How Blockchain & Web 3.0 Are Revolutionizing ESG Investing
A report outlining Systemic Problems and Decentralized Solutions to the ESG Crisis
The Environmental, Social and Governance (ESG) Investment sector emerged and evolved over the past decade without much of a plan or regulatory design to guide its development. As a result, there are still a number of design flaws, systemic challenges, and inefficiencies in existing systems and infrastructure for measuring, reporting and rating ESG performance. In addition, there is a massive (and justified) public credibility and trust deficit in the largely legacy finance controlled and centralized sector. If the sustainable and ethical investing movement is to be rehabilitated and scale in order to meet the critical environmental and social challenges we face as a society, these issues must be urgently and transparently addressed.
This report outlines some of the core systemic problems in the Legacy ESG and carbon markets infrastructure. It then explores how the application of Web 3.0 and blockchain technology and principles offers potential for more impactful and regenerative solutions. Finally we outline some steps that we believe can further scale the impact of this new web 3 approach to ESG and move us from a focus on ESG compliance to one of ESG value creation and real-world impacts.
Potential of the Web 3.0 ESG sector
The ESG investment sector is rapidly growing, with an estimated $2.7 trillion in assets now managed in more than 2,900 ESG funds and about one-third of global AUM funds listed as being assessed on ESG criteria. Global ESG funds received a record $649 billion in investments in 2021 through Nov. 30, up from $542 billion in 2020 and $285 billion in 2019, according to data from financial services firm Refinitiv Lipper.
As a relatively new investment class, the fact that ESG assets are projected to top $50 trillion by 2025 is evidence of the huge potential for growth of the asset class as a whole. Increasing International and National-level regulation as well as growing shareholder and consumer demand is requiring more public companies to measure, report and verify their ESG scores. This is a trend that is likely to only continue to accelerate as younger generations become more politically and economically engaged and as the sector spreads to new parts of the globe.
Despite the many issues with the sector to be discussed below, what is clear is that there is a growing demand for more socially and environmentally impactful investing. Jim Coulter, MBA, Executive Chairman & Founding Partner of TPG believes there is much more untapped demand, from a new generation of entrepreneurs seeking ‘impact capital’ providing an opportunity for this market to grow substantially. Coulter believes the climate revolution will mimic the explosion of the digital economy:
“Many people 30 years ago knew tech would be big, but they still underestimated just how big it would get.”
Such sentiment and explosive projections are also commonly made around the emergent blockchain and Web 3.0 economy today. According to a comprehensive research report by Market Research Future (MRFR), “Web 3.0 Blockchain Market forecast to 2030” this market is projected to grow at a healthy compound annual growth rate by 2030.
According to another report by PwC -Time for trust:
“The trillion-dollar reason to rethink blockchain, assessing how the technology is being currently used and exploring the impact blockchain could have on the global economy” — blockchain technologies could boost the global economy US$1.76 trillion by 2030.
The key part of that report is that the core area in which blockchain will achieve this impact is by raising levels of tracking, tracing and trust. “Tracking and tracing of products and services has the largest economic potential (US$962bn)” and merging these two sectors offers a significant multiplication factor. As we will discuss below, the core problems present in the ESG sector at present center around the tracking and tracing of products and services and creating trusted systems.
Systemic Problems in ESG Investing
It is increasingly accepted that there are serious systemic problems within the ESG sector today preventing the regenerative impacts that many believed it offered. The current system is complex and opaque and it is not easy to navigate or improve upon despite the efforts of well-intentioned companies or governments.
A 2020 Paper from The University of Hong Kong states that due to the lack of data authentication, consistency, and transparency, ESG-based sustainability evaluation is still inadequate.
Prestigious Social Impact journal SSIR is also among those raising questions and doubts about ESG ratings. Another is Tariq Fancy, BlackRock’s former chief investment officer for sustainable investing. He declared in an essay for USA Today:
“…in essence, Wall Street is greenwashing the economic system and, in the process, creating a deadly distraction. I should know; I was at the heart of it.”
