ESG Impact Watch: Blockchain

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Blockchain technology is increasing in popularity across industries but, in its current iteration, triggers significant environmental, social, and governance (ESG) considerations. As the financial services sector simultaneously invests in blockchain technology and commits to ESG-sensitive policies and portfolios, how are the “E” and “S” impacts of blockchain and its applications to be weighed?

Blockchain, the digital infrastructure popularized by the Bitcoin cryptocurrency and now expanding into data validation and transfer uses in fields from supply chains to healthcare to governance, is a digital distributed ledger system that records and verifies information in real-time, without reliance on a central authority to verify the data. For effective data validation in the absence of a centralized monitor, a “block” of data may only be added to an existing “chain” when a disperse network of individual users agree to add the block by solving complex computational problems and verifying the solutions in a process called “mining”. This system, called “proof of work” (PoW), is blockchain’s most common validation structure. ESG considerations, particularly related to the environmental “E”, arise when powerful computer systems are racing to seek solutions, consuming significant electrical power along the way. To the extent such power is provided by fossil fuels, blockchain-related mining activity produces greenhouse gas emissions and leaves a meaningful carbon footprint.1 The carbon effect is particularly measurable in cryptocurrency because financial incentives for successful miners, such as earning cryptocurrency and transaction fees,2 result in a high volume of such activity. Taking Bitcoin as an example, according to University of Cambridge’s Bitcoin Electricity Consumption Index as of April 2021, Bitcoin accounts for 0.62% of the world’s energy consumption, ranking just ahead of the country of Sweden in its energy use. Similar technology, with its attendant carbon impact, is applied to the secure transfer of non-fungible tokens or “NFTs”, which represent unique assets or information such as art, real estate, and personal data.

A comprehensive ESG analysis of blockchain technology, however, will account not only for emissions related to energy use but also for its broader environmental, social and governance effects.

For example, consider the PoW data validation structure. PoW validation is designed to be energy-intensive in order to maximize security of the information in the chain. In order to record data blocks to the chain, problem solutions must, in effect, demonstrate not only the correct answer to the problem but also that the appropriate amount of computing power was utilized to achieve the result. This high-energy structure prevents manipulation of data because a potential falsifier would need to use a significant amount of computing power to overcome the aggregate computing effort of multiple miners working toward solution.3 Can the “S” value of the security of the blockchain system therefore be balanced against the “E” impacts of the related power consumption?

Further social considerations arise when blockchain’s feature of providing a transparent system of sharing and validating data transactions collides with enhanced privacy regulatory regimes, e.g., the European Union’s General Data Protection Regulation. On the one hand, blockchain technology offers trust and reliability because it is immutable. On the other hand, as principles of “the right to be forgotten” become standardized, blockchain may slow efforts to prevent certain data from being captured on the chain or from being removed once validated on the chain. Balancing the “S” principles of trust, transparency, privacy, and data protection will continue to be critical for blockchain market participants.

Blockchain’s naturally transparent tracking process may also be applied to improve monitoring of compliance with, and performance of, ESG standards. Allison Herren Lee, acting chair of the US Securities and Exchange Commission, stated as much in a March 17, 2021 speech in which she suggested blockchain technology may be useful in providing retail investors with visibility into how funds vote on ESG matters, given funds’ typically diffuse ownership structure.4 Blockchain may also enhance supply chain visibility, an area of likely increasing importance to businesses, capital providers and regulators. In the fishing industry, the Norwegian Seafood Association (NSA) has partnered with IBM to experiment with ensuring an actively monitored and transparent tracking system through use of blockchain’s distributed ledger technology.5 Utilizing QR codes and accredited transactions, the NSA hopes to demonstrate the sustainability of its fishery practices and offer consumers an insight into the path individual salmon products take from source to table. Tracking and documenting natural resources in an open and peer-established method also offers potential cost savings for any institution looking to comply with environmental and sustainability regulations. Such tracking processes have been applied to other industries as well, such as the tracking of conflict-free diamonds.6 In addition, as global supply chains become digitized and more transparent, for example, through platforms such as IBM’s and Maersk’s jointly developed TradeLens program, efficiencies in global trade as well as the environmental and sustainability commitments made by companies, investors and governments may more easily become part of the supply chain ESG calculus.

Back on the “E” side, continued development of blockchain technology and applications may mitigate related greenhouse gas emissions. Blockchain may be used to facilitate carbon trading, which involves creating a fixed number of carbon credits and allowing such carbon credits to trade in the open markets in a manner similar to the cryptocurrency exchange process. To date, the primary challenge of implementing a carbon trading market has been the creation of a uniform and transparent system for tracking the exchange of carbon credits, which blockchain’s ledger technology could potentially be leveraged to address. Blockchain technology may also evolve to adopt less energy-intensive validation systems as alternatives to PoW or users may commit to using renewable energy sources or to moving mining operations to regions that offer lower-carbon energy sources to power blockchain and NFT transactions.7 According to the September 2020 Global Cryptoasset Benchmarking Study, 39% of total cryptocurrency-related PoW energy consumption was powered by renewable sources.

1 E.g., J. Sedelmeir et al., “The Energy Consumption of Blockchain Technology”, Business Information Systems Engineering (June 19, 2020).

2 E.g., Yaga, D., et al. “Blockchain Technology Overview”, National Institute of Standards and Technology (October 2018).

3 E.g., J. Sedelmeir et al., “The Energy Consumption of Blockchain Technology”, Business Information Systems Engineering (June 19, 2020).

4 Acting Chair Allison Herren Lee, “Every Vote Counts: The Importance of Fund Voting and Disclosure” (March 17, 2021); https://www.sec.gov/news/speech/lee-every-vote-counts; Chris Flood, “US regulator aims to revitalise shareholder democracy” (March 21, 2021), Financial Times.

5 De Sousa, A. Blockchain will let you track salmon from sea to dinner plate, BLOOMBERG LAW: ENVIRONMENT & ENERGY REPORT (June 25, 2020).

6 E.g., Aaron Ricadela, “Blockchain Records Are Forever In Opaque Diamond Market”, Forbes (July 12, 2019).

7 E.g., Shangrong Jiang, et al., “Policy assessments for the carbon emission flows and sustainability of Bitcoin blockchain operation in China”, Nature Communications (April 6, 2021).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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