On March 20, 2023 President Biden exercised his veto power for the first time since being inaugurated in January 2021. The veto kept in place final regulations issued by the Department of Labor under the Biden administration which made it clear Employee Retirement Income Security Act (ERISA) plan fiduciaries are not precluded from making investment decisions that reflect environmental, social, or governance (ESG) considerations. These final regulations were issued in response to a different set of final regulations put in place at the tail end of the Trump administration (referred to as the 2020 final regulations) which sought to restrict investment products from being marketed to ERISA fiduciaries based on goals and benefits that were unrelated to financial performance. Critics of the 2020 final regulations believed the regulations infringed upon plan fiduciaries’ ability to act prudently and solely in the interest of the plan as required by ERISA. The Biden administration agreed and thus put forth its own regulations which a bipartisan delegation of Congress repealed on March 1, 2023 through the Congressional Review Act which allows Congress to rescind regulations within 60 days of the regulations effective date. However, as a result of Biden’s veto, the final regulations, which became effective February 1, 2023, remain in place.
To say the regulations have created a good amount of controversy would be an understatement. Therefore, in the spirit of keeping the debate surrounding the ESG final regulations alive, there is no more appropriate topic to cover than how Bitcoin mining interacts with the final ESG regulations. The remainder of this publication will review unique issues renewable energy projects face due to energy load. We will then explore the basics of Bitcoin mining and how it could be a solution to overcoming the obstacles renewable energy projects encounter. Finally, we will review how Bitcoin mining and bitcoin (please note that Bitcoin with a capital “B” refers to the Bitcoin protocol while bitcoin with a lowercase “b” refers to the currency) should be viewed in light of the final ESG regulations issued under the Biden administration.
Obstacles Renewable Energy Projects Encounter
One of the biggest challenges for renewable energy projects like solar and wind is the misalignment between the energy production and the energy demand. For solar projects energy is only created during the day while the sun is shining. On the other hand, wind, which is more unpredictable, tends to create more energy at night. Unfortunately, there is a misalignment of the creation of power for both solar and wind renewable projects and the demand for power which is at its peak during the late afternoon and early evening. This is problematic as electricity must be consumed moments after it is produced or stored for later consumption (which has its limitations too).
Energy load refers to the amount of electricity demand placed on the power grid at a particular time. The demand for energy fluctuates throughout the day based on variables such as weather and the time of day. When energy demand is too high it can lead to a strain on the power grid which can lead to events such as blackouts or brownouts. These disruptions are widely understood to have significant economic costs through issues such as loss of productivity and damage to electric equipment. What is less well known is that too much energy in the system can be problematic. Situations where the supply of energy exceeds the demand can be extremely costly to energy companies as well. For example, United Kingdom consumers paid an astounding £215 million to turn off wind turbines in 2022 because the grid could not handle the amount of electricity the turbines were producing on the windiest days. That’s a gigantic waste of potential energy and money. Any alternative use of the excess energy that was bypassed by shutting down the wind turbines should be thoroughly explored to make these projects more efficient!
A successful, efficient energy system demands that the system never has brownouts or blackouts but also never experiences energy overloads. The focus of this particular paper is on how energy overloads can be controlled with alternative uses of excess energy. One potential industry which could utilize the excess energy is Bitcoin.
How is Bitcoin Mined?
Bitcoin was created by Satoshi Nakamoto (Satoshi), a pseudonymous person or persons, in 2008. Satoshi released the Bitcoin whitepaper, which goes into detail of the mathematics and computer science that allow Bitcoin to function, on October 31, 2008. However, the Bitcoin protocol did not start operating until January 9, 2009 when Satoshi mined the first block. Since that time, a new Bitcoin block has been created and recorded approximately every 10 minutes on Bitcoin’s public blockchain ledger.
A mathematical formula is used to determine who successfully mines the next block using a concept known as proof-of-work (PoW). The PoW concept ensures that a certain amount of computation power is expended before the next block is created. While there are several different types of PoW systems, Bitcoin miners essentially enter guesses (known as a nonce) to see if they can come up with the right criteria to successfully mine the next block.
