Key developments in data mining and energy market transparency

US 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 facilitate the transition from carbon-based fossil fuels.

Here are six major developments and actors to watch, covering two main categories:

• Initiatives targeting carbon emissions associated with data mining operations (clauses 1, 2 and aspects of Clauses 3 and 4); And the

• Efforts to promote integrity and transparency in the energy and related digital asset markets (clauses 5 and 6 and aspects of Clauses 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 energy sources. The bill sets a two-year moratorium during which the state will not issue new permits or agree to renew existing permits for any electricity generation facility that (a) uses carbon-based fuels and (b) provides, in whole or in part, the “behind the scale” electric power consumed by mining operations. Cryptocurrencies that use “Proof of Work” (“PoW”) methods to validate blockchain transactions.¹ If the bill is signed off by Governor Hochhol, New York would become the first state in the country to ban new crypto-mining infrastructure, which could encourage other states to follow its lead and push a growing share of mining networks to more crypto-friendly countries. Like Texas. Critics have warned that such a ban not only harms the intended targets and their workers, but may also discourage mining operations based on renewable energy over concerns about “regulatory creep.”

2. At the federal level, new legislation was proposed on June 7, 2022 by US Senators Loomis and Gillibrand, which would take a more industry-friendly approach to cryptocurrency mining. The new legislation, called the Responsible Financial Innovation Act, aims to “create a complete regulatory framework for digital assets.” The legislation does not impose any restrictions on mining; Instead, it requires the Federal Energy Regulatory Commission, in consultation with the Commodity Futures Trading Commission (“CFTC”), to analyze various issues related to the impact of cryptocurrency mining and acquisitions on energy markets and the environment and to report the annual report to select congressional committees. The issues to be analyzed in the report include: (a) energy consumption for mining and stabilization of digital asset transactions and the impact on energy prices and base load energy levels, (b) the use of renewable energy sources in relation to mining and storage; and (c) the procedure for regulated entities to make information publicly available on energy consumption.

3. Meanwhile, the Biden administration has begun formulating its own Proof of Work cryptocurrency mitigation policies. On March 9, 2022, President Biden signed an executive order calling on the various departments and agencies of the executive branch to collaborate in researching a range of topics related to the DLT program and establishing time frames for these agencies to report on their findings and policy recommendations. In particular, the order directs the White House Office of Science and Technology Policy, in consultation with the Secretary of the Treasury and the Secretary of Energy, among others, to examine “the links between [DLT] energy transitions” and “the potential of these technologies to impede or enhance efforts to address climate change,” including the impact of cryptocurrency consensus mechanisms on energy use, potential mitigation measures, and alternative consensus mechanisms. The order also directs the Financial Stability Oversight Board (“FSOC”) to Reporting risks to financial stability and regulatory gaps posed by digital assets and recommendations for addressing such risks.The report will build on the FSOC’s previous recommendations to address climate-related financial risks, which were issued in October 2021 in response to a previous executive order.

4. Through its seat in the FSOC, the CFTC is expected to play a leading role in responding to these initiatives. In March 2021, CFTC Chair Rustin Behnam established the Climate Risk Unit within the agency tasked with addressing the climate impacts of digital assets, as well as its broader focus on the role of derivatives in pricing and addressing climate risk. Chairman Behnam has sometimes issued a skeptical tone regarding the role of digital assets in environmental sustainability, noting a “clear disconnect” between the energy consumption needed for mining operations and the economic output of digital assets. He emphasized the need for transparency in the digital asset markets, proposing some energy-related disclosures regarding the purchase of digital assets as a mechanism to lead the industry to Proof of Stake models. While the CFTC’s mandate is limited to the core “spot” (or “cash”) markets to exercise its authority to combat fraud and manipulation, Chairman Benham cited “many unique elements” of the cash markets for digital assets (eg , many individual investors involved in speculative, custody and cybersecurity issues) that distinguish it from other money markets and indicate that “they would benefit greatly from the oversight of the CFTC.” He also called on Congress to expand the CFTC’s authority over cryptocurrency markets, noting that the agency’s focus on market integrity through oversight of exchanges, clearinghouses, and data warehouses makes it “well-positioned to play an increasingly central role” in overseeing such markets.

5. On June 2, 2022, the CFTC issued a Request for Information (“RFI”) for public comment on climate-related financial risks in both the derivatives and commodity markets, with a view to informing the agency’s “next steps” to enhance Innovation, ensuring financial integrity and avoiding systemic risks.² Among other topics, RFI requests comment on the role of digital assets and DLT, including whether digital asset markets create climate-related financial risks, as well as any risk mitigation benefits that these technologies may provide. The RFI also touches on the Voluntary Carbon Market (“VCM”),³ Request comment on which aspects of these markets are susceptible to fraud or manipulation or merit enhanced oversight by the CFTC and any steps the CFTC should take to enhance integrity and enhance transparency and liquidity in these markets, including the potential for a registration framework for VCM participants . Although the RFI was approved by all five commissioners, one commissioner, Summer Mersinger, expressed concerns that some questions (including those related to DLT and VCM) extend outside the CFTC’s purview on the underlying money markets, warning in a concurrent statement that the “RFI reflects either unintended ‘mission creep’ at best, or a power grab to extend 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 related to the VCM, including the market structure for carbon offsets trading, and efforts to standardize The product and appropriate role of 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 credit quality and integrity, the “double count” problem, and concerns about market segmentation. Several participants called on the CFTC to help resolve the “confusion crisis” by creating a comprehensive framework based on standardized pricing and a common set of features. In his remarks, President Behnam pointed to an opportunity to build on lessons learned from the crypto markets, where the CFTC has played an important role in raising issues 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 outlined above, including improving transparency and traceability of carbon credits by exposing public and immutable data on the blockchain, facilitating efficient transfers, and reforming market segmentation through “token” balances. Carbon then “pull” credits into the registry to prevent double spending.⁴ It remains to be seen whether the CFTC will take advantage of DLT or smart contracts in shaping its regulatory response to the concerns identified at the meeting.

footnotes

1 Bitcoin and Ethereum, the two largest cryptocurrencies by market capitalization, are currently based on a “proof-of-work” model, in which miners compete to solve complex computational problems to verify transactions, which requires abundant energy to achieve the necessary computing power. Etherum is transitioning to a more efficient “Proof of Stake” authentication method, which would eliminate competitive racing and reduce environmental impact. Other technologies, such as side chains and so-called layer two, have been developed to help reduce energy consumption.

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

3 VCM has recently come under scrutiny as a result of its rapid growth, with the VCM trade exceeding $1 billion for the first time in 2021 and expected to reach $50 billion by 2030. President Behnam emphasized that voluntary carbon credits are commodities and that the primary role of the CFTC is in identifying and addressing fraud or manipulation of the underlying VCM. With major exchanges launching futures and other derivatives based on carbon offsets, the CFTC will examine whether there is an appropriate correlation between these derivative markets and the underlying cash markets of the Notebook baby.

4 For example, KlimaDAO, a Revolving Finance (ReFi) project, uses a certain decentralized finance technology to allow high-security carbon credits issued through Verra and Gold Standard registries to access the blockchain. The Toucan Bridge created by the Toucan Protocol allows carbon credits to be linked to the blockchain, where users receive the project’s TCO2 tokens that can then be transferred. REGEN