Blockchains and Social Enterprises

Introduction

In the United States, non-profits contribute an estimated US$900 billion to the economy, and socially responsible investing as grown to US$6.5 trillion. These socially-focused organizations face unique and unprecedented challenges from funders, and regulators; and pressures to evolve their business models. Moreover, they experience increased scrutiny of transparent practices and social impact measures, and face limited funding sources and increasing competition with the traditional for-profit sector.

A novel software technology — called blockchain, may offer new and profound ways to change how some non-profits and social enterprises operate and collaborate.

In this working paper, I explore what blockchain is, how organizations are using it today, and what can these organizations do now to evaluate this technology.

Background – in brief

Blockchain is a type of database structure that is used to implement an indelible distributed ledger of transactions that is secured from tampering and revision. Multiple transactions are validated and stored in chunks or blocks. Each subsequent block references the prior block via a mathematical function called a “hash”.

When a transaction occurs (i.e. transfer of money, execution of a contract, registration of property, etc.), it must be validated and appended to the ledger using a method of consensus to prevent cheating or double spending. This consensus process begins with the broadcasting new transactions to any node that is connected to a network. Each node has a copy of all prior validated transaction blocks (i.e. the ledger). The receipient node will check whether it has seen the transaction before and if not, that node will broadcast it to other nodes on the network, known as “flooding”. Transactions are checked by nodes against a set of validation criteria. Valid transactions accumulate until they reach the size of an entire block, at which point the candidate blocks are mined by “miner nodes”.

Miner nodes run a candidate block through a special algorithm that by design requires a significant amount of computing power and electricity to be spent (a Proof-of-work proxy) in order to transform the candidate block into a particular pattern of data — which is achieved at random. Once this criteria is met, the block is “solved” and is broadcast through the network to other nodes. Nodes then receive, validate, and broadcast the block as they did with transactions, cease computing the same candidate block, and begin working on the next candidate block.

History

Blockchain became popularized well after the debut of Bitcoin, a digital currency that implements a blockchain to serve as a basis for accounts, and a computational method of consensus applied to verify the authenticity of each bitcoin transaction. Unfortunately, Bitcoin has had its share of negative media attention associated with the bankruptcy of the Mt. Gox exchange, Silk Road, and banning by certain governments.

In turn, Bitcoin and blockchain have often been lumped together and viewed by some as corrupt or nefarious technologies. However, this view is short-sighted.

As of this writing, Bitcoin still continues to serve as a means of value transfer and is the most tested and liquid digital currency. In addition, blockchain technology is being explored by

  • several central banks for its potential use to support digital domestic currency,
  • major commercial banks such as Citi, UBS and Royal Bank of Scotland for reducing the time it takes for financial transactions to clear, and
  • many entrepreneurs.

How organizations and people generally use this “ledger” technology can be divided into distinct characteristics.

Ledgers

There are two general types of distributed ledgers: “permissioned” and “permission-less”.

Permission-less ledgers (blockchains) involve a network that is open to all actors in the network — meaning miners, nodes, and account holders. Bitcoin, Ethereum, and Stellar are among those companies using permission-less blockchains.

In permissioned ledgers, the network is restricted to only certain authorized nodes and miners. For example, nodes and miners are restricted to only those institutions who are part of a consortium. Ripple and Blockstream are among those companies employing permissioned ledgers.

Note that permissioned ledgers implies a centralized authority (i.e. only authorized nodes are allowed) that could influence whether a transaction is valid or accepted. As such, it is not a “blockchain” per se.

Distributed ledger systems

There are dozens of companies involved with deploying distributed ledgers and cryptocurrencies, and at a first approximation each differ in types of ledgers, consensus protocol, and features. Here are a few to mention:

Bitcoin, bitcoin.org, a 501(c)(6) under the Bitcoin Foundation, Inc.

The Bitcoin Foundation sponsors the open source Bitcoin project — a type of cryptocurrency that can be mined (analogous to gold), and bought, exchanged, and sold in various markets from online exchanges to physical coffee shops. Miners use computing power and electricity to verify the authenticity of transactions and are awarded bitcoin in return for this service — known as a “Proof-of-work” consensus. Currently, reaching consensus on a bitcoin transaction can take 10 minutes.

Ripple, ripple.com, by Ripple Labs, Inc.

Ripple is a venture-backed private company that aims to develop global financial settlement solutions using a permissioned distributed ledger (not a blockchain) and their own digital currency called “ripples”. Ripple’s consensus protocol is new, and aims to achieve consensus in 1–2 seconds. There are many companies that have already announced integrations with Ripple.

Ethereum, www.ethereum.org, a Swiss non-profit (Stiftung Ethereum)

Among developers, the Ethereum Foundation’s project is the second most popular blockchain, which features smart contracts — or digital contracts that can be executed like software; and a cryptocurrency called “ether”. Today, Ethereum uses the same method as bitcoin does to verify transactions (Proof-of-work), and transactions reach consensus in ~15 seconds. In the future, Ethereum plans to shift to a different consensus mechanism called “Proof-of-stake”.

The Ethereum smart contract is famous for creating the Decentralized Autonomous Organization (DAO), which is the first of a type of investment vehicle that mimics that of a venture capital fund. The DAO raised more than US$150 million from more than 11,000 investors. By investing in the DAO and holding DAO tokens, a DAO holder can vote and take part in DAO governance. The DAO can deploy “ether” to contractors under specific payment terms and project parameters. Contractors execute work with ether to produce products or services, and revenues are shared back with the DAO under the terms of the agreement.

