fact that those making decisions are incentivised to make them so that they serve the community at large. In Bitcoin, for example, the miners (those solving the mathematical puzzles) are in control of the network and therefore the asset. However, it is in the miners’ interest, economically, to stay honest and not to cheat. Cheating, first of all, would require a single malicious actor to hold 51% of all of the processing power in the network – a rather expensive feat to accomplish. Secondly, assuming they had 51% of the processing power, it would not be in their interest to go about reversing transactions and making non-existent rebates. Why? If they did, the value of the asset would immediately crash, yielding all their investment worthless; in the end of the day, the miners get paid in the asset they are mining. If the asset is worth zero, there is little point mining.

As discussed in “The S”, anyone can access the network and use the asset. Furthermore, anyone can mine (or stake) the digital asset, contributing to the network and its robustness. This principle of complete inclusivity ensures that nobody is excluded from participating in the asset. Pretty good, eh?

Conclusion

While digital assets get bad press often, they are not evil. There are short-term problems that need solving, but I believe the overall impact of digital assets is a net positive – especially in the longer term.

[1] Proof of work is the process of using computing power to calculate solutions to hard mathematical problems which are then used to secure the bitcoin networ

[2] The comparison made here may not be quite exact; on the blockchain it is relatively easy to track illicit cash flows on a per transaction level, whereas those avenues do not exist for traditional currencies. Therefore, the FATF figure of 3.6 is per cent of GDP related to illicit activity, whereas for digital assets it is per cent of transactions. While not perfect, this should be a pretty good proxy for what is happening behind the curtains.

[3] There are also digital assets known as “Privacy Coins” whose purpose is to mask the movements of the assets completely. While this might sound like a paradise for criminals, there are actually very feasible use cases as well (e.g., establishing free capital movements to individuals/organisations who have been excluded from the financial system by an authoritarian state actor).

[4] DAOs, or decentralised autonomous organisations, are an interesting topic (which I highly suggest learning more about) but outside of the scope of this exploratory article

References

CGLytics. n.d. ESG criteria: WHat they are and how they affect companies and investors. Accessed May 29, 2021. https://cglytics.com/what-is-esg/.

Chainalysis. 2020. “The 2020 Geography of.”

Chawaga, Peter. 2021. ELON MUSK, MICHAEL SAYLOR ANNOUNCE BITCOIN MINING COUNCIL. 25 May. Accessed May 29, 2021. https://bitcoinmagazine.com/business/musk-saylor-announce-bitcoin-mining-council.

Cuen, Leigh. 2021. The debate about cryptocurrency and energy consumption. 21 March. Accessed May 29, 2021. https://techcrunch.com/2021/03/21/the-debate-about-cryptocurrency-and-energy-consumption/.

Huber, Raffael. n.d. Bitcoin’s Energy Consumption. Accessed May 29, 2021. https://www.bitcoinsuisse.com/research/decrypt/bitcoins-energy-consumption.

NuScale Power, LLC. n.d. The Duck Curve. Accessed May 29, 2021. https://www.nuscalepower.com/environment/renewables/the-duck-curve.

Statista. 2021. May. Accessed May 29, 2021. https://www.statista.com/statistics/881541/bitcoin-energy-consumption-transaction-comparison-visa/.

United Nations Office on Drugs and Crime. 2011. Illicit money: how much is out there? 25 October. Accessed May 29, 2021. https://www.unodc.org/unodc/en/frontpage/2011/October/illicit-money_-how-much-is-out-there.html.

Wirfs-Brock, Jordan. 2015. Lost In Transmission: How Much Electricity Disappears Between A Power Plant And Your Plug? 6 November. Accessed May 29, 2021. http://insideenergy.org/2015/11/06/lost-in-transmission-how-much-electricity-disappears-between-a-power-plant-and-your-plug/.

World Bank. 2017. “THE UNBANKED.” Accessed May 29, 2021. https://globalfindex.worldbank.org/sites/globalfindex/files/chapters/2017%20Findex%20full%20report_chapter2.pdf.