Insights

Vol. 1: ESG and Cryptocurrency

August 17, 2021
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For years, many have questioned the sustainability of cryptocurrency, pointing to its environmental impacts. This concern has peaked in recent months, with the most prominent development being Elon Musk’s announcement in May that Tesla would no longer accept Bitcoin as payment because of concerns about its energy consumption—news that caused Bitcoin’s value to drop.

Given the increasing importance of environmental, social, and corporate governance (ESG) issues to investors, careful consideration of cryptocurrency’s sustainability is in order. CkSum Capital, as an investment firm specializing in cryptocurrencies and decentralized finance (DeFi) technology, is well placed to address investors’ concerns. We are deeply embedded in the cryptocurrency ecosystem and want to help our investors understand the pros and cons of DeFi technology from an ESG perspective.

This article will focus on the environmental component of ESG. We will cover how and why the industry uses energy, its relatively limited carbon footprint when compared to the broader banking system, and how crypto and DeFi can actually help the renewable energy industry. Later articles will consider the impacts cryptocurrency adoption could have on social issues and corporate governance.

What is Bitcoin, and why does it use so much energy?

Bitcoin holds an important position within the cryptocurrency ecosystem. It is the original and, to date, the most secure blockchain. By holding hundreds of billions of dollars in value without being hacked, Bitcoin has demonstrated the viability of a global digital currency which anyone, anywhere in the world, can use to both hold money that has protections against inflation and to send money across borders at a low cost.

What has enabled Bitcoin to be so successful, and to stay beyond the control of governments, corporations, and hackers, is its innovative method of securing its ledger. Every 10 minutes or so, Bitcoin “miners” compete to solve a complex mathematical puzzle. Whichever miner solves the puzzle first gets to verify a “block” of transactions and earn a reward of new bitcoins. The more computational power a miner puts toward solving the puzzle (and thus the more energy they consume), the more likely they are to win the competition.

This is called a “proof-of-work” consensus mechanism, and its very energy intensive. This is because the Bitcoin protocol is designed to regulate block times — that 10-minute figure mentioned above. If blocks are mined too quickly, the difficulty of the puzzle increases, and vice versa. More difficult puzzles require more energy consumption, and the protocol cares about maintaining that 10-minute block frequency. As Bitcoin becomes more valuable, it’s worth spending more and more energy to mine, and the difficulty increases to match. There’s no limit to how hard the problems can get, and hence no limit to the energy expenditure.

This is the source of the environmental concerns, but this feedback loop has also made Bitcoin extremely secure. Corrupting the record of transactions would require even greater amounts of energy than the miners use. Since Bitcoin miners in the aggregate currently expend roughly the same amount of energy as Finland, this would be an extremely expensive proposition. Thus, Bitcoin is able to store so much value so safely precisely because of its energy expenditures.

Bitcoin and DeFi use less energy than the broader banking system

To further contextualize the demand for electricity by the crypto industry, let's compare Bitcoin energy consumption to that of the broader banking system.

As the graph shows, Bitcoin mining uses roughly 7% of the energy of the banking system. However, unlike the global banking system, where more transactions mean more employees, more offices, more server farms, more card machines, more security—and hence more energy—Bitcoin has a non-linear relationship between usage and energy consumption. As the number of transactions increases, the Bitcoin network doesn’t consume proportionally more energy. And while the Bitcoin blockchain famously has a low transaction throughput (a paltry 7 transactions per second), that’s a misleading figure: “second-layer” technology solutions enable thousands of transactions to be processed on top of the Bitcoin base layer, allowing even more complex transactions to take place without materially increasing Bitcoin’s energy output.

As more and more individuals and businesses in the developing world seek financial inclusion and opportunities, cryptocurrencies and DeFi (not only Bitcoin) are proving their ability to scale more efficiently than traditional finance.

The fastest-growing crypto and DeFi projects are energy efficient

When thinking about the industry as a whole, it is important to note that Bitcoin’s demand for energy is an outlier among cryptocurrencies, driven by its value and its reliance on the proof-of-work (PoW) system.

Many newer cryptocurrencies and DeFi applications verify transactions and run “smart contracts” using a proof-of-stake (PoS) system, based on users’ holdings of the currency rather than a miner’s ability to solve a computational puzzle. The second biggest cryptocurrency after Bitcoin, Ethereum, is in the process of switching from PoW to the more energy-efficient PoS.

