John Pierpoint Morgan is reported to have said: “Nothing so undermines your financial judgement as the sight of your neighbour getting rich.” Had he lived to see the emergence of Bitcoin he might have added that it can have the same effect on your principles.
The rise of ESG investing is a powerful trend which looks set to continue. No longer is it enough to make money, investors demand that that their portfolios reflect the decisions they take in everyday life, at a minimum avoiding harm and ideally doing good. Against this backdrop, it is surprising to see Bitcoin gaining acceptance among institutional investors. It is no exaggeration to say that the cryptocurrency is antithetical to each of the three principles – Environment, Social and Governance – that make up the acronym.
Bitcoin is nothing short of an environmental catastrophe. At present it is estimated to consume as much electricity as the Netherlands and have a carbon footprint equal to the entire country of New Zealand. The reason for this is the proof-of-work algorithm which underpins validating new transactions on the network and involves carrying out highly intensive calculations that use lots of power. Bitcoin “miners” are in a race to complete the proof of work against other miners. The winner of each race (which occurs every 10 minutes or so) is awarded new coins. As the value of Bitcoin has risen, so the prize for “winning” increases and Bitcoin miners are incentivised to deploy ever greater resources in pursuit of victory. These resources take the form of vast, air conditioned server farms, a significant proportion of which are based in China and rely on coal power. Bitcoin is much less efficient than the networks it aims to replace. It is estimated that a single transaction on the Bitcoin network uses as much energy as 500,000 transactions on Visa.
Bitcoin investors tend to show a similar indifference to its social impact. In the US, issuance of bearer bonds was outlawed in 1982 and now such financial exotica live on only as plot devices in movies such as Die Hard and Beverly Hills Cop. Today’s drug traffickers, money launderers, child pornographers, extortionists, and terrorists have turned to Bitcoin – a digital bearer instrument – as their preferred means for settling illegal transactions.
What of governance concerns? The fundamental attraction of Bitcoin to its advocates – that of a decentralised network incapable of being debased by government fiat or co-opted by illiberal diktat – presents its own challenges. With no depositary, central register, or formal governance arrangements, there is no one that an investor can turn to when their Bitcoin is lost, stolen or their password forgotten. There are also persistent rumours that the price of Bitcoin is being manipulated by bad actors. Whether true or not, the lack of regulatory oversight makes manipulation more probable than in mainstream markets.
Anonymity in financial markets has been in decline for decades. Libertarian ideals have been ranged against the legislative and coercive powers of the state. It has not been a fair fight; states have won and society at large has accepted the outcome. The benefits of financial anonymity to law abiding individuals are modest, yet the costs to society from criminal exploitation of anonymity are great and take the form of tax evasion, money laundering, and financing of terrorism.
By setting itself outside of – and in opposition to – the prevailing trend against financial anonymity Bitcoin could yet attract the attention of regulators and see itself heavily marginalised or even replaced by a “better” digital currency.
Like any other human institution, Bitcoin is capable of reform but its decentralised nature makes change cumbersome. Whether it is able to reform while retaining its appeal among its proponents remains to be seen. For the time being, investors with any consideration for ESG principles should avoid it.