The increasing exposure of banks to crypto assets with a significant carbon footprint is leaving the financial system more vulnerable to climate risks, according to a new report from the European Central Bank (ECB). A number of regulators have also issued similar warnings in recent months.
The report suggests that action to address emissions associated with crypto assets is inevitable, particularly as governments take a more critical look at overall energy use amid current disruptions to supply. The authors suggest investors are unlikely to have priced in the impacts of such measures.
A Bank for International Settlements report published earlier this year found that although banks’ direct exposures to cryptocurrenices have remained limited thus far, they may play a more active role in providing services to the sector in the future. It suggested they may also become increasingly reliant on exchanges and other intermediaries as demand for crypto assets grows.
The ECB researchers suggest the Basel Committee on Banking Supervision (BCBS) may look at adjusting the treatment of crypto assets in its capital framework. This could take the form of risk weight add-ons or – more punitively – could stipulate that banks deduct capital for all new exposures to crypto assets with a significant carbon footprint. The latter approach was advocated by the Brussels-based NGO Finance Watch in a letter to the BCBS.
Some regulators have already called for policy measures to address the carbon footprint of cryptocurrencies. Following the increased prevalence of crypto mining in Sweden, the national financial supervisory authority has recommended a ban on the proof of work (PoW) method for confirming transactions and generating new assets. China has issued a ban on all crypto transactions and mining, citing environmental and financial stability concerns. The White House has opened an investigation into crypto’s climate impact.
Regulator concerns are focused on the huge amount of electricity required for the PoW method. The ECB paper cites studies by the Cambridge Centre for Alternative Finance and others which have estimated the annual energy consumption of bitcoin and etherium as being akin to that of Spain or the Netherlands.
Although there are some efforts underway to decarbonise the cryptocurrency and blockchain industry, and alternative design choices can result in large differences in the ultimate carbon footprint per transaction, the ECB researchers express scepticism over whether these will have a significant impact.
“While these initiatives are welcome in principle, they remain voluntary in nature and are unable to enforce changes in the consensus method,” they conclude.
This page was last updated July 14, 2022
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