Analysis suggests institutional investors are experiencing a 'creeping' exposure to cryptocurrency – and with it, ESG risks
As investors around the world feel their way through uncharted economic territory, institutional investors are slowly but surely starting to embrace cryptocurrency as an asset class to hold in their portfolios. But even now, they may have more exposure to the risk of crypto assets than they realize.
In a new commentary, MSCI researchers Nigel Fletcher, Siyu Liu, and Aura Toader said that cryptocurrencies are now a part of business for at least 52 companies covered by MSCI ESG Research.
“While Bitcoin remains a focus for many of these companies, the number of coins has exploded in recent years,” they said.
Most cryptocurrencies are only speculative investments and have little evident utility, but some have seen a certain degree of success as genuine currencies, while other have seen eye-watering growth. That growth, they said, has been a driver of both the rise of crypto-exposed companies, and efforts by established companies to gain cryptocurrency exposure.
Even equity investors with major misgivings about cryptocurrencies may experience “creeping” exposure without realizing it, they said. Newly listed crypto companies may get added to indexes, or current index constituencies might announce strategies that include bitcoin or other cryptocurrencies.
Investors stand to take on more ESG risk with that rising exposure, the researchers said. From an environmental standpoint, crypto mining lends itself to greenhouse-gas emissions from energy usage, as well as the generation of electronic waste. Evidence suggests Bitcoin, along with other proof-of-work cryptocurrencies, have a greater impact than others.
“Identifying where mining occurs and what energy sources are used is key to assessing a coin’s emissions profile,” the researchers said.
The social impact of cryptocurrency remains unclear, though there are certain risks arising that centre on investor protection and education, as well as transaction disputes for companies that accept cryptocurrencies as payment. Boards of crypto-exposed companies, the researchers added, may need to adapt existing risk management policies and practices to specific risks arising from cryptocurrencies.
“[T]he governance of cryptocurrencies may present some new challenges for boards and investors alike,” they said. “By design, most cryptocurrencies are decentralized; no single decision-making body oversees a cryptocurrency’s strategy and direction.”
Cryptocurrency-exposed companies can, however, develop informal governance frameworks from communities of software developers, crypto miners, and other actors in the space. Even though the issues they deliberate on are often technical, investors may want to consider engaging more actively with companies that have significant exposure by encouraging the development of cryptocurrency protocols, supporting decentralization within the cryptocurrency’s financial ecosystem, or engaging with other actors within the cryptocurrency’s governance framework.
“Regardless of whether a cryptocurrency-exposed company passively monitors or actively engages in the governance of cryptocurrencies, understanding how it approaches the intersection of its strategic plan and the long-term development of cryptocurrencies may help investors make more informed risk decisions,” the researchers said.
