May 04, 2022 - 15 min read
In today’s world, both corporations and individual investors are putting a much greater emphasis on the ethical, environmental, and social impact of their actions, in a bid to both enhance their reputation and increase potential profits. Much of this work falls under the banner of ESG, or environmental and social governance efforts, which are taken on by corporations and other institutions, typically with the intention of setting and achieving sustainable development goals, or SDGs.
ESG efforts are also closely tied to the concept of impact investing, in which both individual investors and investing institutions, such as mutual funds, hedge funds, ETFs, or even hedge funds attempt to create an investment strategy that aligns with ethical and measurable goals that can help improve the well-being of various populations as well as the planet as a whole.
Major issues that both ESG initiatives and impact investors focus on commonly include climate change, pollution, poverty alleviation, efforts to uplift potentially marginalized groups, and individuals with disabilities.
While ESG was once a fringe effort by certain socially conscious companies, it’s now fully entered the mainstream. Consulting firm NAVEX Global reported that as of 2020, “88% of publicly traded companies, 79% of venture and private equity-backed companies, and 67% of privately-owned companies had ESG initiatives in place.”
ESG initiatives have had a particularly strong impact on the finance sector, with ESG funds under management increasing from $236 billion at the end of 2020 to $330 billion by September 2021, a staggering increase of nearly 40%. However, those numbers are dwarfed by global ESG financial initiatives, with ESG funds assets under management increasing from $1.65 trillion at the end of 2020 to $3.9 trillion in September 2021, an increase of over 236%.
While funds with a direct ESG focus are growing quickly, the overall market of managed assets with some focus on sustainability is even larger, with some estimating that assets under management with some sustainable focus has grown up to $20 trillion, accounting for nearly a quarter of the close to $100 trillion of managed assets worldwide.
While these numbers are impressive, they may not tell the whole picture. The world of ESG initiatives and sustainable funds is often murky, with unclear objectives and a clear lack of standardized reporting methods. Funds and corporations often compete, instead of collaborating, on important projects, while many ESG initiatives and impact investing funds are considered to have little true impact on the problems they are supposed to be solving.
This has led to cynicism and distrust of the ESG and impact investing industry by many, some who believe that much of these efforts are simply PR campaigns to clean up the images of institutions that may still have an overall negative impact on the environment, human rights, and other essential issues.
With distrust, fragmentation, and reporting issues rampant, blockchain technology could be the perfect solution to many of the dilemmas currently faced by the ESG and impact investing sector. By creating immutable ledgers of information and combining new technologies, such as IoT (internet-of-things) into global supply chains, blockchain can help institutions prove the impact of their efforts, reduce fraud and corruption, and create a far greater degree of public transparency into their ESG efforts.
In addition to distrust, reporting problems, and unclear objectives, there are a variety of other challenges plaguing the ESG and impact investing industry, many of which blockchain may be able to address.
According to a study by the International Institute for Sustainable Development (IISD), some of the major issues currently faced by the industry include “appropriate capital across the risk/return spectrum, common understandings of definition and segmentation of impact investing market, suitable exit options, the sophistication of impact measurement practices, and high-quality investment opportunities.”
The same study mentioned that “blockchain can increase trust between parties, promote financial and social inclusion, improve data collection and accelerate monitoring, reporting, and verification processes, and Incentivize behaviors that promote sustainability.”
Another potential challenge may be to convince investors that ESG-focused and sustainable investing does not necessarily mean that investors and institutions will need to face trade-offs between impact and profitability. In fact, a 2015 analysis of over 2,000 empirical studies showed that highly-focused ESG investments “either outperform or perform on par with traditional assets.”
It should be mentioned that one area where blockchain has actually created an ESG challenge is the Bitcoin and crypto mining sector, which, according to some sources, consumes up to 2% of the world’s entire electricity usage, with much of that energy coming from non-renewable sources. However, blockchain may be able to help reduce crypto mining’s carbon footprint via improved tracking and verification mechanisms.
