Lawmakers And Regulators Examine Role Of Blockchain Technology In Energy Transitions – Fin

U.S. state and federal lawmakers, as well as federal regulators,
are increasingly focusing on the role of blockchain and distributed
ledger technology (“DLT”) in ongoing efforts to combat
climate change and to facilitate the transition from carbon-based
fossil fuels.

Here are six key developments and players to keep an eye on,
covering two broad categories:

• Initiatives targeting carbon emissions associated with data
  mining operations (items 1, 2 and aspects of items 3 and 4);
  and
• Efforts to enhance the integrity and transparency of energy
  markets and related digital assets (items 5, 6 and aspects of items
  3 and 4)

1. On June 3, 2022, the New York legislature passed a bill to
temporarily halt certain bitcoin and other cryptocurrency mining
operations that run on carbon-based power sources. The bill sets a
two-year moratorium during which the State would not issue new
permits or approve renewals of existing permits for any electric
generating facility that (a) utilizes a carbon-based fuel and (b)
provides, in whole or in part, “behind-the-meter”
electric energy consumed by cryptocurrency mining operations that
use “proof-of-work” (“PoW”) methods for
validating blockchain transactions.¹ If the bill is
signed into law by Governor Hochul, New York would become the first
state in the country to ban new crypto mining infrastructure,
potentially encouraging other states to follow its lead and driving
an increasing share of mining networks to more crypto-friendly
states such as Texas. Critics have warned that such bans not only
harm the intended targets and their workers but may also discourage
renewable energybased mining operations due to concerns over
“regulatory creep”.

2. At the federal level, new legislation was proposed on June 7,
2022 by U.S. Senators Lummis and Gillibrand, which would take a
more industry-friendly approach to cryptocurrency mining. The new
legislation, dubbed the Responsible Financial Innovation Act, aims
to “create a complete regulatory framework for digital
assets.” The legislation does not impose any limits on mining;
rather, it requires the Federal Energy Regulatory Commission, in
consultation with the Commodity Futures Trading Commission (the
“CFTC”), to analyze various issues relating to the impact
of cryptocurrency mining and staking operations on the energy
markets and the environment and to submit an annual report to
select Congressional committees. Issues to be analyzed in the
report include: (a) energy consumption for mining and staking of
digital asset transactions and the effect on energy prices and
baseload power levels, (b) the use of renewable energy sources in
connection with mining and staking; and (c) a process for regulated
entities to make publicly available information regarding energy
consumption.

3. Meanwhile, the Biden Administration is beginning to craft its
own policies to reduce the emissions footprint of PoW-based
cryptocurrencies. On March 9, 2022, President Biden signed an
executive order calling on various executive branch departments and
agencies to collaborate in researching a range of topics relating
to DLT and sets timeframes for these agencies to report their
findings and policy recommendations. In particular, the order
instructs the White House’s Office of Science and Technology
Policy, in consultation with the Secretary of the Treasury and
Secretary of Energy, among others, to examine and report on
“the connections between [DLT] and energy transitions”
and “the potential for these technologies to impede or advance
efforts to tackle climate change,” including the effect of
cryptocurrencies’ consensus mechanisms on energy usage,
potential mitigating measures and alternative mechanisms of
consensus. The order also instructs the Financial Stability
Oversight Council (the “FSOC”) to report on the risks to
financial stability and regulatory gaps posed by digital assets and
recommendations to address such risks. The report would build on
the FSOC’s prior recommendations to address climate-related
financial risks, which were issued in October 2021 in response to a
prior executive order.

