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Why Crypto Risks Becoming an ESG Conflict for Banks

Despite regular volatility events, crypto and digital assets are further on the rise regarding retail and institutional adoption. But when it comes to environmental, social and governance (ESG) aspects, those new asset classes are still lacking behind. Given the increasing pressure on financial institutions, especially banks must look for sustainable investment products. 

2021 has been a landmark year for cryptocurrencies in many ways. But one of the most significant developments has to be the turnaround in institutional sentiments towards digital assets. According to research from Blockdata published in August, more than half of the top 100 banks by AuM have made some kind of investment in cryptocurrencies or blockchain-related companies – either directly or via subsidiaries.  

Institutions are often credited with giving Bitcoin the impetus needed to reach its most recent all-time highs close to $65,000. However, the market euphoria was relatively short-lived. One of the pivotal moments was undoubtedly when Elon Musk announced that Tesla would no longer accept Bitcoin payments for its electric vehicles, due to concerns over the environmental impact of mining. It marked a sharp u-turn from his previously bullish, if often cryptic, statements on cryptocurrencies.  

Despite the cries of dismay from cryptocurrency advocates, many of whom pointed to an increasing appetite for renewable energy among Bitcoin miners, the market damage was swift. Crypto investors and influencers railed against Musk, citing his influence on the markets as “unhealthy.”   

But this viewpoint fails to consider the weight of another strategic imperative for banks, one that matters to their clients and investors – the environmental, social, and governance (ESG) agenda.  

The ESG investing boom 

If a $2 trillion cryptocurrency market capitalization is enough to pique institutional interest, then consider the scale of the ESG market. Based on Bloomberg’s relatively moderate estimates, ESG assets under management are set to reach nearly $38 trillion by the end of this year and $53 trillion within the next four years. As a result, sustainable investing is a critical priority. There’s increasing pressure on the financial sector to do more to demonstrate transparency when it comes to participant’s green credentials – or lack thereof.  

In this context, transparency means that firms and financial institutions are now obliged to make statements regarding their ESG investments and commitments as part of their annual reports and related disclosures. To date, this has largely come about as a result of meeting investor demand. Nevertheless, in the absence of any defined or measurable classifications of ESG investing, allegations of “greenwashing” have become rife. One accusation is that firms only need to reduce their carbon footprint to paint themselves as ESG without necessarily taking any positive action to reach a goal of becoming carbon-neutral.  

Enter the regulators

Now, the issue is being taken out of their hands as the regulators step in. In the European Union, the Sustainable Finance Disclosure Regulation came into effect in June, requiring larger financial market participants to apply a standard taxonomy to ESG products which must be available to investors. The Swiss government will bring in similar legislation starting from January 2022.  

In the US, both the Federal Reserve and the Securities and Exchange Commission have announced plans that indicate more ESG regulation could be on the way. Each time new regulations come into play, banks have a new compliance project ahead of them as they must retroactively fit each product or service to the new laws.  

Timing is an important factor here. It’s worth remembering that the pandemic put social and environmental issues into the daily headlines for months at a time. The pandemic forced social changes such as confinements to home and digital communication that fueled the interest in cryptocurrencies. So when investors see that Bitcoin’s lack of green credentials is in the headlines, they are easily spooked.  

Addressing the conflict

How can financial institutions reconcile these two competing interests of crypto and ESG? Bitcoin’s supporters who point to renewable mining energy may make some valid points. Still, if banks are to settle the conflict between their ESG obligations and cryptocurrencies, then they need concrete numbers and verifiable facts to present to shareholders and clients.  

One way to achieve this is for participants in the cryptocurrency sector to make greener options available to institutional clients. Most newer blockchain platforms, such as Polygon or Binance Smart Chain, now shun the energy-intensive proof-of-work consensus in favor of lighter proof-of-stake, and Ethereum is now well on the path to doing the same. However, as long as Bitcoin is crypto’s flagship asset and running on proof-of-work, then this represents the biggest challenge.  

With an understanding of the carbon impact of Bitcoin transactions, banks need a way to transact Bitcoin with minimal environmental impact and the ability to positively offset any impact that does occur. Renewable energy in mining addresses the first part and investment products such as the green energy mining ETF that recently launched on the New York Stock Exchange address this element.  

Creating ESG-friendly crypto products

“Green wallets” offer a unique and pioneering way to address the second part of the equation, turning a cryptocurrency offering from an ESG liability into an attractive, revenue-generating green investment product for a bank.  

A green wallet is effectively an institutional-grade trading platform and wallet that does the work of tracking and offsetting the carbon footprint of every single cryptocurrency transaction. Furthermore, because each transaction is tracked on the blockchain and compensated with corresponding green tokens representing the offset, ESG transparency and reporting are baked into the process.  

ESG is currently the biggest issue in the world’s markets, and so if banks are to continue to embrace cryptocurrencies, there must be a way to do so that doesn’t compromise ESG priorities. Therefore, the onus is on the blockchain and digital asset sector to develop solutions that will promote adoption in the most sustainable way.  

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