Fancy and others say the emphasis on ESG has delayed and displaced the urgent need for action to tackle the climate crisis and other issues, including the widening chasm between the rich and poor.
Some of the fundamental problems leading to these poor outcomes in the ESG sector are:
Measuring The Wrong Things
A 2021 Bloomberg Report highlighted the shocking fact that many ESG ratings in fact measure the risk environmental, social and governance issues pose to a company, not the other way around. This fact is not commonly known by the public or even by investors in ESG funds. As the report states:
“Environmental factors are the most deceptive to the uninitiated, because MSCI rates the potential impact of the world, not the company’s impact on the world.”
Even worse, most rated companies do not even measure or disclose their emissions or other environmental impact data. David Larcker, professor emeritus of accounting at Stanford GSB and director of the Corporate Governance Research Initiative, has also found that this uncertainty is compounded by numerous flaws in how policies and impacts are measured and analyzed. As he puts it:
“There’s a lot of bad assumptions, bad measures, and unsupported claims.”
Lack of Transparency Around Ratings
The above points to a core problem with the current ESG system — the lack of transparency and attention placed on how the data underlying ESG ratings is generated. It is usually intentionally unclear exactly what metrics, rules and standards are being used by individual rating providers. MSCI only shares this information with corporate finance clients according to Bloomberg.
The Bloomberg Report found that competitors in ESG rating often disagree with one another, sometimes wildly and there is a lack of oversight.
“That’s because each ESG rating provider uses its own proprietary system, algorithms, metrics, definitions, and sources of nonfinancial information, most of which aren’t transparent and rely heavily on self-reporting by the companies they rate. No regulator examines the methodology or the results.”
This proprietary approach leads to centralization of information leading to perceptions of disproportionate access to smaller organizations. This closed approach also suffers from inherent technical challenges and inefficiencies in that it prevents feedback and improvement on the rules and measures used by all players in the network, from consumers to companies, to NGOs, and verification bodies. Open data approaches are now well-known to lead to far more efficient and trusted systems and greater innovation and adaptability. By ensuring full transparency, the legacy ESG system could benefit from these efficiencies of a decentralized and open-data approach.
Lack of Standardized ESG Rating System
Current rating systems fall short in many ways. There is no universally accepted standard for measuring and tracking the environmental and social impacts of specific corporate practices.
Alexander Gelfand Dave Gilson of Stanford Business School points out that without mandatory disclosure or commonly accepted metrics, it’s difficult to make apple-to-apple comparisons of firms’ track records.
“Corporations may cherry-pick the numbers they disclose, increasing the possibility of greenwashing or greenwishing.”
As a group of 8 Sustainable Business leaders at the Davos Summit discussed recently, despite growing momentum toward a coherent system for corporate disclosure, progress on tracking and measuring ESG commitments and performance remains uneven. The general consensus is we are inching closer to shared measurement around “Environment,” but when it comes to “Social” and “Governance” reporting there are outstanding questions around what’s best to measure and how to capture company performance with a lack of objective data points.
The Social Impact Dilemma
In the Social category, impact investing experts, scientists and others have long grappled with the complexity of measuring social impacts created by business activities. As Amit Seru, a professor of finance at Stanford GSB and a senior fellow at the Hoover Institution says “Good luck measuring the impact of an investment on social or economic inequality .. The data are messy, crude, and measured with a lag.”
We need a similar science-based target approach to the “Social” reporting as we have the “Environment” reporting — just without taking as many decades to do it! — Ruth Harper, Chief Sustainability Officer, ManpowerGroup
Academics at MIT Sloan School of Management published a recent report claiming the lack of standardization on ESG scoring is leading to ‘aggregate confusion.’ Social and Governance issues in particular, are much harder to ‘aggregate’ up into single ratings. They are subject to human judgment and inconsistent access to ESG information, making for variability across raters.
Even worse, this system allows companies to achieve high composite scores even if they cause significant social or environmental harm but do well on all other parameters. Classification of governance, for example, lacks sufficient reporting metrics for various practices given the complexity and diversity from one organization/industry to another and the fact that they are capturing fundamentally different things. For example the cigarette industry — responsible for more deaths per year than the global COVID-19 pandemic — can at present receive a solid “BBB” rating from MSCI, one of the leading ESG ratings firms.