One open-source software project, Green Hashrate, released by nonprofit group Energy Web, will allow miners to verify their renewable energy usage on a decentralized blockchain network, which will uphold strict KYC standards while simultaneously protecting miner privacy. That means that companies and individuals purchasing Bitcoin from miners can know if the mining operation utilized renewable energy, and even estimate the carbon footprint of each Bitcoin mined. With companies like Tesla announcing that they will only accept Bitcoin as payment if the miners use at least 50% renewable energy, such tracking, and verification tools may grow increasingly important.
In addition to many of the challenges mentioned above, one major issue for ESG and impact investing is trusting the impact of sustainable development initiatives in developing countries. Many countries, particularly those in which poverty is the greatest, face incredible amounts of corruption, and there are countless stories of government officials and local charities misusing, if not outright stealing millions of dollars in sustainable investment funds. All of this creates a very low trust environment, which can significantly benefit from the implementation of blockchain technology.
One strong example of the implementation of blockchain for impact investment in the developing world actually comes in the form of a charitable initiative, the Building Blocks platform, a blockchain-based program implemented by the World Food Program that tracks food payments to refugees. The program has reportedly resulted in millions of dollars of savings by creating unique digital identities for each program recipient, often in the form of biometric identification such as fingerprints or retina scans. By verifying the identity of individual recipients, charitable donations can be tracked directly, which circumvents the need to trust third-party distribution groups or government agencies that may have a questionable financial track record.
While the World Food Program’s initiative is purely charitable in nature, the same technology and systems can be implemented in for-profit microfinance programs, particularly those that provide funds to farmers and small business owners in the developing world. For example, blockchain-based platforms could track a farmer’s use of a microloan, including their purchase history, while making it easier for them to make regular payments via a mobile app. The same goes for international remittances, which currently carry extremely high costs, costs that can be significantly reduced via the use of blockchain platforms.
Many of these ideas are already being studied by institutions. For instance, Principles for Responsible Investment is an investor initiative that has partners with the U.N. Environmental Program (UNEP) Finance Initiative and the U.N. Global Compact in order to research the benefits of blockchain in reducing transaction costs for ordinary people in developing countries, making it easier for them to access credit and get loans.
One of the most interesting and potentially impactful trends in blockchain and impact investing is the growth of impact tokens. Impact tokens generally attempt to represent some type of impact in relation to a specific sustainable development goal (SDG), and, like traditional cryptocurrencies and tokens, are often issued via initial coin offerings (ICOs). Like other implementations of blockchain technology, impact tokens offer the benefits of decentralization as well as the creation of immutable, verified data points that can more easily track the impact of specific impact investing and ESG initiatives, potentially preventing the trends of malign data manipulation and greenwashing that often plague these types of initiatives.
Experts have suggested that impact tokens may be able to significantly improve verification and reporting systems for greenhouse gas management under the Paris Climate Agreement, as well as other international climate and environmental agreements. The potential for the tokenization of impact initiatives was considered so promising that in 2017, a series of international organizations, including the United Nations Framework Convention on Climate Change (UNFCCC) Secretariat created the Climate Chain Coalition (CCC).
According to the organization’s website:
While groups like the CCC are certainly contributing to blockchain R&D efforts and examining new ways that blockchain can be used for environmental impact initiatives, impact tokens have generally been created by startups and private enterprises. Some have struggled to take off, while others have reached a limited degree of success.
For example, SolarCoin (SLR), which launched in 2015, was one of the earliest and most interesting impact tokens to come onto the market. One SLR token is rewarded for the verified production of 1MWh of solar power in order to incentivize a greater amount of solar power production. The token, however, as of yet, has not taken off commercially, perhaps due to a misalignment of economic incentives.
Below, we’ll list some of the most well-known impact tokens on the market today– as we mentioned earlier, some have become moderately successful, while others have struggled to have an impact. The impact token industry is still in its infancy, however, so future tokens with better economics and incentives are likely to overtake these tokens in the near future.
