European Parliament pushes for sustainability disclosures in crypto market
It is a truth universally acknowledged that Bitcoin has the same carbon footprint as [insert small-to-medium sized European country here]. Now the European Parliament is trying to encourage cryptoassets like Bitcoin towards a more sustainable way of working as part of broader plans to regulate cryptoasset markets in the EU. The UK and US have also said they are looking closely at energy usage associated with crypto.
ESG meets fintech
Bitcoin is the best-known example of the proof-of-work consensus mechanism. This involves computers competing to solve complex mathematical puzzles to add transactions to the blockchain. This consensus mechanism, referred to as mining, requires electricity – around 707 kWh per Bitcoin transaction, according to the European Parliament – which is often (but not inevitably) generated from fossil fuels.
1. updating the EU’s ESG Taxonomy Regulation to cover cryptoasset mining activities
2. requiring white papers of cryptoassets using proof-of-work to include an independent assessment of the asset’s likely energy consumption
3. applying sustainability disclosures to cryptoassets, cryptoasset service providers and issuers.
The Taxonomy Regulation establishes the criteria for determining whether an economic activity is “environmentally sustainable”. An activity is environmentally sustainable if it contributes substantially to certain environmental objectives set by the Taxonomy Regulation and meets several other conditions. Technical screening criteria determine whether a given activity contributes to the relevant environmental objective and “does no significant harm” to any of the other environmental objectives.
The European Parliament has suggested that the Commission should include cryptoasset mining in the economic activities that contribute to climate change mitigation in the Taxonomy by 1 January 2025. The likely result is that technical screening criteria would be drafted explaining what an eco-friendly consensus mechanism would look like. Other forms of consensus mechanism would be considered non-compliant from a Taxonomy perspective, which could influence investor demand for the cryptoasset.
MiCAR will require offers of cryptoassets in the EU to be accompanied by a white paper. The white paper must include certain information including a detailed description of the rights and obligations attached to the cryptoasset.
According to the European Parliament, this white paper should also share information on the sustainability of the cryptoasset including whether the underlying ledger has been maintained in compliance with the Taxonomy, plus an independent assessment of the likely energy consumption of the cryptoasset where the proof-of-work model is used.
MiCAR will also impose various conduct obligations on cryptoasset service providers. Relevant services relating to cryptoassets include custody, trading, exchange, brokerage, promotion and advice. These providers would be required to act honestly, fairly and professionally in the best interest of their customers and provide information to them which is fair, clear and not misleading.
The European Parliament plans to add sustainability disclosures to these requirements in MiCAR. Under its plans, cryptoasset service providers would have to publish information related to the environmental and climate-related impact of each cryptoasset for which they offer services. This should be placed prominently on their website. Again, the expectation is that this would explain whether the relevant cryptoassets are in compliance with the Taxonomy.
Collectively these proposals do not amount to a ban of proof-of-work mechanisms. However, the greater transparency on ESG factors would aim to drive investment decisions away from “brown” crypto and towards “green” crypto.
Beyond the EU
The EU is not alone in exploring this topic. For example, having committed to regulating some stablecoins, the UK is preparing to set out its plans for regulating other forms of cryptoasset in a consultation paper due later this year. The government has already said that it recognises the issue of rising energy consumption from certain cryptoassets and that its approach will be aligned to environmental objectives, including the UK’s net zero target. President Biden’s Executive Order on the responsible development of digital assets also requests reports from various US federal agencies which should address the effect of consensus mechanisms on energy usage.
The final content of MiCAR is due to be negotiated between the European Parliament, Commission and Council. These negotiations – known as trilogues – will likely take several months. Neither the Commission nor the Council included sustainability-related requirements in their draft versions of MiCAR so it is up in the air whether the European Parliament’s proposals will make it into the law. The expectation is that the text will be finalised in autumn 2022.