Supply Chain Issues
Another problem is that ESG ratings fail to take a full supply-chain into account. For example they often consider a company’s direct greenhouse gas emissions but not its Scope 3 emissions — i.e. emissions from the use of its products and supply-chain. This leads to situations in practice such as Tesla receiving a worse ESG ranking than Exxon.
‘Greenwashing’ & ‘Wokewashing’
There have been mounting concerns (both from the public and Governments) that some funds seeking to profit from the rise in ESG investing practices have misled shareholders over what’s in their holdings, oftentimes double-counting shares in a practice known as greenwashing.
As the Bloomberg report states, in many instances across the industry, existing mutual funds are cynically rebranded as “green” — with no discernible change to the fund itself or its underlying strategies — simply for the sake of appearances and marketing purposes.
‘Wokewashing’ is essentially the same practice as Greenwashing, but instead of companies or funds making misleading environmental claims it would involve them making misleading claims around “woke” or progressive corporate social practices including diversity hiring, social impacts, labor conditions, and economic equality.
In response to such concerns, on 25 May 2022, the Securities and Exchange Commission (SEC) proposed two rule changes that would prevent misleading or deceptive claims by U.S. funds on their environmental, social and corporate governance (ESG) qualifications and increase disclosure requirements for those funds. SEC Chair Gary Gensler has stated that this proposal would modernize the agency’s “Names Rule” for today’s markets specifically to prevent misleading claims being made by funds around their ESG compliance.
This step should lead to greater consumer confidence around the legitimacy of claims being made around ESG, however there is still a great need to move beyond compliance on public statements to more systemic fixes that apply greater transparency and better systems for verification and regulatory oversight of ESG funds and ratings frameworks.
Lack of International Coordination
International Coordination over sustainability standards is another major problem. A patchwork of inconsistent standards across jurisdictions makes it confusing for projects providing services and for consumers. However, Standards and Rating systems that attempt to solve a complex global problem like ESG require effective global coordination and investment. This can not be managed by one company or country but must be decentralized and open to enable transparency and a consensus to emerge democratically.
We’re seeing some signs of movement in this direction. The International Sustainability Standards Board (ISSB), established at COP26 to develop a comprehensive global baseline of sustainability disclosures for capital markets, has launched a consultation on its first two proposed standards. The final requirements are expected to help meet the information needs of investors in assessing enterprise value. It is unclear what steps will be taken by this Board to reform the ESG sector or what involvement NGOs or ordinary citizens will have in this process.
Overall it is difficult for ordinary consumers to access these markets and invest directly in value creating services, as opposed to investing through large legacy index funds who are operating in a highly centralized way. The industry is still dominated by legacy financial markets players like Deloitte, KPMG, or MSCI which verifies around 60% of all ESG-compliant companies globally according to Bloomberg.
Robert Zevin, credited with pioneering the practice of ‘socially responsible investing’ in the 1980s, believes ESG is Wall Street flipping sustainable investing on its head for profit.
“It’s not just Wall Street, it’s capitalism. It always finds some way to repackage an idea so it’s profitable and mass-producible, and that’s going to be hard to overcome.”
Former managing director at Engine №1 and author of Accountable: The Rise of Citizen Capitalism, Michael O’Leary wrote an article for Harvard Business Review in 2021 titled “An ESG Reckoning Is Coming.” He and his co-author warned that “A movement meant to benefit the public good risks becoming a buzzword coopted to keep maximizing short-term profits.”
A big part of the problem is that key stakeholders involved in ESG are corporations, investors, and ratings firms whose interests as businesses are ultimately to generate a profit. The reality is ESG compliant companies in general are not any more profitable as those that have no regard except for shareholder profits. A 2021 meta-analysis of 1,400 studies performed by researchers at the Wharton School, NYU, and Johns Hopkins indicates that the financial performance of ESG investing has on average been indistinguishable from conventional investing. In addition, Stanford GSB finance professor Jonathan B. Berk recently showed that when companies failed to meet their proposed ESG criteria it had little impact on their financial performance or their cost of capital.