Thus, while Bitcoin will remain an important and useful store of value, the recent rapid growth in the cryptocurrency and DeFi sector is driven by platforms based on a much less energy-intensive consensus mechanism. These DeFi apps can offer services comparable to the traditional banking industry (such as borrowing and lending as well as currency and asset exchanges) but with less energy consumption, lower fees, and greater accessibility

Bitcoin subsidizes renewable energy project

Even in assessing the sustainability of Bitcoin in particular, we must remember that energy consumption is different from CO2 output. For instance, gas cars consume less energy than electric cars but produce more CO2. In the context of the global energy transition, Bitcoin is well suited to being powered sustainably and incentivizing the development of renewable energy. Already, it is estimated that anywhere from 39 to 74% of Bitcoin energy comes from renewable sources. Even the most conservative estimate of 39% would mean that a much larger share of Bitcoin’s power is renewable than the overall share of renewable energy in global electricity production (25%). Therefore, while the network may consume significant energy, a large proportion comes from green sources.

In fact, Bitcoin can even help to subsidize new solar, hydroelectric, and wind projects, which are often built to produce more power than will be needed immediately. Though the price of renewable energy continues to decrease, renewable sources struggle not only with intermittency but also the difficulty of transferring and storing the energy near the end-user due to the remote locations where renewables are produced. As a result, energy from sources like hydroelectric and solar is often wasted, and its unpredictability makes it unsuitable for many uses. But Bitcoin can be mined anywhere in the world, allowing miners to exploit cheap renewable energy near its source. Bitcoin mining operations can be set up to take advantage of the otherwise wasted energy near a new hydroelectric plant, for instance, and help it to more quickly pay off its initial building costs.

Conclusion

To summarize, Bitcoin energy consumption has been in the headlines for good reason, but investors should understand the nuances of cryptocurrency’s overall environmental impact. Bitcoin’s value and PoW system have driven up the energy requirements, but a higher-than-average share of that energy (anywhere from 39 to 74%) comes from renewable sources. Furthermore, Bitcoin mining has the potential to subsidize green energy, since it can be located anywhere, including places where surplus renewable energy might otherwise be wasted. Additionally, Bitcoin uses only a fraction of the energy consumed by the traditional banking industry, and it is able to scale up with more energy efficiency than a system reliant on physical locations, security, and so on.

Most importantly, investors should understand Bitcoin is just the first iteration of an ever-evolving technology that can revolutionize the way we do business. Many new cryptocurrencies and decentralized financial apps are being built to run on the more energy-efficient proof-of-stake principle, and our portfolio is diversified across many such platforms, which promise to connect more participants to the global economy, especially in the developing world. The next article in this series on ESG will discuss these benefits of cryptocurrency and DeFi technology, looking at their potential impact on social equality.

Written By

Written by,

Richard Sparrow
CIO/Director
Paul Wehner
Director

AUTHOR HIGHLIGHTS

Richard Sparrow - CIO/ Director

In addition to being the Chief  Investment  Officer  for  CkSum  Capital,  Ltd,  Richard  is  a Vice President of Attribution at CipherTrace, Richard has spent the past 4 years building on Bitcoin and blockchain helping law enforcement, regulators, and the financial industry understand how crypto is transforming industries. For the prior 20 years, Richard worked in the Silicon Valley providing mobile and fintech infrastructure solutions for Amdocs, Deutsche Bank and Lending Tree, among others

Paul Wehner - Director

Since graduating from MIT with a Bachelors in Finance, Paul has been a serial entrepreneur specializing in financial technology. He is the Co-Founder and Chief Product Officer of SFB Technologies, a venture-backed company selected to lead the development of the world’s first decentralized legal tender, the SOV, for the Republic of the Marshall Islands. He also won the $100K First Place Prize at 2018 EOS Global Hackathon in Hong Kong for a decentralized identification solution. Previously, Paul led Product Management for the eCommerce vertical of Endeca Technologies which was purchased by Oracle for $1.1 billion, and led development efforts at MyLife, growing it from 0 to 250,000 monthly active users and an eventual acquisition by Meredith.

INVESTMENT STRATEGY

CkSum invests in a well-researched, diversified portfolio of cryptocurrencies and decentralized finance (DeFi) projects. CkSum follows a multi-stage investment process which includes identifying key, long-term industry trends, picking the best currencies, protocols and companies within those trends, and leveraging our holdings to generate increased returns through low-risk, high-yield staking and lending opportunities. We strive to provide an easy, safe, and reliable entry point into this revolutionary industry.

DISCLAIMER                                                                                                                                                                              

This material does not constitute an offer or solicitation to purchase an interest in CkSum Select Fund I, LLC or any related vehicle; such an offer will only be made via a confidential offering memorandum. An investment in the fund is speculative and subject to a risk of loss, including a risk of principal. There is no secondary market for interests in the fund and none is expected to develop. No assurance can be given that the fund will achieve its objective or that an investor will receive a return of all or part of its investment. This material contains certain forward-looking statements and projections regarding the future performance and asset allocation of the fund. These projections are included for illustrative purposes only and are inherently speculative, as they relate to future events, and may not be realized as described. These forward-looking statements will not be updated in the future. Returns for each investor and investment series will differ based on the timing of capital contributions. Please note, information above is subject to change; this is for general, illustrative purposes only.