Thread by @smdiehl

This year #ESG investing has a lot of momentum in Europe, and many funds are interested in how crypto factors into their portfolios. (1/) 🧵

For those that don't know, ESG stands for:

* Environmental
* Social
* Corporate Governance

It's an investment philosophy that tries to allocate capital towards companies that are better than their peers with regards to sustainability and societal impact. (2/)

Investing in directly cryptocurrency is one of the most anti-ESG investment you can possibly make.

The environmental exposure of crypto is a nightmare that directly contributes to carbon emissions and climate change at the level of nation states. (3/)

ofnumbers.com/2021/02/14/bit…

Companies servicing the crypto mining industry also incentivizes massive levels of electronic e-waste and disruptions in the supply chain for semiconductors and unsustainable overuse of rare-earth metals. (4/)

cen.acs.org/environment/su…

From a social analysis, large portions of the crypto mining industry are performed in Xinjiang region of China and this potentially poses concerns from both a transparency, human rights and product sustainability perspectives. (5/)

barrons.com/articles/bitco…

The governance aspect of cryptocurrency is concerning and most crypto assets are directly tied to and create incentives for corporate corruption, money laundering, tax evasion, bribes, sanctions evasion and are widely used by organized crime. (6/)

ft.com/content/8e26bb…

While most ESG funds will never directly invest in crypto for the above reasons; a more progressive and future-looking approach is to consider crypto as a risk factor in portfolio construction, for both choosing new positions and rebalancing. (7/)

This is a useful selection criterion and for portfolio stress testing. If we can quantify the exposure of our portfolio to the negative externalities of crypto we can shift capital away from it towards more sustainable thesis investments while simultaneously minimising risk. (8/)

Most of the smart money (at least in London) believes that crypto is an unsustainable asset bubble that will badly quite soon. It is however a strange bubble that seems to be both highly correlated with the broader market while producing nothing in the larger economy. (9/)

Our methodology was to combine several quantitative metrics.

a) Pct. of direct holdings of crypto assets to book ratio
b) Price correlation coefficient with BTC/ETH
c) Market-beta with respect to Bloomberg crypto indexes
d) Pct. indirect holdings of crypto-positive funds

e) Earnings report text analysis
f) Public vendor relations from press releases
g) Pct. earnings crypto mining ( for Technology sector )
h) Pct. earnings crypto custody services ( for Financial Services sector )
i) Pct. earnings blockchain services ( for IT sector )

We only consider publicly listed equities (no ETFs or OTC products) on US exchanges and we end up with 39 large to mid-cap stocks with highest crypto risk exposure. (10/)

There are some bizarre OTC products like $GBTC that are direct investment vehicles for bitcoin, and some small Canadian and European microcap companies but we won't consider those because they're so thinly traded there's not enough data to say anything. (11/)

The top quartile of this analysis:

The first is $MSTR (MicroStrategy Inc) this company ranked highest on all of our metrics, and not surprisingly—what that company is doing is doing is truly insane on a transcendent level. (12/)

Microstrategy issued over $1 billion in corporate debt to add bitcoin to company balance sheet. A failed IT company trying to pivot into becoming a crypto holding company.

When bitcoin collapses there is no universe in which this company doesn't also instantly implode. (13/)

Second is $COIN (Coinbase), there isn't enough data in Bloomberg to do beta regression simply because the company has only been public long enough, it does appear it's price (not surprisingly) is highly correlated with bitcoin. Also doing very poorly after its failed IPO. (14/)

Third is $SI (Silvergate Capital) serves as a banking provider for several US-based crypto companies. Their stock price has high metrics on crypto beta, governance, direct and indirect holdings. (15/)

$SQ (Square) is the highest crypto beta in our analysis. Their business is as a payment services provider and they are directly exposed to bitcoin volatility through governance and direct holdings. It is however still a small line compared to the rest of their business. (16/)

The last is $TSLA (Tesla). I'll write a longer thread about this scheme sometime, but effectively they're buying bitcoin directly on their balance sheet, getting their CEO to promote it, and then quickly dumping it to pad their earnings report. It looks pretty shady. (17/)

The rest of the companies in the model are very indirectly exposed and represent very weak indirect relations through banking, common investors, and software vendor relationships.

The good news is that when bitcoin does implode, it's not going to take much with it. (18/)

Which most of us in tech already intuit even without looking at the market data.

Crypto is a tiny subsector of tech tied mostly to gambling and not much else. There's no big blockchain industry, because ... well, it's useless for anything that touches the real world. (19/)

Put the data for Q2 model up on Github. Usual disclaimers apply, just my opinions and not investment advice.

Factor score is like Barra, 0-100 with 100 being highest risk.

sdiehl.github.io/crypto-risk-fa…

/fin