Throughout history, societies have evolved around different governance models, pointing towards centralized entities. People and communities have entrusted power to few people in control, relying on their ability to be good actors. This concept of “power” has been pulled apart by blockchain technology and the emerging Web 3 ecosystem.
Satoshi Nakamoto’s Bitcoin Whitepaper released in 2008 made use of mathematical algorithms and an immutable ledger to dismantle traditional models, founding an entirely new governance structure that can potentially disrupt multiple environmental, social, and governance (ESG) factors at once.
From a financial perspective, the integration of ESG factors within investment frameworks and strategies has become crucially important for driving profits and asset growth in the future. Moreover, ESG Factors are also critical in assessing the overall investment risk: companies neglecting ESG policies, for instance, might incur legal actions and financial penalties at the cost of investments’ performance.
ESG has ultimately pushed investors to pivot their investment strategy combining ESG metrics with traditional financial ones. In the US, for example, 86% of investors favor investments that match their values, believing companies with strong ESG practices may drive higher yields. At a global level, sustainable fund assets hit nearly $4 trillion in the third quarter of 2021.
While ESG metrics are not part of mandatory financial reporting, they are noticeably more relevant in today’s financial system and investment strategies than a decade ago. Nevertheless, ESG data remains inconsistent with poor audit systems in place.
With that regard, blockchain technology can provide a systematic level of ESG analysis. Its architecture makes it very easy to solve complex data challenges, as data is always accessible, traceable, and immutably referenced on-chain. There’s a full spectrum of ESG factors that blockchains can help address:
– It enables greater governance efficiency by improving and simplifying existing processes.
– It brings accountability, transparency, and security through real-time data collection and validation. It promotes social inclusion by democratizing access to finance.
– Ideally, accurate and systematic integration of ESG data across blockchains has the potential to open up new opportunities while also unlocking new products and services across markets.
From Proof-of-Work to Proof-of-Stake
Bitcoin and Proof-of-Work (PoW) are getting a bit of a “black eye” regarding people’s perception of its environmental impact. An example that captured a lot of media attention was Elon Musk’s decision to suspend Bitcoin for Tesla’s vehicle purchases due to its environmental impacts. More debates have followed this environmental discussion, such as the often referenced comparisons to the energy consumption of medium-sized countries like Denmark, The Netherlands, or Finland.
At the core of such misconceptions and misbeliefs, there’s the Proof-of-Work (PoW) consensus mechanism, which implies solving highly complicated math problems to verify transactions and add new blocks to the chain. This mechanism is widespread in the crypto mining operation used by Bitcoin and other PoW networks to create and add new coins to the blockchain.
Bitcoin and PoW mining is performed by ASICs, a hardware device designed for this specific purpose. However, ASICs require a significant amount of energy to work, which has drawn rising criticism and environmental concerns against ESG sustainability principles.
Instead, proof-of-stake (PoS) networks are based on a different and less energy-intensive consensus mechanism that randomly selects validators to confirm block transactions. Furthermore, PoW gives mining power to ASICs’ owners, whereas validators in PoS networks are selected based on the percentage of tokens they stake, hence addressing the scalability and environmental concerns surrounding PoW. In summary, PoS uses significantly less energy than PoW.
The analysis of blockchain protocols within an ESG context will become increasingly critical as institutional investors move into the space.
