Blockchain and Impact Investing
Since Satoshi Nakamoto’s 2008 Bitcoin Whitepaper, Blockchain has represented a form of innovation with truly seismic implications. By eliminating the use of traditional financial intermediaries, Nakomoto’s peer-to-peer payment vision has decentralised millions of transactions throughout networks of linked encrypted ledgers, aggregating security through proof-of-work sealed chains. The degree of security provided by this system has endeared blockchain with the title of trustless - ‘not because [users] don’t trust each other, but because they don’t have to’, revolutionising transactions through enhanced immutability, privacy, traceability and efficiency. These qualities distinguished blockchain as a highly appealing vehicle for impact investing. Where traditional investing prioritises maximum financial return, impact investing primarily seeks ‘ethical and measurable goals’ - ESG aligned or other - with various rates of return. This form of investment enjoyed over 60% growth between 2019-2021 and is forecast to add another half a trillion worth of value by 2027. However, impact investing faces several challenges, which appear to complicate its scalability, accessibility and quality of funds, invoking blockchain as a potential remedy to these and other issues.
Impact Investing
Impact investing encompasses investments ‘made with the intention to generate positive, measurable social and environmental impact alongside a financial return’ . The growth of Corporate Social Responsibility (CSR) has instigated a commensurate emphasis and adoption of this form of investment, expected to reach a market value of $6 trillion by 2031. However, several obstacles complicate this projected growth. The first of these is data standardisation, without which capital deployment by any private or public investor is made far less desirable. Though the GIIN produced an impact performance measurement methodology in 2020, the documentation of consistent data standards remains problematic for current and prospective investment patterns. Moreover, the International Institute for Sustainable Development (IISD) has noted ‘inadequate capital across the risk/return spectrum’, characterising the current risk-return spectrum within impact investing as incomplete depending on risk appetite. Other issues identified by the IISD included insufficient clarity on sustainable investment definitions and integration, with the range of ‘impact themes, geographies and asset classes’ complicating consistent understandings amongst portfolio managers. Highly restrictive exit options for private securities within the sector, most of which have long holding periods, also detract from impact investing’s uptake. Moreover, both the quality of impact investing funds and the sophistication of non-financial return measurement practices continue to complicate the use of impact investing amongst hedge funds, ETFs and other investors.
Blockchain
The current buzz around integrating blockchain technology into impact investing stems from its ability to address the aforementioned issues through the use of secure ‘impact tokens’, which use smart contracts to authenticate transactions without the need for a third party. By using these impact tokens to quantify and distribute non-financial assets - for instance, carbon credits, which can verify greenhouse gas sequestration - parties can record, monitor and authenticate impact. This process entails a degree of trust and consistency much needed by the impact investment sector and its ‘MRV’ processes, establishing a reliable means through which to address pressing environmental and social concerns globally whilst promoting financial inclusion. The integration of blockchain within supply chains offers further scope for positive impact, slashing energy consumption and costs by identifying ‘redundant points’ as well as exposing the ethical reliability of sourced labour and materials. Solarcoin provides one such example of how blockchain technology has been used to generate both financial returns and environmental impact. Established in 2014, Solarcoin rewards properties for every megawatt-hour of solar energy generated with an impact token, diminishing global costs of renewable energy by rewarding suppliers.
Outlook
The use of blockchain within finance has repeatedly proven a volatile affair, in large part due to its novelty as a maturing class of asset. Previous attempts to improve the liquidity of cryptocurrencies have resulted in abject failure, as well as the loss of billions of dollars worth of assets under management. Even with recent regulatory developments, uninsured deposits and sparse regulatory frameworks may not yet prove capable of adequately securitising impact tokens; hardly an endearing quality for prospective investors. Energy consumption presents another substantial challenge, threatening to undermine positive impact through excessive carbon production. Effective regulation, infrastructure and implementation, however, could help facilitate and grow the use of impact tokens amongst hedge fund managers, ETFs as well as retail investors, transforming impact investment from a corporate buzzword to universalised financial exercise. The scope of this development is critical to addressing the mutating environmental and social issues the planet faces today, helping to channel investment to where it is most in need.