To understand how Bitcoin mining works the concept of a hash function is critical. A hash function is a computer program which transforms any kind of data of any length to a fixed number of characters. There are many different hashing algorithms that have been created. However, the Bitcoin protocol uses the hashing algorithm known as Secure Hash Algorithm 256 (SHA256). SHA 256 provides a fixed length output of 64 characters using only the hexadecimal numbers (0, 1, 2, 3, 4, 5, 6, 7, 8, 9, a, b, c, d, e, and f).
One of the ways the Bitcoin protocol uses a hash function is to mine a new block. A new block is mined when a miner inputs a block header that has a hash value that is lesser than or equal to the target hash. Importantly, there are some items of the block header that the Bitcoin miner does not have the discretion to change and other parts the Bitcoin miner has the discretion to change. This is important because each block header is unique which makes each problem the miner needs to solve different than previous blocks. As a result, past solutions do not assist miners in mining new blocks.
Bitcoin mining has evolved rapidly since its inception in 2009. There has been a steady race to create mining equipment that can produce the highest number of nonces in the shortest period of time. Application-Specific Integrated Circuit (ASIC) machines have become popular for Bitcoin mining because they are much more efficient and effective than general purpose computers, such as CPUs (central processing units) and GPUs (graphics processing units) which were the original equipment that was used for Bitcoin mining. ASIC machines use a custom design, which allow the machines to execute the specific hash function used in Bitcoin mining at a much faster rate than general purpose hardware. ASIC machines have continued to improve at a rapid pace making the efficiency level of ASIC machines different depending on when the machine was built.
The probability of successfully mining bitcoin is proportional to the energy expended attempting to find the nonce that will produce a result less than the target hash. As a result, the price of a successful miner is linked to the resource of energy assuming similar ASIC hardware is being used. Thus, one of the most important variables in finding cost effective mining locations is finding the cheapest energy sources. As a result of the unique properties of Bitcoin mining discussed more thoroughly in the next section, Bitcoin mining can be done efficiently anywhere on earth if there is cheap energy. Consequently, despite the conventional “wisdom” that has been promoted by the mainstream media, a partnership between Bitcoin miners and energy projects, particularly renewable energy projects with excess energy, could enhance the chances for these projects to be successful!
The Unique, Malleable Characters of Successful Bitcoin Mining Operations
There are several characteristics of Bitcoin’s PoW protocol that could assist renewable energy projects overcome the misalignment of energy supply and demand. To understand how Bitcoin’s PoW system could assist these projects it is important to understand nine characteristics of Bitcoin’s PoW system which are outlined in greater detail in an influential paper written by Ibanez and Freier titled Can Bitcoin Stop Climate Change? Proof of Work, Energy Consumption and Carbon Footprint.
Flexibility of Load
Bitcoin mining equipment can be turned on and off in under a second without the need to warm up or cool down. As a result, the equipment used to mine bitcoin can be turned on and off effortlessly depending on the supply of energy in the system.
Interruptibility
A bitcoin is mined approximately every 10 minutes. As discussed above, past solutions do not assist miners in mining a new block. Therefore, a miner is at no disadvantage in mining the next block even if it is turned on and off frequently!
Portability
The only two things that are needed for Bitcoin mining is an electricity source and a dependable internet connection. Additionally, the equipment necessary for Bitcoin miners to operate (ASIC machines and other mining equipment) can be transported easily. As a result, Bitcoin mining can theoretically occur anywhere on earth.
Cost and Price Sensitivity
The primary input to profitable Bitcoin mining is the electricity price powering the ASIC machines. Furthermore, the ASIC equipment has evolved as Bitcoin has matured. The newer ASIC machines can be profitable at a higher energy price. However, older ASIC machines are still viable options if the price used to power the ASIC machines is low enough. Importantly, Bitcoin miners are able to know the profitability points (measured by the cost of energy) for each ASIC miner with exact precision. As a result, Bitcoin miners can make prudent, efficient choices on which, if any, ASIC machines should be on at various times depending on the energy price.
Scalability
A unique feature of Bitcoin mining is a miner can enter the competition to mine the next block no matter how much energy it can access. An individual wishing to attempt to mine the next block may do so with CPU from an old laptop at home. On the other end of the scale, a renewable energy project wishing to use its excess energy can run as many ASIC miners as it can on the excess renewable energy being created. Any point between these two extremes is also feasible with Bitcoin mining. As a result, the Bitcoin mining industry can serve as a shock absorber for the energy grid and lead to more efficient energy consumption.
