A practical overview of models and opportunities to apply blockchain technology in impact delivery and financing.
The first version of this article was published in May 2017. A lot has happened in the blockchain space since then. I have tried to keep it updated and consolidated as much as possible just to keep it relevant.
We need to talk about the blockchain, folks. Because it will change everything. And there are so few people that understand what it is and where the opportunities lie that the ones who do will have a huge edge.
You want that edge.
Even more so in the do-good industry, where the opportunities are enormous, and where shockingly tech-illiterate incumbents struggle every day to roll out the same old interventions following the same antiquated cycles.
First, a super-quick description of the blockchain
(skip this if you have a basic grasp of this technology)
A blockchain is a public, shared record that cannot be modified retroactively and that everyone trusts to be accurate forever. This record could be a list of transactions (as in the blockchain’s flagship application, bitcoin) or it could be any other information that once recorded cannot be modified anymore. It’s basically a ledger kept honest by mathematics, rather than humans or institutions.
This Video does a great job explaining:
Think about how many institutions are out there — some of them widely loathed — that exist simply as formalized witnesses for some sort of data-point in history: Notaries. Banks. Insurance companies. The National Gazette. Passports. Elections. Bookies. Copyright.
Blockchain applications could drive all of these into irrelevance. And I am personally looking forward to see quite a bit of disruption in the near future.
Blockchain and the Impact Industry
But what of the development industry? What about donors and implementers and — lest we forget — the proverbial beneficiary?
Well, I think the development industry – just like all other industries – will be deeply affected by blockchain. I also think that most of the incumbents will be slow to understand (never-mind adopt) this technology, which will create a once-in-a-generation opportunity for smart insurgents to shine. In any case, these large, slow incumbents are slowly but surely headed towards a cliff).
The First Generation of Blockchain-for-good models
The first wave of adoption in the development industry will be related to these oportunities:
This is the most obvious application and there are plenty of exciting initiatives in this space bringing bitcoin and other crypto currencies into low-income markets. Millions of unbanked people could enjoy the benefit of a virtual currency that they can save, spend and trade. “Banking the unbanked”, as the cliché goes, without the need of an expensive operational infrastructure. This would also offer millions of people a way to hedge against bad fiscal / financial policies if they have the misfortune to be living in a place where such policies are rolled out (see Venezuela). People fleeing conflict or persecution could store whatever values they have in a crypto currency and access it en route as needed and/ or once they are in a safe place. Today, many refugees leave their belongings behind and/ or get robbed or ripped off by criminals and corrupt officials they encounter during their perilous journey.
Un-banked, hard-working migrants currently pay astronomical fees to the likes of Western Union when they send money home. A crypto currency allows instant, no-fee transactions. This can be set up right now, without the need for any single extra line of code. The only thing needed is an extensive operational presence, which many non-profits have and which a nimble social entreprise could set up quickly using a franchise model, for example
3. A global, secure, distributed registry for identity
Like a global passport that you can never lose and never expires. All important events — birth, marriage, death, driving license, voting card — can be recorded on a blockchain, forever accessible and indestructible. No-one could have access to this data, unless permitted by the owner who is always in control. There are further opportunities here: Medical records. Credit history. Insurance status. This could help refugee processes in recipient countries speeding up processes and removing doubts about nefarious elements infiltrated among legitimate refugees.
4. Traceability & Provenance
That coffee you are enjoying. The seller claims it is free trade and organic. But do you know for sure? Often you could be wrong. One of the most exciting application of blockchain will be related to the ability to track commodities from origin to market and know for sure what the standards are that get applied across the value chain. Here is an example of an epic failure and how it could have been avoided by the use of blockchain.
These are just a few possible applications and each of them could have a tremendous impact on local economies. But their combined impact is even higher and it unlocks entirely new categories of opportunities related to local entrepreneurship and economic growth that I will outline in the next post.
New forms of equity structure and trading
Currently, there is no real equity structure on under-served markets. There are many reasons for that — no infrastructure, no regulatory framework, no real incentives to bother with any business structure. Capital doesn’t follow opportunities here. In fact, there is no capital to speak of — hence, no real growth.
Sure, it is a bit of a stretch to expect that there is any appetite for any equity structures on markets where the typical business is a lady selling a few bananas or a local store selling rice by the cup and the odd beer?
What if we could structure the equity on these markets, and raise the capital on modern, sophisticated markets?
