29 May 2023
In recent years, Environmental, Social and Governance (ESG) considerations have become increasingly important to individuals and organisations when making investment decisions. Charities are no exception, as they seek to align their investments with their mission and values. However, as new technologies and investment options emerge, it can be challenging to navigate this landscape. One such emerging investment option is cryptocurrency. In this article, we will explore the intersection of ESG and cryptocurrency and what charities should consider when investing in this new asset class.
The cryptocurrency landscape
A cryptocurrency is a digital or virtual currency based on a network that is distributed across many computers. It is notably not issued, nor is it under the control of any government or central authority, allowing for cheaper and faster money transfers. The asset remains largely unregulated in the UK, meaning that there is no protection for investors, although this is not the case in many other jurisdictions.
Significant governance risk surrounds the volatility of the cryptocurrency market itself, with a lack of a hierarchical structure leaving market participants exposed to fraudulent activity, and the insolvency of individual currencies and exchanges through a lack of transaction audit trail.
Ultimately, the consideration of all risks and opportunities that charities face as part of their strategic planning is at the heart of operating a sustainable, resilient business. Such an assessment should incorporate those associated with cryptocurrency, as well as climate factors.
This absence of market regulation places considerably more risk on the shoulders of individual investors, as there are no central bodies in individual jurisdictions to provide oversight of operators in the market.
One example is Bitcoin, established in 2008 and is the most popular cryptocurrency, despite the significant reduction in its value over the past 12 months. Now, there are thousands of alternatives in the marketplace, and Cryptocurrency markets skyrocketed in value, reaching almost $2 trillion in May 2022, attracting investors and generating significant profits for many. The potential for gain, however, has also attracted unscrupulous behaviour with significant evidence of criminal activity.
ESG and sustainability have become major societal issues and therefore, such a significant negative environmental impact can be hard for the environmentally conscious investor to overcome. There are also concerns from the ‘social’ aspect of ESG, with many incidences of market manipulation, hacking and other fraudulent activity resulting in huge losses for investors.
Younger generations (who make up an increasing proportion of the workforce and consumer base) are more attuned to sustainability matters aligning themselves to organisations whose values mirror their own in this regard.
Reputationally, the cryptocurrency market suffers from an inherent association with criminal activity. The lack of regulation within crypto trading platforms provides a reduced incentive for operators in the market to act in an ethical manner and without resorting to fraud, together with a lack of traceability.
Influential individuals - such as Elon Musk - can significantly and unilaterally distort the crypto market, potentially materially devaluing individual platforms and currencies (as highlighted by recent failures in the sector such as FTX, which led to significant losses for institutional investors such as BlackRock).
The ESG credentials of the cryptocurrency industry have been called into question, given the high energy consumption and significant computing capacity requirement of the 'mining' process (being the creation and verification of new blockchain transactions), involving large data centres, which generate substantial carbon emissions. For example, Bitcoin generates new coins by supercomputers that solve highly complex puzzles, which become ever more energy-intensive, with much of this coming from fossil fuel sources. It has been stated that Bitcoin alone is responsible for around 0.4% of the world’s total energy consumption. Whilst more energy-efficient mining hardware is becoming available, costs remain a prohibitive factor and the mining process will only become fully decarbonised as quickly as the global energy sector itself. Whilst some countries are addressing the issue of energy mix, others are lagging.
Mining factories are reliant upon graphics processing units (GPUs) of which there has been a global shortage in recent times (and the production of which is significantly carbon-intensive). The resultant supply chain issues have inhibited businesses' continuity and their ability to plan, whilst the heavily carbon-intensive nature of semiconductor production itself adds an extra layer of environmental risk.
The energy usage predicament is being progressively addressed and increased regulation is evident globally, providing a greater degree of protection for investors. As the industry matures, the risks may dissipate but it is important, nevertheless, to understand and consider these issues when assessing the suitability of such assets for investment and trading purposes.
Practical implications for charities
In conclusion, there is no doubt that cryptocurrency is here to stay and will become more and more prevalent as time goes on. This is especially true given the uncertain economic environment and the unpredictability of traditional revenue streams.
The ability to safely receive donations via this method, and then satisfy traceability concerns and future-proof the donation by rapid conversion into a cash equivalent is something to be considered. A charity’s investment policy statement (IPS) would need to be updated to reflect this by order of the trustee board.
There are various organisations and companies that will assist with all stages of this process. If you are a large enough charity, the dealing of cryptocurrency can be delegated to the executive team to implement the appropriate policy as agreed by the board. It should be noted however, that cryptocurrency is not yet a regulated area, which means the appropriate legal and accounting advice should be sought accordingly and in advance by any trustee board considering this. There are also various investment timelines, alongside potential ESG and reputational issues, to consider.
Get in touch and speak to your usual contact, Hannah Catchpool and Steven Radcliffe at RSM or Lynne Lamont at RBC Brewin about what your charity needs to consider in relation to cryptocurrency and ESG.
Lynne Lamont is Head of Charity & Institutional Clients at RBC Brewin, leading the eight specialist Charity Investment Management teams up and down the country. In her role, she is responsible for strategic planning, the investment offering and the development of the client base and team.