Consumption-Level Granularity
As a result of ASIC machines having different break even points given the rapid evolution of the equipment used to mine bitcoin, the energy consumption being utilized by Bitcoin miners can be adjusted up or down with extreme precision, with great efficiency, at no extra cost. In other words, a diverse mix of ASIC miners would allow for many different levels of energy consumption. This is a clear advantage to binary alternatives which feature an all or nothing approach to energy consumption.
Non-Rival Energy Consumption
If Bitcoin miners are properly integrated with renewable energy projects, the energy needed for the Bitcoin mining will not necessarily cause the need to generate more energy. Rather Bitcoin mining can help these renewable projects operate more efficiently and use energy that would otherwise be wasted. Beautifully the ASIC machines will allow the renewable projects to make a profit, through the mining of bitcoin, on energy that would otherwise be wasted with no additional emissions being released in to the atmosphere.
Uncorrelated Revenue Streams
Bitcoin mining can be a beneficial and stable source of income for renewable energy projects because the fluctuation of bitcoin prices and electricity prices follow independent processes which are not correlated, providing the option to switch outputs when it is optimal.
Heat
The process of Bitcoin mining requires the input of energy. As a result of the law of conservation of energy (which states that energy cannot be destroyed rather it can only be transferred from one form of energy to a different form of energy), the energy used to mine the next Bitcoin block is largely transformed into heat. In the early days of mining cooling procedures were developed so the ASIC machines could continue to function. However, recently miners have been looking at ways to efficiently use the heat created through Bitcoin mining for everyday items such as heating homes, schools, commercial real estate, or water. If heat needs to be created for something, creating the heat with something functional such as Bitcoin mining is more efficient. This feature of Bitcoin mining will be used in the future to make a more energy efficient grid.
The nine characteristics listed above show how Bitcoin mining can be a unique partner for energy projects. Bitcoin miners can assist energy projects to become more efficient and resilient to load issues, prevent the need to flair methane gas and instead use the currently wasted methane gas to mine bitcoin which is not only more efficient economically but also massively reduces emissions, and create a new revenue stream by accumulating bitcoin instead of letting the excess energy go unused. All energy projects could benefit from either partnering with Bitcoin mining companies or, alternatively, acquiring Bitcoin mining equipment and performing the mining themselves!
Finally, if a government is subsidizing renewable energy programs which may no longer be necessary if proper partnerships are formed or vertical integration occurs, it could use the excess energy and mine the bitcoin for the country’s reserves all while assisting to manage the load. Any country providing subsidies to the renewable energy project should demand to have access to the excess energy for use in mining Bitcoin. This would allow the country to not only position itself better for a transition to a new era of power consumption but also place it in a better position to adjust to the evolving landscape of the world’s monetary system which could be decoupling from the control of the world’s governments.
New Hampshire Commission Report Study
The idea of harnessing the unique properties of Bitcoin mining to make a more efficient use of energy is not isolated to academic papers such as the one written by Ibanez and Freier. On December 21, 2022 the State of New Hampshire released the findings of a Commission the State assembled to study cryptocurrencies and digital assets. The goal of the commission was to assess the effectiveness of existing State laws and regulations on cryptocurrencies and digital assets, and identify necessary modifications to enhance innovation, economic competitiveness, financial system impacts, and protect privacy and liberty rights.
With respect to Bitcoin mining, the Commission concluded that Bitcoin miners could have a positive impact on stabilizing the State’s electric grid (see page 39-40 of the Commission’s report). The report states “the unique, interruptible nature of bitcoin mining’s electricity demand may actually offer stabilizing benefits to electrical grids and even encourage the development of new energy resources (including renewables).” The report focused on the ability to turn on and off the Bitcoin mining equipment with virtually no friction and how that quality could be used to help the overall economics of renewable energy projects. The Commission concluded that the Governor and Legislature should instruct the New Hampshire Department of Energy to review the potential integration of Bitcoin mining operations into a statewide energy plan, focusing on stabilizing the electricity grid, promoting sustainable generation projects, lowering consumer costs, and exploring legal avenues for vertical integration for renewable energy development and Bitcoin mining within New Hampshire.