Let’s start with the basics. The lady selling bananas. Could we assume her business has a value? Could we valuate her and other similar businesses, just like we would any other business? How much would it be worth today? 15 dollars? 100 dollars?
I think we can. And once we do, we can record the valuation on a blockchain. Then we can sell shares and/ or stock options — either directly, or through a token/ Coin Offering. The buyer of these micro-shares could be from the same village or from a big city on the other hemisphere.
You could aggregate (i.e. index) and structure this micro-equity into modern investment instruments that can be traded directly with investors or through legacy brokers. Hell, you could even structure all sorts of derivatives on these instruments, increasing the flow of capital into capital-starved market with a high profit potential.
Commodity trading/ futures
Now let’s imagine one of these businesses is actually an agri-business. We can record various inputs onto the blockchain as well as crop yield and other outputs. We can structure a token (and smart contracts) and use that to basically sell/ buy futures. A bit like an old fashioned cooperative bank, but without the bank (and without the bank fees);.
With all crop data on the blockchain it should be easy to insure that crop. Or anything else, for that matter. Premiums are registered on the blockchain (linked to a smart contract and maybe fulfilled using a blockchain currency?). This can be done at any frequency — daily, weekly, etc. Once the insured event is registered, payment comes automatically.
Externalities on the balance sheet
Understanding and pricing externalities remains one of the most challenging components of modern economic theory. As the pressure increases on companies and governments (because Post-Millennials) to find ways to demonstrably account for externalities.
The traditional way to price externalities has been through taxes. However, the taxation model has failed to reflect the actual social & environmental costs and alternative models are necessary.
The biggest challenge with externalities is quantifying them fully. However, exponential developments in technology – sensors, IOT, Machine Learning – are making modelling externalities easier and it is now attainable for a company to put systems in place that will give them accurate models around their emissions, but also waste and water management and social impact among others. Shareholders, Investors and consumers are already pressuring brands to demonstrate neutral or positive externalities.
By compelling them to add externalities on the balance sheet this practice can become mainstream and companies will start focusing resources towards reducing their negative externalities and increasing their positive impact.
As companies with negative impact balance will have to purchase/ fund impact in order to offset their externalities, they will be compelled to fund impact in their communities or elsewhere, in order to become profitable.
This will lead to the evolution of impact marketplaces where impact creators can make their verified impact events (i.e. positive externalities) available for purchase by buyers, just like currently companies with high carbon emissions are buying CO2 credits on global emissions markets.
The demand for verified impact generated by companies and governments needing to balance their externalities unlocks an additional business model/ opportunity.
Because of the inherent difficulty in articulating and tracking impact in real time, historically non-profit funding have been subjected to onerous monitoring standards built around top-down impact frameworks, in order to prove their impact. This has stifled innovation in the non-profit sector and has favoured large incumbents over smaller, more innovative insurgents.
However, the evolution and spread of emerging technologies can now facilitate near real time verification of impact being delivered, as it gets delivered. This could allow, for the first time ever, an objective, day-by-day evaluation of impact being delivered.
Conversely, verified impact can be priced on an open market, with the understanding that anyone who delivers outputs to the specified standards would be paid accordingly. This means that one tree planted by a local community in Ecuador would be priced and financed by the same standards as a 5-year, multi-million regeneration project set up by a large global conservancy. Here is more on output markets.
This would be a great equalizer as it would eliminate onerous and expensive fundraising for impact implementers and allow access on the same terms to funding, which would unlock innovation and entrepreneurship in impact delivery.
RELEVANT: Inputs vs. Outputs vs. Outcomes in Impact
Transparency into value chains and the ability to automate and scale payments regardless of amounts is unlocking additional business models and new ways to think about retail.
Once it will be possible for consumers to see where the produce is coming from – and the conditions and standards by which it was produced – it will become unacceptable to consumers to purchase produce that does not allow visibility into the production standards. This is obviously a great opportunity for small producers to differentiate themselves through sustainable practices and it can also evolve into a source of revenue for small sustainable farmers and their communities.
Early direct financing models include structures such as “tip the farmer”, where consumers are encouraged to make voluntary contributions to farmers. An evolved version of this models would be a royalty model, where a percentage of the market price of a produce (or product containing a certain commodity) is structured through smart contracts to be paid back to the original producer (or the producer’s community). The payment can be triggered by the purchase – without any additional burden put on the consumer – or it can be triggered by other predefined events even earlier in the value chain (i.e. arrival at retailer, leaving an aggregation facility etc);.
