Crypto Meets ESG – Is the Future Looking Green?

With the Markets in Crypto-Assets Regulation (“MiCAR”), the EU legislator is creating a legal framework for crypto-assets for the first time. The provisions of MiCAR have already applied in part since June 30, 2024 (Title III and Title IV in relation to so-called stablecoins). From December 30, 2024, the remaining provisions of MiCAR will apply directly in all EU member states. An issue that has received less attention in the context of MiCAR is crypto-assets and their environmental impact (Environmental, Social and Governance – “ESG”).

In today’s article, we shed light on the topic of Crypto & Sustainability. We provide a brief overview of the regulatory requirements for the disclosure of ESG impacts of crypto-assets and highlight the challenges that exist in practice when implementing these requirements.

An article by Attorney Awet Yohannes, Annerton & CEO Tim Zölitz, Crypto Risk Metrics

MiCAR disclosure requirements for the ESG impact of crypto-assets

Anyone wishing to issue, publicly offer or trade crypto-assets in the EU or provide services in connection with crypto-assets must comply with the requirements of MiCAR. One requirement introduced by the EU legislator with MiCAR is the disclosure of certain information in connection with crypto-assets.

The Information to be disclosed includes the main adverse climate impacts and other environmental impacts of the consensus mechanism (see Art. 66 para. 5 sentence 1 MiCAR for Crypto-Assets Service Providers (“CASPs”)).

This information must be disclosed either in a clearly recognizable place on the CASPs’ website or in a so-called crypto-asset whitepaper (“whitepaper”).

For a long time during the MiCAR development process, it was unclear how exactly the environmental impact would be taken into account in EU legislation. In addition to the complete exclusion of impacts, extensive bans were also discussed, e.g. for the operation of so-called Proof-of-Work blockchains.  In the end, the EU legislator opted for mandatory disclosure of information containing the most important adverse environmental impacts of the consensus mechanism used and the validation of transactions within the network.

MiCAR itself does not set out any specific requirements for the content, methods and presentation of information on adverse environmental impacts.

Instead, the EU legislator has mandated the two supervisory authorities ESMA and EBA to draw up so-called Regulatory Technical Standards (“RTS”), which will, among other things, regulate the content, methods and presentation of information on sustainability indicators in relation to adverse effects on the climate and other environmental impacts.

ESMA specifies MiCAR requirements through draft RTS

On July 03, 2024, ESMA published a final draft on sustainability indicators in relation to adverse effects on climate and the environment. The European Commission has not yet decided whether to adopt the final draft and issue a delegated act (also known as a Level 2 act).

Key takeaways from ESMA’s final RTS draft are as follows:

Who does the draft ESMA RTS apply to?

• Person drafting crypto-asset white paper
• CASPs offering one or more of the following services
  • Operating a trading platform,
  • Exchanging crypto-assets for funds or
  • Exchanging crypto-assets for other crypto-assets
• CASPs only providing services other than those listed above

What are ESMA’s requirements for data availability and reliability?

• The data must be permanently and easily accessible on the CASPs website.
• The data must be updated once a year (so-called Regular Update).
• However, significant changes (“material changes”) must be updated on an ad-hoc basis (so-called Event-Driven-Update).

Which content, methods and presentations are relevant

• A key indicator must always be published. This key indicator is the energy consumption of the crypto asset per year.
• If this key indicator exceeds a threshold of 500,000 kWh, five additional indicators must be published (so-called One-plus-five-approach).
• CASPs that neither operate a trading platform nor exchange crypto-assets into funds or other crypto-assets are exempt; these CASPs only have to publish the key indicator.
• In addition to the quantitative indicators, qualitative information must also be disclosed. This includes, for example, master data on the crypto-asset, descriptive texts regarding the consensus mechanism, data sources, methodology used in the calculation of the indicators, etc.

The main sustainability indicators that may need to be published for information are, in particular, the following:

• Total energy consumption (kWh) per year
• Consumption of renewable energies (%)
• Energy intensity per transaction (kWh)
• Scope 1 and Scope 2 greenhouse gas emissions (TCO2e)
• GHG intensity per transaction (kgCO2e)

(see also Annex 1: Spreadsheet Overview)

Practical challenges

Meeting the regulatory requirements of “ESG compliance” in connection with crypto-assets poses practical challenges, particularly in connection with data collection. In particular, the calculation of indicators poses a practical challenge, as the entities involved in the distributed ledger network and their energy consumption must first be identified. The corresponding data sources can also become a practical challenge, as the individuality of the networks means that the necessary data sources can vary, making it difficult to obtain reliable information on the nodes within the networks. The use of certain search algorithms (so-called “crawlers”) may be helpful here. The data sources also require information on the power consumption of the hardware running the software required to operate a node. Although this data can be collected empirically using measurement techniques, the measurements are complex, because there are a large number of hardware components and usually several software clients per network, which quickly leads to a large number of possible combinations. In addition, this data must be combined with data on the energy mix of the node locations in terms of renewable energy and CO2 emissions per unit of energy.

Bottom line

The regulatory requirements for the disclosure of information relating to the environmental impact of crypto-assets pose challenges in practice. In particular, the content, methods and presentation of the information are new requirements that still need to be mastered in practice. The new requirements entail considerable additional work (e.g. when monitoring data on material changes). Specialized third-party providers can also be used to meet the disclosure requirements, ensuring MiCAR compliance with regard to the environmental and climate-related impacts associated with crypto-assets.

Annex 1:       Spreadsheet Overview

(Source: Annerton Rechtsanwaltsgesellschaft mbH)