4. With its seat on the FSOC, the CFTC is expected to play a
leading role in responding to these initiatives. In March 2021,
CFTC Chairman Rostin Behnam established a Climate Risk Unit within
the agency that is tasked with addressing the climate implications
of digital assets, in addition to its broader focus on the role of
derivatives in pricing and addressing climate risk. Chairman Behnam
has at times sounded a skeptical tone with respect to the role of
digital assets in environmental sustainability, citing a
“clear dislocation” between the energy consumption needed
for mining operations and the economic output from digital assets.
He has emphasized the need for transparency in digital asset
markets, suggesting certain energy-related disclosures in
connection with digital asset purchases as a mechanism for driving
the industry to proof-of-stake models. While the CFTC’s
jurisdiction over the underlying “spot” (or
“cash”) markets is limited to exercising its antifraud
and antimanipulation authority, Chairman Benham has cited
“several unique elements” of digital asset cash markets
(e.g., multitude of retail investors engaged in speculation,
custody and cybersecurity issues) that distinguish it from other
cash markets and suggest “it would benefit greatly from CFTC
oversight.” He has also called on Congress to expand the
CFTC’s power over cryptocurrency markets, noting that the
agency’s focus on market integrity through oversight of
exchanges, clearinghouses and data repositories makes it “well
situated to play an increasingly central role” in overseeing
such markets.

5. On June 2, 2022, the CFTC issued a Request for Information
(“RFI”) seeking public comment on climate-related
financial risk in both the derivatives markets and underlying
commodities markets, with the aim of informing the agency’s
“next steps” to promote innovation, ensure financial
integrity and avoid systemic risk.² Among other topics,
the RFI solicits comment on the role of digital assets and DLT,
including whether digital assets markets are creating
climate-related financial risk, as well as any risk-mitigating
benefits that these technologies may offer. The RFI also touches on
the voluntary carbon market (“VCM”),³
requesting comment on aspects of these markets that are susceptible
to fraud or manipulation or merit enhanced CFTC oversight and any
steps the CFTC should take to enhance integrity and foster
transparency and liquidity in these markets, including the prospect
of a registration framework for VCM participants. Although the RFI
was approved by all five Commissioners, one, Summer Mersinger,
expressed concerns that some of the questions (including those
relating to DLT and VCM) extend beyond the scope of the CFTC’s
jurisdiction over underlying cash markets, warning in a concurring
statement that “the RFI reflects either inadvertent
‘mission creep’ at best, or a power grab to expand the
CFTC’s authority at worst”.

6. On the same day the RFI was issued, the CFTC’s Energy and
Environmental Markets Advisory Committee (“EEMAC”) held a
public meeting to discuss issues relating to the VCM, including the
market structure for trading carbon offsets, efforts at product
standardization and the proper role for the CFTC in these markets.
Market participants cited a range of difficulties in scaling up
these markets, including the need for data collection and
transparency to ensure the quality and integrity of credits, the
problem of “double counting,” and concerns around market
fragmentation. Several participants called on the CFTC to help
resolve a “crisis of confusion” by establishing an
overarching framework based on standardized pricing and a common
set of attributes. In his remarks, Chairman Behnam noted an
opportunity to build on lessons learned from cryptocurrency
markets, where the CFTC has played a significant role in bringing
cases despite its limited jurisdiction in the underlying crypto
markets. Efforts are underway in the private sector to use DLT and
smart contracts to address some of the issues highlighted above,
including improving transparency and traceability of carbon credits
through public and immutable data disclosure on the blockchain and
facilitating efficient transfers and repairing market fragmentation
by “tokenizing” carbon credits and then
“retiring” the credits on the registry to prevent double
spending.⁴ It remains to be seen if the CFTC will
leverage DLT or smart contracts in formulating its regulatory
response to the concerns identified at the meeting.

Footnotes

1 Bitcoin and Ethereum, the two largest cryptocurrencies
by market cap, currently rely on a “proof-of-work” model,
whereby miners compete to solve complex math problems to verify
transactions, requiring abundant energy to achieve the necessary
computing power. Etherum is in the process of transitioning to a
more efficient “proof-of-stake” authentication method,
which would eliminate the competitive race and limit the
environmental impact. Other technologies, such as side chains and
so-called Layer 2 solutions, have been developed to help reduce
energy consumption.

2 Comments on the RFI are due on or before August 8,
2022.

3 The VCM has come under scrutiny recently as a result of
its rapid growth, with VCM trades topping $1 billion for the first
time in 2021 and expected to reach $50 billion by 2030. Chairman
Behnam has emphasized that voluntary carbon credits are commodities
and that the CFTC’s primary role is to identify and address
fraud or manipulation in the underlying VCM. As key exchanges
launch futures and other derivatives…