Transactions between things
As global payments infrastructure evolves and, it will be possible to make any global payment at any amount, at zero cost in a fraction of a second. This is unlocking a whole world of transactions between things.
Smart contracts can be written, audited and executed automatically, based on inputs and outputs from sensors and other verified data & events and payments – micro-payments – can be triggered instantly by the occurrence of events along loosely connected value chains.
Royalty micro-payments can be triggered along the value chain. Producers and other stakeholders can receive micro-payments in exchange for data that will help improve increasingly complex predictive agriculture & climate models. Consistent practices, adherence and ongoing compliance to standards can be verified, traced and compensated in real time. Data from smart cities can be structured in defining payable events (rewards for positive externalities/ penalties for negative externalities).
This will make it easier for =economic players across value chains to access capital continuously, based on real events/ data generated through their work.
Impact implementation is a black box. This is the root problem in impact. Now imagine that we record unique, individual events on a public ledger, as they happen. Each time a child is vaccinated. Every time a tree is planted. Every time a solar panel is installed anywhere in the world or every time a pound of garbage is recycled. These events become unique entries recorded on a public ledger. They get entered into the ledger along with the characteristics that make them unique: location, timestamp, patient ID, product serial number etc.
But do we REALLY need blockchain?
Verifying and recording unique events is awesome, but one could argue that this would be easier, cheaper and faster done in a standard database. We could store gazillions of events at trivial costs and querying the data base would be fast and precise.
Yet there is a big problem with centralized databases: They can be easily revised. This means that whoever controls the database can either modify the content (create spurious events) or they can duplicate events, leading to double attribution problem (this is also true for private blockchains, by the way).
But surely we can address these risks with checks and balances, audits, governance etc. After all there is a lot of critical data out there on which we rely every day that sits in centralized, well managed databases.
In fact, if our purpose would be simply to track these events, we probably wouldn’t need the headache of blockchain at all.
However, we’d miss a huge opportunity.
The moment an event has been entered into a blockchain ledger, a token can be issued for this event. This token can now be held privately or can be transferred, just like any asset.
People can hold these tokens — essentially holding full attribution for unique events — without having to have any relationship with any organization or entity. As long as they prove token holding they prove attribution. This means that they can trade these tokens, essentially taking their money out and passing the attribution to someone else. And because these tokens sit on a public blockchain, they can trust that they are genuine and they can even track their history if trading on a secondary market. This will accelerate the emergence of a global impact capital market accessible to anyone, anywhere in the world.
This is the power of Tokenization. And it will change the way we think about financing impact
Crowdfunding and crowd-lending
Crowdfunding is all the rage. Platforms like Kickstarter and Gofundme have brought into the mainstream the possibility for a high number of people from across the world to fund together single projects.
Blockchain has taken this model further and, indeed, crowdfunding models such as the Initial Coin Offering (ICO) and Security Token Offering (STO) will be big drivers for projects to raise funds (2019 update: remember the 2017 crypto bubble and the crash in January 2018 :)).
ICOS and STOs – as well as other, more sophisticated models such as Simple Agreements for Future Tokens (SAFT) – are creating financing opportunities that that allow projects to bypass or supplement traditional funding structures. This is a great opportunity, particularly for projects that would otherwise not have access to traditional financing, due to lack of infrastructure or other structural reasons.
Crowdlending & MicroCredits
In its basic form, crowdfunding simply involves people contributing small amounts to fund a project. Funders usually don’t expect anything in return, except reports (and certainty) that pre-agreed milestones are met by the project.
Individuals from all over the world pool small amounts together into a fund that then uses this money to provide individual (micro)credits, usually in a part of the world where such credits are not available, or where such credits would be too expensive.
Crowdlending has lower overheads than traditional lending and lenders in countries with low (or negative!) interest rates can earn higher returns compared to savings and investment products offered by banks, while borrowers can borrow money at lower interest rates. Due to the small amounts put forward by individual lenders, Crowdlending is more resilient/ tolerant of high default rates, which is why it is a popular model for high risk lending such as inclusive finance lending, spearheaded by companies such as Kiva or, in Europe, Lendahand.
However, due to the high cost of managing funders and recipients individually, in traditional crowdfunding, funds and risks are pooled together. This makes it difficult to track the impact of individual funders/ recipients. Additionally, in most jurisdictions lending is regulated restrictively, which means that facilitating crowdlending carries high compliance and regulatory costs.