Governments clearly need to provide prescriptive regulation that prevents gaming of the system, but this is difficult and costly without clear measurements and verification standards in place. As Madeline Hawes, Director at Engine №1 says “It’s hard to push them until we really have that data.”
Therefore, it is also necessary to more rapidly move to incentivise these stakeholders financially to act (as opposed to talk) more responsibly and collaboratively without the need for excessive regulation or compliance efforts.
Legacy Carbon Markets Were Never Meant to Scale
One way for companies to meet ESG obligations is through Voluntary Carbon Offset Markets (VCM) — either through nature based solutions (eg ecosystem regeneration) or increasingly through decarbonization technologies. However, the legacy system of Voluntary Carbon Markets has some serious problems.
We lack an effective and clear global verification system for carbon credits to ensure that carbon offsets are real and are actually helping the environment. This requires decarbonization project ESG data to be tracked with full data and transparency globally, which is not happening at present.
Scaling VCMs also requires an efficient system for creation and verification of carbon offset credit supply onto the market at a rapid rate so that actual decarbonization impacts continue increasing and price pressure is maintained. This is another serious challenge at present, as Jeremy Epstein, Head of Growth for Open Forest Protocol recently stated most succinctly:
“In the macro picture, liquid markets aren’t the main barrier to a flourishing VCM. The main problem is the legacy system of carbon MRV/accreditation was never built with scale in mind, and will never be able to meet this decade’s demand. In fact, in terms of fulfilling the grand vision of a truly flourishing market for nature-based carbon drawdown, it’s a failure. How do I know this? We’re still cutting down more trees each year than we are replanting.”
Global Coordination Failure
In short — our ongoing global social and environmental challenges are a result of a Global Coordination Failure. ESG is a complex global issue that encompasses climate change, ethics, culture, equality and many more of the greatest problems we can solve as human beings. However, these challenges, and the ESG markets intended to address them, both suffer from coordination failure on a global scale. As Kevin Owocki of Green Pill and Gitcoin states:
“Coordination Failures occur when a group of humans could achieve a desirable outcome by working together but fail to do so because they don’t coordinate their decision-making.”
Whenever we try to solve ‘wicked’ global problems like climate change by relying on individual companies or countries and centralized and profit-driven systems — coordination failure is the most common outcome.
Solutions: How Blockchain Can Help Move ESG Forward
We are in a Transition phase from a legacy ESG system to the new emergent decentralized system. Transitional phases usually emerge after a massive coordination failure and a breakdown of public trust in the old system, leading to a period where the two systems co-exist before the new supplants the old.
The great news is the emergent Blockchain and Regenerative Economics approach to ESG is already rapidly proving its superiority in providing better coordination on a global scale. The potential of this technology to power a more efficient and effective system that solves the key challenges we need to overcome has been widely accepted at the highest levels.
Aya Miyaguchi, Executive Director of The Ethereum Foundation recently proposed in a post as part of the World Economic Forum’s Crypto Impact and Sustainability Accelerator (CISA) that blockchain can help address the global coordination failures of ESG. She stated that inspiration can be taken from the way public blockchains such as Ethereum and Bitcoin handle coordination globally without any single company or team managing the effort.
“While Ethereum is still evolving and is far from perfect, it is a unique case study on solving coordination issues related to building public goods.”
Miyaguchi points to the crypto incentive mechanisms that encourage participants to help secure the networks and prevent abuse and manipulation through mechanisms that incentivise participation and ensure decentralization. She highlights the principles of the Ethereum blockchain as offering potential guidance for an ESG system — which includes: its open source code and rules, its permissionless nature, its ‘emergent consensus’ (free debate, and criticism) model, and its forkable nature.