Other Alternative Energy Resources to Alleviate Load Issues
Other uses of the excess energy could also be utilized to stabilize the energy grid. However, all of these alternatives suffer from different shortfalls making the challenges of implementation less feasible if perfect parameters are not in place. Ibanez and Freier explore several alternative uses for excess power that renewable energies create such as water desalination, batteries, and flexible data centers, but conclude Bitcoin mining is most likely the best solution because of the flexibility discussed above. We highly encourage interested readers to review the findings of Ibanez and Freier in section VIII of their article. For this paper it is sufficient to say that we understand that there are other viable uses for the excess energy created by renewable energy projects so long as certain parameters are satisfied. However, none of these viable alternatives have the flexibility possessed by Bitcoin mining operations.
Bitcoin mining is unique because if there is excess energy in the system, additional Bitcoin mining equipment can be turned on to efficiently use the energy. Alternatively, if there is too much demand and more energy is needed, Bitcoin mining equipment can easily be turned off without any friction. The ease at which Bitcoin mining equipment can adjust to the demand for energy is extremely valuable.
Bitcoin Mining Can Be a Powerful Tool Used to Combat Climate Change
As Ibanez and Freier along with the New Hampshire Commission concluded, Bitcoin mining is increasingly becoming recognized as an ESG friendly activity. Contrary to popular belief, the energy used to power Bitcoin mining is not necessarily wasteful, as it can be generated using energy from renewable energy projects that would otherwise be wasted, and can even help promote the development of renewable energy projects by providing alternative revenue streams such as providing a use for the energy before the renewable projects are connected to the energy grid. By relying on renewable energy sources and promoting the development of additional renewable energy infrastructure, Bitcoin mining can not only be environmentally sustainable but can also help to promote future ESG projects. Having established that Bitcoin mining can be considered ESG friendly, it is finally time to examine how this revelation should be integrated into a fiduciary analysis under ERISA particularly in light of the ESG final regulations.
How do ERISA Fiduciary Duties and the ESG Final Regulations Relate to Bitcoin Mining?
Title I of the ERISA sets forth minimum standards for employee benefit plans, including rules on fiduciary responsibility. Section 404 of ERISA mandates that plan fiduciaries act with prudence and diversify investments to minimize the possibility of significant losses, except in situations where it is evidently prudent not to diversify. Additionally, Sections 403(c) and 404(a) stipulate that fiduciaries must act solely in the best interests of the plan's participants and beneficiaries, focusing on providing benefits and covering reasonable plan administration expenses. It is important to keep in mind after both the 2020 final regulations and the 2022 final regulations the underlying responsibilities of loyalty and prudence are still paramount. The 2022 final regulations make that abundantly clear.
Advocates of the ESG final regulations position the regulations as clarifying that ESG factors may be relevant to the risk-return analysis of a potential investment. In the Department’s view this has been the position of the Department for years in non-regulatory guidance. For example, in Interpretive Bulletin 2015-01 the Department summarized its position by stating “…if a fiduciary prudently determines that an investment is appropriate based solely on economic considerations, including those that may derive from environmental, social and governance factors, the fiduciary may make the investment without regard to any collateral benefits the investment may also promote. Fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social, or other such factors.”
The final regulations codify the Department’s previous non-regulatory guidance. For example, section 2550.404a-1(b)(4) states “Risk and return factors may include the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action.” This is the only place the final regulations mention ESG and it does appear the regulations are just restating a position that the Department has held for a number of years regardless of the party who controlled the White House. This language should appease the left side of the aisle.
The final regulations are equally clear the duties of prudence and loyalty are still paramount. For example, section 2550.404a-1(c)(1) states “A fiduciary may not subordinate the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan to other objectives, and may not sacrifice investment return or take on additional investment risk to promote benefits or goals unrelated to interests of the participants and beneficiaries in their retirement income or financial benefits under the plan.” This language should appease the right side of the aisle.
It is only in the rarest circumstances where a fiduciary prudently concludes that competing investment courses of actions equally serve the financial interest of the plan over the appropriate time horizon that the fiduciary can consider collateral benefits such as the ESG factors to break the tie (see 2550.404a-1(c)(2)). Even in those circumstances the regulations are clear that “A fiduciary may not, however, accept expected reduced returns or greater risks to secure such additional benefits.” (see 2550.404a-1(c)(2)).