Hyperledger, www.hyperledger.org, by Linux Foundation, 501(c)(6)

An open source blockchain project led by IBM and a group of Fintech companies. The key focus for Hyperledger is to create consensus protocols that scale. Its consensus is based on a technology that has been well-studied (Practical Byzantine Fault tolerance). Hyperledger is still in early development.

Stellar, stellar.org, a non-profit company, not yet 501(c)(3)

An emerging distributed ledger that is focused on payment processing and financial inclusion for underbanked and unbanked people worldwide. This company is currently focused on creating partnerships in Nigeria — which is currently undergoing rapid technological advancement especially in the Fintech sector. Stellar also aims to concentrate on NGOs, accelerators, foundations and educational institutions. Its currency is in “lumens”, and has been giving them away through various challenges to encourage development. Consensus on the Stellar network takes 2–4 seconds.

Applications

Here is a sample of some non-profit and socially-focused organizations that are using Bitcoin or blockchain technology.

AliceSI, alice.si

is a philanthropy platform where donations are held conditionally in a smart contract using the Ethereum Blockchain. Organizations can raise funds based on impact transparency – funds are released once an independent party can validate outcomes.

The Water Project, thewaterproject.org/donate-bitcoin, a 501(c)(3)

accepts many payment methods including bitcoin for donations. Small donations through traditional services such as PayPal and Square may incur a significant transaction fee (relative to the donation). Using a cryptocurrency such as bitcoin allows the donor to transfer money direct to the organization without the use of any financial intermediary, thus reducing transaction fees (Note: miner’s fees still apply).

BoardRoom, boardroom.to

is a governance application built with the Ethereum blockchain and smart contracts. The application attempts to aid boardroom transparency and accountability, and organizational decision-making during crisis response. A trial was recently announced in April 2016 with Star Network NGOs.

BitGive, bitgivefoundation.org, a 501(c)(3)

is building a donation transparency platform that allows donor funds to be directly transferred to an organization at much lower cost than financial donor systems of today. Beyond lower cost, the platform aims to allow everyone to observer how the funds were used and what impact they have. BitGive is in early development at the time of this writing.

Provenance, www.provenance.org

is a privately held for-profit developing supply-chain transparency solutions powered by the Ethereum blockchain. As of this writing, their blockchain implementation is still in development but they aim to build a verifiable and transparent way to track the origin of materials and products.

UNICEF, www.unicef.org, a 501(c)(3)

is currently hiring blockchain developers to explore applications of blockchain to help distribute and deploy foreign aid. According to U.N. Secretary General Ban Ki-moon, 30% of foreign aid never reaches its destination due to corruption, or failure of accountability and transparency.

Foreign aid powered by blockchain and smart contracts could enable accountability and transparency protections, thus disbursing financial aid directly to people or organizations and requiring certain conditions such as verification of delivery — to be meet before the financial aid is completely settled.

Two general reasons for use

To sum up, there are two main test cases in considering whether applying blockchain technology will add value:

  • Replacing a centralized authority or creating a decentralized authority adds value
  • Having a cryptographic audit trail adds value

Implications

Complexity

Blockchain will require implementing organizations to evaluate the use of

  • cryptographic keys and digital signatures,
  • consensus mechanisms, and
  • peer-to-peer or distributed architectures.

Though some blockchains and services attempt at abstracting away these complexities, it may be some time before all the bugs are worked out and in the meantime expert knowledge in the blockchain and its APIs is critical for any deployed implementation.

Risk

First, blockchain is still a young technology and we are likely to continue to see both adoption fury and fast failures. The investment interest in blockchain will continue to spur new startups, with US$160 million of VC funds being pumped into the technology and 56 new initiatives by traditional companies announced in Q1 2016 (Source: CoinDesk). And many of these startups and initiatives must stand the test of time.

Second, regulation on certain blockchain applications — specifically financial or payment applications involving blockchain and/or cryptocurrencies or virtual currencies is still ambiguous and is likely to evolve over time as governments and institutions grapple with legal implications. Several countries have banned cryptocurrencies including: Bolivia, Ecuador, Iran, and Russia. Other countries have passed laws regulating bitcoin. In the US, New York has regulation for virtual currencies — called BitLicense. North Carolina passed a law supporting virtual currency. Other states have drafted similar bills. One overarching compliance affecting some non-profit and social enterprise donations and grants is KYC-AML (Know Your Customer — Anti-Money Laundering), which becomes problematic with certain virtual currency payments.

US institutes such as the Securities and Exchange Commission have been looking into whether distributed ledgers systems can be used for financial instruments and what regulation might be needed.

US courts have little precedence —in June 2016, The State of Florida vs Espinosa set precedence rejecting the view that bitcoin is a form of money. This sets a contrast to Florida’s regulator that suggests one must have a license to use currency or payment instruments for certain amounts of transactions. More recently – September 2016, The US vs Murgio, a US Federal judge ruled that bitcoin is money. Regulations will continue to evolve.

Third, credibility has become murky at best with many participants racing in to raise money and claim expertise with particular blockchain technology. There are few certifying bodies, insufficient formalized training, and business continuity ranges between 0.5–4 years.

Decentralization

By design, the blockchain has no central authority. There is no service or organization to call to help fix a transaction error, like there is with a traditional financial service (i.e. request stop payment). An error or misstep could have significant consequences — like the recent DAO attack where an attacker drained the funds from the DAO into his or her account.

Conclusion

Blockchain technology is young and evolving. We will discover new types of ledgers, consensus methods, functionalities, and applications in the coming months. We are already beginning to see early applications to the social sector such as donation platforms, organizational accountability and transparency tools, supply-chain provenance, and aid disbursement. Interested socially-focused organizations should be aware that this technology introduces new complexities and with it risks and regulatory uncertainty.