With the addition of blockchain, the amounts lent are written into a Ledger and are issued corresponding tokens. These tokens are then transferred to smart contracts that execute on milestones triggering repayments. This model allows individual tracking of all funding at very low relative costs as well as executing small payments on milestones, which reduces the risk (and cost) of default. Here is an example of Tokenized lending for Education.
Impact Investing and Impact Capital Markets
The current state of the Impact Investing Market
Impact investing sucks. There simply aren’t enough viable and investable implementation opportunities.
Among the estimated 130Trillion USD in assets under management (AUM) globally – according to the most conservative estimates, only a very small fraction is paying for positive impact delivered (and proven). This in spite of significant signals from investors that there is a large appetite for positive/ sustainable investing products. (Even the big incumbents have noticed)
Here is an opportunity to create a new generation of investment opportunities and investment vehicles that enable investors to pursue impact and financial returns in ways that are consistent with the high standards of proof of a new generation of investors.
Blockchain technology can support scalable inclusion of verified impact content (impact tokens) into any impact funding product. This methodology reduces the administrative and management costs of these funding products while significantly substantiating the impact claim, and making otherwise illiquid assets, tradeable.
Impact capital markets
In incumbent capital models, impact is a lens through which investments are defined. Because of that, impact financing is top-down and expensive to measure and track. Impact validation and tokenization allows this model to be flipped and, instead of retroactively evaluating and measuring impact, financial companies can simply find and validate impact events and fund them directly as they happen. This means that impact becomes the underlier for a new generation of assets: impact capital.
Impact capital includes natural capital as well as other positive externalities markets. Once the unit of impact/ externality (i.e. verified impact event) has been tokenized and priced, it can be traded again, on secondary markets, just like other liquid assets.
Liquid, Retail-friendly Impact Bonds
Among the blended capital models that have received significant attention from both the public and private spheres, the social impact bond model remains one of the more attainable.
Essentially, a Social Impact Bond (SIB) is a contract between three parties: an investor, an implementer and an underwriter, by which investors put forward the capital risk and the underwriter pays a premium on achieved social milestones. A social impact bond is not a bond, per se, since repayment and return on investment are contingent upon the achievement of desired social outcomes. If the objectives are not achieved, investors receive neither a return nor repayment of principal.
In spite of high hopes and resources invested in structuring social impact bonds, their track record until now has not been at the level of expectations. The main reason is their complexity and the enormous costs that come with structuring and measuring impact. This also makes them extremely illiquid and therefore only available to large institutional investors.
With the addition of Blockchain, we can now structure a new generation of impact bonds that remain truthful to the objectives of a bond (attract private capital to impact financing & provide a return on investment) while eliminating the technical complexities as well as the low liquidity problem.
Here is how it would work:
- Develop a Theory of change/ Impact Thesis using other available demographic/ health data (i.e., assumption that X & Z outputs correlate to Y Outcome);
- Agree on a lump sum/ price for outcome with an underwriter;
- As outputs are verified, a token is issued that corresponds to that unique, individual output. That means that total tokens will be capped to the no. of outputs in our theory of change);
- These tokens are made available to investors— the initial valuation is (outcome price – 40%-60% discount);
- Once the quantitative milestone is achieved (i.e. no. of outputs verified/ tokens issued = outcome), the bond matures, and investors (anyone who holds PBT) receive full price;
Derivatives and other Complex products
The best way to achieve scale and volumes on capital markets is by integrating impact content in more complex investment instruments and portfolio. Some of the more obvious structures would include Compound indexes of some sort that would track a multitude of impact event types either based on SDG or impact area (“sustainable agriculture”, “soil regeneration” “climate change”) or focused on a geographical area (“agriculture Costa Rica”, “Reforestation, Madagascar”); These models would be attractive to a wider segment of investors as well as to fund managers who can fold them into Exchange-Traded and managed Funds and wider portfolios
Entirely new categories of derivatives can evolve on top of priced impact tokens. CFDs, futures, options among them. This will lead to a thriving financial market built around impact, which for the first time aligns the incentives of investors, businesses and government with the environmental and societal challenges of the coming generations – The Purpose Economy.
I will stop here. Would love to hear your thoughts on above or any other opportunities you can think of in this space. Obviously, this technology will not solve ALL problems — no technology ever has or ever will — but I am convinced that it will unlock a new era of opportunities that we cannot even conceive right now.
I can’t wait.
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