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Assessing ESG risks while investing in blockchain ETFs

Morningstar Sustainalytics released a report that aims to help investors evaluate ESG issues related to applications of blockchain in public equities markets.
Diagonal chain made of zeros and ones. Cryptocurrency and mining. A bitcoin metaphor. Gray background. A close up. 3d rendering mock up

While blockchain initiatives are still at an early stage of development across most sectors, Morningstar Sustainalytics has developed a framework to help identify companies that are well positioned to integrate this technology into their ESG strategies, in its thematic research report entitled “An ESG Lens on Blockchain and Public Equities.”

The research created a model fund of funds (FOF) based on 10 blockchain-themed ETFs and compare its ESG risk profile with that of a global equities index.

The funds are incepted from 2018 to 2021 and domiciled in the US, Canada, and Ireland.

The analysis found that the model FOF has an overall weighted ESG risk score of 19.9, compared with 21.6 for its global equities index, which suggests that investors in the blockchain market face slightly less overall ESG risk than investors in the broader global equities market.

Blockchain ETF investors may also avoid some of the material ESG risks, as the report found that only 10.4% of the FOF ’s market value falls into the high or severe ESG risk categories, compared with 13.8% for the global index.

However, the FOF exhibits much less sector diversity that the global index, suggesting that the potential benefits of application use cases in other sectors may be untapped by investors.

ESG risks

When investing in the crypto market, non-uniform and dynamic regulatory environments can expose firms in this sector to compliance and ethical risks, according to the report.

According to the Global Legal Research Directorate of the Law Library of Congress, 51 countries have placed implicit or explicit bans on specific crypto-related activities, up from 23 in 2018, while nine jurisdictions have made cryptocurrencies illegal.

Another risk related to bitcoin and other proof-of-work based cryptos is the environmental impact associated with crypto mining, said Morningstar.

For example, bitcoin uses 0.65% of global electricity consumption each year, more than the energy use of many countries, such as Finland and Switzerland, according to University of Cambridge’s online tracker.

This makes mining crypto an activity with significant carbon footprints in some countries which generate the majority of its electricity by burning coal.

However, there is also some crypto mining that can draw on renewables such as hydro-power, and some cryptos function without having to rely on proof-of-work mining, the report noted.

Integration of blockchain

In Asia, DBS and Ping An Insurance, are at the forefront of innovating with blockchain and have strong management programmess to mitigate relevant ESG risks, the Morningstar report found.

Singapore Bank DBS Group expects to grow its blockchain digital exchange user base by 20% to 30% over the next three years. The exchange supports fundraising with asset tokenization and digital asset trading. In China, Ping An Insurance Group ranked second in the global blockchain patent race as of November 2021, with 1215 blockchain patent families filed since 2016.

Part of the Mark Allen Group.