In addition to initiatives that use tokens and cryptocurrencies to promote impact-based causes and outcomes, corporations can utilize blockchain in their supply chains to promote ESG and impact investing initiatives. By tracking goods at all points in their supply chain, firms may be able to eliminate redundant points in their supply chain, reducing the need for additional transportation and saving energy. Blockchain supply chain tracking can also help companies uphold various ethical and product standards, helping to ensure product purity and prevent the purchasing of goods that may be linked to unfair or abusive labor practices, particularly in developing countries.
One major initiative in this regard is IBM’s Responsible Sourcing Blockchain Network (RSBN). The RSBN initiative is specifically focused on helping companies ensure that the raw materials they utilize have been ethically sourced. One major raw material the network has tracked is cobalt, an essential component in the lithium-ion batteries that are widely used in laptops, smartphones, and electric cars.
Currently, 60% of the world’s cobalt is sourced from the Democratic Republic of Congo, where much of it is mined by hand, an extremely dangerous process. The RSBN initiative helps companies utilize a shared blockchain to track cobalt mining from the source in order to avoid hand-mined cobalt, as well as to avoid other minerals produced in dangerous conditions, such as lithium, gold, nickel, copper, and tungsten. Several major companies are currently using the network, including car manufacturer Volvo and multiple large mining firms.
In another interesting example of blockchain-based supply chain management with an ESG focus, Diamond giant Debeers has launched its own blockchain, Tracer, which it hopes to use to trace every diamond, from the initial mine to the final retail sale. Ideally, this should be able to reduce counterfeit diamonds as well as prevent the purchase and sale of “blood diamonds” mined from known conflict zones, where proceeds can be used to finance violence and miners may face extremely poor working conditions.
In today’s market ESG and impact investing are two of the fastest-growing trends on both main street and Wall Street. Corporations are under increasing pressure to prove that their companies make a positive, rather than negative impact on the world around them, and both retail and institutional investors are beginning to become far more interested in how their investments may impact global issues, such as global warming, poverty alleviation, and pollution.
Current ESG and impact investing initiatives suffer from a significant lack of trust, with many corporations and funds accused of “greenwashing” or significantly overstating the positive impact of their ESG efforts, while simultaneously hiding activities with a potentially negative impact. This often leaves investors confused and unsure of where to invest their funds, which can lead to the allocation of capital to sources that have the best PR, not the most impact.
Fortunately, blockchain has the potential to change much of this through the use of immutable, decentralized ledgers that can be shared both publicly and privately to confirm an institution’s impact on the world around them. In addition to utilizing blockchain inside institutions, the growth of impact tokens, which often represent units of impact, such as trees planted or units of renewable energy production, are fast gaining in popularity.
However, it should be noted that both internally-based blockchain ESG tracking efforts and the growth of the impact token economy are still in their infancy. Blockchain data, while immutable, is only as accurate as the data that companies provide, meaning that there is still the risk of data manipulation and greenwashing at initial data entry points. In addition, while impact tokens have gained in popularity, there are still major issues with tokenomics and incentivization, meaning that the majority of these tokens have not been able to provide significant investment value to users, leading to a lack, so far, of mainstream adoption.
For blockchain-based ESG and impact investing efforts to thrive, new and more stringent reporting standards may have to be implemented, potentially combining blockchain ledgers with difficult-to-falsify data points, such as data from GPS-enabled IoT devices used to track factors such as energy use and global supply chains. In comparison, for the impact token industry to thrive, tokenomics will have to evolve to create significant profits for investors.
Overall, the future for blockchain to impact ESG and impact investing is bright, but efforts won’t change the industry overnight. Blockchain may be a powerful tool, but it’s only one tool of many that may be able to transform this burgeoning sector.
For blockchain ESG and impact investing efforts to truly make an impact, the public, governments, and other institutions will have to continue to put pressure on the private sector to evolve and look past a profit-only philosophy in order to embrace a more ethical, impact-focused mindset that looks not only at earnings reports but on the long-term effects of their actions.
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