The first digital currency, bitcoin, was launched in 2009, and since then growth has been incredibly fast; as of January 2021, there were more than 4000 digital currencies in existence.
Over the past year, headlines relating to cryptocurrency have appeared with ever increasing frequency – from El Salvador adopting bitcoin as legal tender, to hackers stealing $600m, and a host of related stories in between. Here, we run through some considerations to bear in mind when it comes to investing in digital currencies and consider what, if anything, they might add to the world of finance in terms of sustainability.
Unlike conventional currency, digital currencies have no physical form, and exist only as virtual “coins”. They are “mined” using dedicated computer hardware, stored in “virtual wallets” and can be exchanged online without the need for a bank account. The technology that underpins digital currencies is known as blockchain. Whereas historically transactions of all kind have largely depended on a third party – for example banks, social media companies or property agents – blockchain allows transactions to be made directly from person to person.
Digital currencies and financing change
In theory, digital currencies could be used to finance projects having a positive environmental, cultural or social impact - for instance, digitally building ecosystems with trading other (sustainable) values pegged to a coin or on a blockchain can create sustainability. Moreover, the technology behind digital currencies (blockchain) can be a good way to enhance transparency in supply chains – as proven by the exciting B Corporation Provenance.
However, the mechanism of investing in digital currencies means that rather than money being out in the world creating positive change, the currencies are sitting in a wallet waiting for the market value to change. If the currency is successfully sold at a profit, this benefits the individual investor, but not the wider society or the environment. When used for speculative investing and without transparency about where the money is going, cryptocurrencies represent a side of money we believe is not sustainable: money generating money but not generating real economic value.
The problem of carbon footprint
As with natural resources, the more digital coins that are mined, the harder they are to come by, and the discovery process takes increasingly more computing power. Mining for bitcoin is estimated to create between 22 and 22.9 million metric tonnes of carbon dioxide emissions a year – between the levels produced by the countries of Jordan and Sri Lanka annually. At a time when governments, business and individuals should all be taking urgent steps to reduce carbon emissions and avoid the worst consequences of the climate crisis.
Digital currencies and blockchain can play a useful role in the economy
Since their launch, both digital currencies and blockchain have largely been described as disruptive. It is theoretically possible for anyone to create a new digital currency, and there are instances where these can generate positive change. SolarCoin, which launched in 2014, is awarded to solar panel owners to make solar energy more affordable. Likewise, by removing the need for a third party, blockchain democratises the process of making transactions. An interesting example of this is the Mycelia project, led by British musician Imogen Heap, which aims to provide a platform for artists to sell their work directly to consumers and hence get a fairer income for their work. It is worth noting, however, that more recently some commentators have observed that despite blockchain having been around for a while, and heavy investment in projects exploring real world applications, the actual rate of translation to market is relatively low.
However, they are extremely volatile
Digital currencies are not backed by a central bank or Government, so they are not influenced by the typical factors that affect standard currency. History has shown that the value of digital currencies is prone to large fluctuations. This is, in part, what can be so appealing to investors. The prospect of buying a digital coin – or a fraction of a digital coin - at one price, and selling at some point in the future for a vastly larger amount of standard currency, can be tempting. However, the volatility works in both directions, and can drive the currency down as well as up. Investing in the hope that it will play out in your favour is pure speculation. Some of the factors that may account for a sudden rise or fall in value include:
Market demand – the digital gold rush
The decrease in availability and increase in demand has led to a huge rise in the value of digital currency over the past decade. This rise has in turn led to a higher demand and something akin to a digital gold rush. The dilemma is that whereas traditional currency tends to be backed by gold, there is nothing behind the value of digital currencies beyond what individuals are prepared to exchange for it. Once the speculative bubble burst the risk of a steep drop in value is ominous. In May 2021 bitcoin took a sudden and drastic fall in value following car manufacturer Tesla’s decision to no longer accept digital currency as payment for its products.
In May 2021, the Chinese government banned financial institutions in China from providing services relating to cryptocurrency. It also issued a warning to investors about the dangers of speculative trading. Another instance of regulatory intervention took place in June 2021, when the UK Financial Conduct Authority ordered Binance, one of the world’s largest digital currency exchange programs, to cease regulated activity with immediate effect. The FCA also issued a warning to investors about the platform.
As well as the risk of hacking, increasing attention has been turning to the role of social media influencers in promoting cryptocurrency to their followers. The most prominent of these stories was a reality television star sharing a sponsored post about the currency Ethereum Max with her 250 million followers. Whilst some of these promotions may for part of a legitimate partnership, there is also a trend of fake coins appearing. UK-based Action Fraud reported that £146,222,332 has been lost to cryptocurrency fraud since the start of 2021.
At Triodos we believe that money used consciously can be a force for good. Money is a proxy for value and trust. It serves as a way to enable investment in the things that matter. We look for two types of sustainability from the assets in our portfolio: evidence of actively contributing to a more sustainable future for all by investing in the real economy; and a business model that we would expect to deliver financial sustainability, and the best chance of a financial return for our investors. The history of digital currencies demonstrates that the value is prone to wild fluctuations, and therefore does not represent a financially sound investment option. Whilst both digital currencies and blockchain have the potential to contribute to positive change, without appropriate regulation measures, investors risk exploitation or huge losses in the case of a crash in value.
Making a difference
Triodos Investment Management does not invest in digital currencies through its funds, but focusses on investments in organisations delivering positive impact in the real economy. The Triodos Impact Investment Funds focus on driving positive environmental and societal change around the world and work hard to deliver competitive financial returns.
You can invest in the funds directly or via the tax-efficient Triodos Stocks & Shares ISA.
Please note that with investment in ethical funds and companies, as with all investments, past performance is not a guide for future returns and you may not get back the amount that your originally invested.
The tax benefits of an ISA are subject to change and depend on individual circumstances.