Could DeFi help close the climate gap?
To unlock the potential that decentralized finance has to offer in infrastructure development, there needs to be a solution that bridges infrastructure borrowing to DeFi liquidity.
According to the World Energy Outlook 2021, one of the key measures that can help close the gap between today’s climate pledges and a 1.5º C trajectory over the next ten years is a massive push towards clean electrification. Estimates suggest that this requires a doubling of solar PV and wind deployment relative to the WEO’s Announced Pledges Scenario in addition to other investments and initiatives.
As per the International Energy Agency (IEA), “accelerating the decarbonisation of the electricity mix is the single most important lever available to policy makers”. The war in Ukraine has led to Europe looking to cut its oil and natural gas imports from Russia, which means its energy transition is now even more urgent. Although policymakers have jumped onboard and made pledges towards energy transition, there’s still a key missing link to be able to get the job done: access to capital.
The State of Climate Action 2021 report finds that $5 trillion will be needed annually to finance systemwide transformations to limit global warming to 1.5º C. Developing economies, in particular, need a major boost in investment to be able to chart a path towards sustainable development. While renewable energy is a key focus for most developing economies, they are behind the curve in building basic infrastructure to support urbanization. As per a McKinsey article from 2019, “developing countries will need to invest more than $2 trillion a year in infrastructure just to keep pace with projected GDP growth over the next 15 years”. At the same time, most emerging economies are facing record public-sector debt in the wake of the global pandemic. Significant private sector investment is the only way to bridge the growing gap in infrastructure development.
Developing economies, in particular, need a major boost in investment to be able to chart a path towards sustainable development.
While traditional project finance sources could help drive development, emerging economies also face double digit interest rates and a limited pool of liquidity to draw from. Traditional finance comes with expensive, long and drawn-out due diligence processes which lack transparency. Often these funds come with many strings attached, adding undue stress to small and mid-size projects.
Traditional project finance also stops short of supporting projects that consider leveraging new and emerging technologies. As per an article in the New York Times, the IEA forecasts nearly half the reductions in emissions to meet net-zero targets by 2050, will come from technologies that are in their infancy today. While in theory, climate-focused VCs are gaining significant momentum, they seem to fall short of investing beyond initial start-up funding. While some may take the leap towards pilot projects in partnership with governments offering grants or other support, the scale-capital required to deploy widely to support energy transition is enormous. VCs seemed to have turned their focus to less urgent matters (e.g. the metaverse) recently. According to PitchBook, VCs invested $30.1 Billion in cryptocurrency and blockchain as compared to $11.9 billion in renewable energy globally.
Traditional project finance stops short of supporting projects that consider leveraging new and emerging technologies.
For those who are new to the concept, DeFi is an ecosystem of financial applications built on top of distributed ledgers, enabling decentralized, trustless and permissionless financial services. More on DeFi here.
How can DeFi be part of the solution?
1. Access to liquidity — The Total Value Locked (TVL) in DeFi, at the time this was written, stands at $140 billion. While the amount today is nowhere near what’s needed to fund the infrastructure gap, the TVL in DeFi has seen a ~10x growth since early 2021. Infrastructure-based financial products could offer DeFi investors and stakeholders an opportunity to obtain stable long-term returns while hedging their more volatile crypto investments.
2. Decentralized decision-making — In theory, a decentralized governance system would be better suited towards vetting projects as they would avoid the principal-agent problem that has plagued the infrastructure world. This could enable faster and more realistic project assessments which would be routed via a DAO, who would have better alignment of interests towards seeing projects succeed through their lifecycle. High-impact, small-ticket projects which couldn’t afford to pay expensive transaction fees may now have an opportunity to access finance.
3. Climate impact focus — While traditional financial institutions are focused on maximizing financial returns, the community-based approach could look to prioritize and give weight to impact metrics right alongside financial performance. This could also enable those projects that may be perceived as high-risk due to use of nascent technologies, but once proven at-scale would unlock exponential impact. Using smart contracts, project and developer commitments could be recorded and tracked transparently to ensure performance against initial objectives.
The community-based approach could look to prioritize and give weight to impact metrics right alongside financial performance.
To unlock the potential DeFi has to offer in infrastructure development, there needs to be a solution that bridges infrastructure borrowing to DeFi liquidity. Silta is working on a solution for just that.
Silta DAO aims to steer DeFi towards real-world assets (RWA) with a strong sustainability impact. It is paving the way for community-led, decentralized due diligence and impact assessments for project financing. The result of this assessment is the Silta Score, which is encapsulated in an NFT and validated by the Silta DAO. The NFT is dynamic and updated as the project transitions from financing into construction and operations. The NFT allows for monitoring the progress towards sustainability goals. Token rewards are paid for delivering true impact against Sustainable Development Goals (SDGs). The Silta Score is accessible to anyone that subscribes to the NFT, including DeFi protocol partners, SDG-conscious lenders and TradFi.
DeFi liquidity could spark a revolution in infrastructure finance and if channeled in the right direction, could help accelerate and realize our climate goals. While VCs, governments and influencers focus their attention on blockchain, crypto and NFTs for a variety of reasons — my hope is that they can all align to support the industry in solving the most pressing problem we face today.
About the author
Naushad Oomer is an infrastructure and future mobility expert, startup advisor and investor, and a strategic advisor to Silta Finance.
Disclaimer: What is written in this article are personal opinions of the author and should not be construed as investment advice. Read Silta’s full legal disclaimer here.