One significant change in the new ESG final regulations compared to the 2020 ESG final regulations is plan sponsors can elect a qualified default investment alternative (QDIA) with an ESG theme. This is a stark contrast to the 2020 final regulations which expressly prohibited ESG themed funds from serving as a QDIA. Additionally, the final regulations make it clear that a plan fiduciary of a participant directed account plan does not violate the duty of loyalty solely because the fiduciary takes into account the participants’ preference. This is particularly relevant to Bitcoin as a 2022 survey found up to 50 percent of millennials (individuals born from 1981 to 1996) and generation Z (individuals born from 1997 to 2012) wanted to invest in cryptocurrency in their 401(k) plans. Importantly, for the participants’ investment preferences to be able to be considered, the fiduciary must conclude that the investment is prudent! In other words, participants’ preferences are not a substitute for prudence.
One question that many have had regarding the new ESG final regulations that highlight some of the issues discussed above in this section is how a fiduciary should compare investments with an ESG theme to determine if the investment is prudent. Fortunately, an insightful discussion between Brian Graff of the American Retirement Association and Tim Hauser, the Deputy Assistant Secretary for Program Operations at Employee Benefits Security Administration, discussed an example exploring this question in their thorough discussion on the ESG final regulations. Graff asked Hauser how prudence should be examined by a fiduciary when looking at an investment such as a target date fund that excludes companies that produce fossil fuels. One potential viewpoint to the question above is prudence should be examined and measured against other funds which have similar screens (i.e. funds that also exclude companies that produce fossil fuels). An alternative viewpoint to the question would be that a target date fund that excludes fossil fuels must be compared to all funds even ones which do not screen out fossil fuels.
Hauser explained that the relevant risk and return analysis should be compared to investments which do not have the restrictive ESG screens associated with them. In other words, it appears the EBSA position interpreting the regulations is for an ESG investment to be prudent the investment financial merits need to govern the inclusion of what you are allowing participants to invest. Hauser explained that even if a large number of plan participants want to invest in an ESG themed fund or some other fund promoting an ancillary objective unrelated to providing valuable retirement benefits that investment cannot be offered if honoring the participants’ preferences is going to lower returns, create greater cost, or create greater risk. This is because such an investment would fall short of the prudence requirement.
Therefore, the fact that Bitcoin mining can be viewed as ESG friendly does not play a major role in whether a plan fiduciary can elect to include bitcoin in the investment plan menu. Instead, the fiduciary must determine if bitcoin (or a Bitcoin mining company) would make for a prudent investment based on a financial risk and return factors.
Conclusion
There is growing evidence that Bitcoin mining is ESG friendly and has the potential to help renewable energy projects operate more efficiently and profitably. Despite the ESG friendly nature of Bitcoin mining, a fiduciary should only invest in bitcoin (or a Bitcoin mining company) if the fiduciary concludes that such an investment would maximize the financial interests of the plan participants. .
Ironically, considering many people only hear about Bitcoin when the latest bitcoin crash that will end the Bitcoin dream forever has occurred, Bitcoin has also emerged as one of the most asymmetric investments that could have been made over the last decade. The question then becomes, is it financially prudent to project Bitcoin's past performance or even a fraction of it to future performance? One could make a strong argument that the recent bank failures, the persistent inflation crisis (and in some cases catastrophic), and political events around the world have further strengthened the case for Bitcoin as a decentralized, inflation-resistant asset that can potentially serve as a hedge against economic uncertainty and market volatility.
Understandably, many fiduciaries have been reluctant to even consider bitcoin as an investment option particularly in light of CAR 2022-01. In 2022 the U.S. Department of Labor released CAR 2022-01 to highlight some of the Department's concerns regarding cryptocurrency options being added to investment menus. For bitcoin (or a Bitcoin mining company) to be a prudent investment option, a fiduciary will need to be able to show that a bitcoin investment is prudent compared to alternative investments. Preferably the fiduciary would be able to address some of the concerns of CAR 2022-01. In our next article we plan to do just that by explaining why bitcoin is a prudent investment for plan fiduciaries to consider even in light of CAR 2022-01. If you have any questions, concerns, or disagreements with the contents discussed in this article, please don’t hesitate to contact me.
