Request Free Trial

Regulatory Briefing: ECB warns on climate-related risks of crypto mining

In future, what limited renewable energy is available for mining cryptocurrencies is likely to be diverted away from the highly energy-intensive bitcoin sector, the European Central Bank cautions in its latest Macroprudential Bulletin. Prudential regulators may want to capitalise this risk, possibly with “punitive” treatment of these assets.

These risks could deliver a further blow to the value of bitcoin and other digital currencies that use a ‘proof of work’ method to verify the mining of coins rather than far more energy-efficient alternatives that now exist.

Some crypto assets have an annualised energy consumption estimated to be similar to that of mid-sized countries such as the Netherlands or Austria, suggests the bulletin. Among the worst offenders are bitcoin, ether and tokens based on the Ethereum blockchain, such as the stablecoin Tether, says the ECB.

The ECB’s warning. The central bankers say: “Political and social choices on energy sources and energy consumption levels are needed for the green transition to net zero. These choices could lead policymakers to privilege certain productive activities and their use of energy to meet climate strategy targets and avoid crowding out the limited renewable energy sources for crypto mining. It is unlikely that bitcoin investors have currently priced in the negative ecological externalities and authorities’ possible policy measures.”

The ECB continues that prudential standard-setters may want to capitalise the increased transition risk of crypto assets. One rationale for this action would be that the large carbon footprint of proof-of-work crypto assets means that the risk to them as we transition to a green economy may be more acute. Also, crypto is not yet on banks’ balance sheets in a very significant amount. “Hence, conservatively capitalising the increased transition risk of crypto assets will have no immediate impact on bank capital and thus indirectly on bank lending.”

Crypto capital requirements. Capital requirements for crypto’s climate transition risk could range from risk weights to more “punitive” capital treatment, the ECB suggests. For the banking sector, the Basel Committee could consider imposing uniform additional capital requirements on banks’ engagement in crypto assets that have a significant carbon footprint. Such capital requirements could be risk sensitive in 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 ECB concludes that it is highly unlikely that investments in proof-of-work crypto can be part of an ESG investment strategy.

A service from the Financial Times