How much of an ESG risk is crypto?

GHG emissions are a key risk exposure in crypto as fintech boosts its presence in the volatile asset, yet still pose less threat than other polluters

Even when drilling down into the fintech and cryptocurrency components of the financial services industry, their added risk exposure still ranks low on a global scale. Industries like oil & gas, materials, logistics, and even healthcare, show higher average overall ESG risk exposure metrics. However, when going into these asset classes, investors understand the possible risks.

Of course, carbon usage is among them, but investors must also consider those posed by poor business practices and impending regulation, among others. Investors will always welcome efforts to become more ESG-friendly to a degree, particularly if they can keep producing alpha.

On the surface, companies that work in cryptocurrency face less exposure to risks related to environmental, social, and governance factors. According to Preqin’s ESG Risk Exposure Estimates, US-based crypto-focused private companies scored 0.29 points lower than those that did not. Three of the industries more closely aligned with the crypto industry –  software, financial services, and internet – pose a higher risk in non crypto-based markets. Financial services, however, faces higher exposure than its counterparts.

The financials sector and its tech-focused subset, fintech, make up most of the companies working in the cryptocurrency market. Of the $34.8bn US venture funding spent on companies working in cryptocurrency since 2018, two-thirds went to fintech start-ups. These companies, which have collectively raised $23.2bn, make up only about 3% of the 1,356 companies reviewed by Preqin’s research team. This fraction, albeit rather small, drives the average risk of that subset above that of the broader industry, and to a greater degree than crypto’s impact on software and internet assets. Although the average estimated risk exposure changes little for software and internet companies, with risk exposure even dipping slightly, the average risk exposure for financials companies increases by 15% when cryptocurrency is involved. But where does that risk exposure come from? Crypto’s stress on the power grid is a good place to look.

Fossil-fueled currency

While software and internet companies provide the tools, it’s the fintech companies that carry out the actual mining, verification, and storage processes. These efforts are energy intensive. A recent report from the White House estimates that the energy used to mine the two largest and most common cryptocurrencies in 2021, Bitcoin and Ethereum, was comparable with the amount of energy needed to light every home in the US or power all US-based datacenters during that year. 

It's impossible to know the specific sources of the electricity used for mining cryptocurrencies. However, 60% of the US electric power grid is now powered by fossil fuels, making it a fair assumption that a similar proportion is used nationally to support the cryptocurrency ecosystem. 

Bitcoin and Ethereum operate on a proof-of-work (PoW) process, which requires significant computing power to process transactions and mint new currency. PoW’s counterpart, proof-of-stake (PoS), is far less energy intensive, yet less discovered and favored more toward tenured and crypto-wealthly holders. Cointtelegraph explains this further here. However, Ethereum has recently merged its PoW currency to a PoS process and now goes by Ethereum 2.0. Should this prove successful, it will significantly boost its ESG profile with investors.

The cryptocurrency market is still in its infancy and reducing carbon risk is going to be a key effort for fintech companies, particularly as they move to reduce energy costs. This should mutually benefit investors, both ESG-conscious and otherwise. 

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The opinions and facts included within the above do not constitute investment advice. Professional advice should be sought before making any investment or other decisions. Preqin providing the information in this content accepts no liability for any decisions taken in relation to the above.