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Have You Been Taken To The Greenwash?

Rayne Steinberg
May 23, 2021
Consumers and corporations are constantly chasing the next big thing. This is a broad cultural phenomenon that also occurs in our industry, financial services. Sometimes these trends emerge and grow organically; unfortunately, more often than not, they are energized externally. In asset management, this occurs when firms try to capitalize on legitimate investment goals by exaggerating or misstating aspects of products. The altruistically motivated ESG (Environmental, Social & Governance) investing theme is the most recent victim. Profit-motivated asset managers have co-opted people’s legitimate desire to invest in society conscience initiatives by shoe-horning strategies into the ESG bucket. Unfortunately, this is not an isolated occurrence and especially troubling because it takes advantage of the patron. In the digital assets sector, we are all too familiar with it.
 
Recently, we have seen several examples of this exploitative mentality at play. For instance, Grayscale introduced their Bitcoin Trust (GBTC) in 2013, a financial vehicle designed to track the price of Bitcoin. Initially, GBTC presented a strong value proposition; giving traditional investors a way to invest in Bitcoin using a common and trusted financial structure. The product was in such demand that it traded at a substantial premium to the underlying value of its Bitcoin holdings. The problem arose when the premium evaporated and GBTC started to trade at a steep discount, due to the introduction of more efficient and liquid BTC investment opportunities.  Institutional investors sold on GBTC’s arbitrage opportunity were no longer able to resell their shares on the secondary market to retail investors when the lock-up expired because they would lose money. GBTC has seen its third month trading at a severe discount to the price of Bitcoin. Grayscale’s promise to provide institutional investors the opportunity to gain exposure to Bitcoin has not, in fact, followed the price of Bitcoin at all.
 
Screen Shot 2021-05-18 at 12.21.13 PM
(Source: Bloomberg)
 
According to Grayscale’s end of 2020 SEC filing, “GBTC's investment objective is for its shares (based on Bitcoin per share) to reflect the value of the Bitcoin held by GBTC, less GBTC's expenses and other liabilities. To date, GBTC has not met its investment objective and the shares quoted on OTCQX have not reflected the value of Bitcoin held by GBTC less, GBTC's expenses and other liabilities.” The deficiencies of Grayscale’s GBTC product have become apparent. A once revolutionary product that served a real investor need now stands as a monument to what happens when the profit motive outweighs serving investor needs.
 
This style over substance issue is not only prevalent in the digital assets ecosystem - we see similar events playing out in the food industry, with buzzwords like organic, free-range, cage-free, wild, vegan, etc. slapped on every package for customer appeal. This is a broad societal trend - it’s not what something is, but what that something is perceived to be. 
 
Shiny New Object
The size of the impact investing market grew by 42.4% in 2020 - from $502 billion to $715 billion in assets under management, according to a Barron’s survey. Investors want to see their dollars deployed to benefit the environment and drive positive societal change while still making a good return on capital. Many factors have contributed to the enthusiasm around ESG; including, global warming, racial injustice, gender inequality, and a younger cohort of investors. While the causes vary, investors actively want to promote positive societal change. It is the leveraging of people's good intentions that make greenwashing (providing misleading information about how a company’s products are environmentally sound) so despicable.
 
The deluge of financial products styled as ESG has motivated the SEC to issue guidance/statements for corporations to clarify ESG claims for investors. First, in June 2020, a recommendation to include ESG specific disclosures only for “material” information. And most recently, an ESG Risk Alert identifying the examination areas of registered investment advisors’ and funds’ offering ESG products, “because it is lucrative to do so.” The SEC acted swiftly, and appropriately stepped in to safeguard the investors’ interests. 
 
Digital Assets and ESG
It’s no wonder that the digital assets ecosystem has been highlighted during this ESG surge - it is the most talked about asset class and many of its attributes touch on areas of environmental, social, and governance concerns. 
 
Undoubtedly, digital assets impact the environment due to the method of creating new tokens, or mining. The energy consumption issue, like most things, is nuanced and has considerations on both sides. It would be collectively irresponsible to take celebrity tweets from Elon Musk about bitcoin’s energy consumption at face value. When evaluating this ESG component, multiple factors need to be weighed; including, the purpose of Bitcoin as sound money, the various blockchain protocols and differences in energy use among each, and the opportunities for renewable energy via carbon capture and storage. The frequent headline that ‘Bitcoin consumes more electricity than Argentina’ is not false; however, it is not a complete presentation of the argument. 
 
Our society is offering from a lack of reliable, accurate information and a dearth of trusted sources for this information. The last four years of political news is a prime example - people can form almost diametrically opposed views about the same situation depending on their source of information. In theory, the digital assets ecosystem enables the removal of financial intermediaries, banking the unbanked and promoting wealth equality. Nevertheless, the intention of a technology does not guarantee the implementation will follow the same aspirations. 
 
Take EOS for example, a blockchain-based operating system, created by Block.one, notoriously known for raising the largest and longest ICO in history - $4 billion over a year. The token sale resulted in 6,567% returns to institutional investors, a SEC penalty of $24 million dollars, a token sale audit, broken promises, and a failed governance voting system. The suspicions raised by such activities seem to be strengthened by the statements of Dan Larimer, CTO of Block.one. “In theory, token holders are supposed to vote in producers that provide the most value to the network. In practice, token holders vote in people who pay them kickbacks. It would be like Apple shareholders electing a board that issued new shares and distributed them as kickbacks to a subset of the shareholders.” 
 
The interesting and ironic aspect of blockchain is that it was designed to solve centralization issues through the creation of a distributed and decentralized ledger, but often creates centralization issues in the way it is implemented in the real world. The Harvard Business Review describes, “blockchain is an open, distributed ledger that can record transactions between two parties efficiently and in a verifiable and permanent way.” Blockchain’s very definition assumes what I see as an immutable truth. However, we have seen many examples where blockchain does not alleviate the need for regulation. Case in point, the tale of Quadriga CX, Canada’s largest cryptocurrency exchange in 2019, that suddenly ceased operations and declared bankruptcy, losing more than $135 million with the death (or disappearance) of its CEO/Founder. This is why we are pro-regulation; we see the value of regulators’ investor protection mandates to oversee the decentralization of the financial system.
 
The intention of showing some examples where our industry falls short is not to discourage investment or dampen enthusiasm. We are inviting investors to think independently and examine all sides of these arguments. If ESG has grown to become a new directive for asset managers, where can they find investment opportunities that are ESG compatible? The term ESG is simply that, a term, not a mandate or standard for governance yet, just a topic for debate. As with any debate, one must pursue the search for truth on their own - evaluating data and sources. Socrates famously posited “I cannot teach anybody anything; I can only make them think.” This is as true today as it was in the time of Socrates. I urge newcomers to conduct proper due diligence before blindly investing in something because it is marketed as ESG.
 
To encourage this independent thought process, Arca has created a balanced look at ESG investing as it pertains to Digital Assets. But don’t take our word for it, check it out and form your own opinion.
 
Look for our paper in June of 2021.

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