Creeping Crypto: Cryptocurrency Risk and ESG

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Institutional investors may face creeping exposure to cryptocurrency as new companies built around the asset class are added to indices and older, established companies invest in cryptocurrency. At least 52 public companies covered by MSCI ESG Research are exposed to cryptocurrencies, including 26 constituents of the MSCI ACWI Index. Many of the ESG risks associated with cryptocurrency will be relatively familiar, but others, such as the governance of cryptocurrencies themselves, will likely be new to boards and investors.

Institutional investors may be more exposed to cryptocurrency risk than they realize. Twelve years after the creation of Bitcoins, cryptocurrencies are now part of the business of at least 52 companies covered by MSCI ESG Research, as of September 2021. These companies exposed to cryptocurrencies include 26 components of the MSCI index ACWI.

An illustrative sample of these companies is presented in the table below:

Companies exposed to cryptocurrency

This interactive graph presents an illustrative and non-exhaustive sample of 23 companies in our coverage with direct or indirect exposure to cryptocurrency, including those with exploratory involvement in cryptocurrency. The position on the y-axis indicates the percentile rank of each company’s corporate governance score, assessed using the MSCI ESG Ratings methodology and relative to our global coverage, with higher numbers indicating a better score. The position on the x-axis indicates the market capitalization of each company, expressed on a logarithmic scale. The color indicates the GICS (Global Industry Classification Standard) sector of each company. GICS is the global industry classification standard jointly developed by MSCI and S&P Global Market Intelligence. Hover or tap a circle to view more details about each business. Other companies exposed to cryptocurrency are identifiable through our custom filtering solutions. Data as of September 29, 2021. Source: MSCI ESG Research LLC

While Bitcoin remains a priority for many of these companies, the number of coins has exploded in recent years. Coinbase, a cryptocurrency exchange, and one of the exposed companies identified in our coverage tracks over 5,000 coins and facilitates transactions on the largest coins by market cap. While most cryptocurrencies are speculative investments with little obvious use, some have had limited success as genuine currencies, and many have posted stunning returns. This growth has contributed to both the rise of companies exposed to cryptocurrency and the efforts of established companies to gain exposure to cryptocurrency.

How the creeping exposure to cryptocurrency works

This diagram illustrates how equity investors could passively and unintentionally gain exposure to cryptocurrency. Source: MSCI ESG Research LLC

Equity investors, even those with large reservations about the highly volatile asset class, may face creeping exposure to cryptocurrencies. This can happen when newly listed cryptocurrency companies are added to indices that guide their investments, or when companies in which they are already invested, directly or through indices, announce strategies that include Bitcoin or other crypto. -coins.

The ESG risks of cryptocurrency

What are the main environmental, social and governance (ESG) risks associated with exposure to cryptocurrency? What are some of the considerations for investors when assessing the ESG practices of companies exposed to cryptocurrency? We have identified a number of potential risks, including:

Environmental: The main environmental risks associated with exposure to cryptocurrencies include greenhouse gas emissions from energy consumption and electronic waste (e-waste). Different coins have different environmental impacts, with Bitcoin (and other proof-of-work cryptocurrencies) showing evidence of a higher impact. Identifying the location of the mining operation and the energy sources used is essential to assess a parts emissions profile. Social: The nature and extent of the social impact of cryptocurrencies remains uncertain. Investor protection and education are significant risks for companies that facilitate direct investments in cryptocurrencies. Transaction-related disputes can also present a risk for businesses that accept cryptocurrencies as a form of payment. Governance: Boards of directors of companies exposed to cryptocurrencies may need to adapt existing risk management policies and practices to specific cryptocurrency risks. Many of these topics will be relatively familiar (for example, finance, cybersecurity, and anti-money laundering policies), but new and significant risks may arise from the way the coins themselves are governed. Understanding the governance of cryptocurrencies

In particular, the governance of cryptocurrencies can present new challenges for boards of directors and investors. By design, most cryptocurrencies are decentralized; no decision-making body oversees cryptocurrency strategy and direction. However, the absence of a traditional governance structure does not mean the absence of governance. Decentralized cryptocurrencies are supported and promoted by informal and vibrant communities of software developers, cryptocurrency miners, and other actors. While the issues discussed by these players are often technical, their decisions can result in significant changes in cryptocurrency economies.

At a minimum, investors can benefit from understanding how managers and directors of companies exposed to cryptocurrency monitor developments in these informal governance frameworks. For companies with greater exposure, investor interests may be better served by becoming more actively involved. This could include participating in activities such as:

Encourage or fund the development of cryptocurrency protocols Support decentralization within the cryptocurrency financial ecosystem Engage with other actors in the context of cryptocurrency governance

Whether a company exposed to cryptocurrencies passively monitors or actively engages in cryptocurrency governance, understanding how it approaches the intersection of its strategic plan and the long-term development of cryptocurrencies can help investors to make more informed decisions about risks.

The authors thank Yu Ishihara for his contributions to this article.

Further reading

Our only cryptocurrency episode (ESG now podcast)

Creeping Crypto: The ESG Risks of Cryptocurrency (only available for ESG customers)

Bitcoin: as good as gold?

MSCI Perspectives Podcast: NFT and Players and Bitcoin? Oh my!

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