Below, we explore how Blockchain technology and principles can supercharge ESG in practice:
Introducing traceability into ESG ratings systems is a major challenge — most companies today involve complicated supply chains spanning the globalized world, across different jurisdictions, and industries in a complex web of interconnections. This is exactly why smart-contracts behind blockchains are essential in the process. Smart contracts can be utilized via NFTs to essentially tag and trace physical objects, shipments and track associated data at every step of an industrial or corporate or even agricultural supply chain. This NFT can mirror a physical resource and register all of the characteristics that define the quality and regulatory compliance of its physical counterpart.
The above-mentioned paper from The University of Hong Kong proposes a blockchain-based ESG reporting framework for facilitating the sustainability evaluation of listed companies. It proposes utilizing a blockchain gateway to facilitate raw data authentication issues. Then it proposes a versioning smart contract mechanism to verify the consistency between the raw data and the final ESG report. Finally, it suggests a token-based sustainability evaluation mechanism to evaluate the behaviors of a listed company in the sustainable supply chain.
This approach would allow businesses to improve their internal sustainability data and reporting procedures and enable ESG verifiers and consumers access to the data too. Global energy giant Repsol is leading the charge on this and is already using blockchain to digitize some of its downstream supply chain from refinery or industrial complex through to being processed into a product in subsequent supply chains
An Oracle-based approach could also be applied to ESG investing to ensure open and transparent access to relevant data from across an industry or supply chain.
A report by Chainlink Labs and European research institute Tecnalia posited in a report in April 2022 that the energy industry can make clean energy investments more efficient by leveraging blockchain technologies. The report states that blockchain-enabled ‘Oracles’ can use satellite and remote sensing data to measure carbon sequestration in a certain region to verify a project’s stated carbon offset before issuing a credit. They state that Hybrid smart contract system Hyphen, for example, uses Chainlink oracles to bring verified greenhouse gas data on-chain and prove stated corporate climate commitments. As Hyphen CEO Miles Austin stated:
“We can now supply validated real-world measurements to dynamic carbon assets… This gives confidence to investors, capital markets, banks [and] regulators.”
Blockchain used in this way can bring an added level of transparency, verifiable evidence, and therefore credibility, to ESG reporting. It creates an immutable historical record accurately capturing and tracking progress on sustainability over time. Investors and stakeholders or anyone in the network can verify that reporting is accurate in an ‘emergent consensus’ type system.
Solving The Measurement Dilemma
As discussed, a major challenge is measuring environmental and social impact data. Nathon Menon, Senior Associate at ESG and energy focused Law firm Reed Smith suggests that blockchain can revolutionise social impact investing by providing accessible and even real-time data tracking on social or environmental needs, or on the impact of products such as development impact bonds (green bonds or social bonds) — fixed income instruments that raise money for environmental projects.
Menon suggests that the distributed nature of the blockchain community enables the reconciliation of information entered by multiple parties, which means that on-chain data is time-stamped and verifiable, and therefore is significantly less susceptible to manipulation and fraud.
Menon also proposes that blockchain could be harnessed to supercharge existing ‘Predictive markets’ which incentivize participants across a public network to help predict trends. This open data model could be used to more accurately model and predict the likelihood of certain social needs and how best they can be improved by social impact initiatives. These benefits will also help to create ESG benchmarks and more open, transparent and trusted verification systems.
Creating Sustainable Community
Blockchain for ESG can also economically incentivize corporate sustainability and generate better ESG outcomes by connecting all the players in a supply system together in a circular economy network. By adopting the core decentralized blockchain principles Ayaguchi referred to above, industries can create incentives and rewards for network members that take steps to be more sustainable. Instead of creating laws and regulations to force companies to do the right thing relying on incentives means companies that don’t adapt will be outcompeted by those that do.
This approach would enable different players across a supply chain network to share data, ideas and support each other in a mutual goal. This could see manufacturers, suppliers, financiers, venture capitalists and entrepreneurs all working to develop and improve their businesses, as they begin to interact via and through the ESG blockchain network.
This will also enable entire supply chains and industries to accurately measure and track individual companies and their collective industry averages to provide a benchmark as to best practices. All of this depends on the ability of everyone on the network to trust in the validity of the data, and the metrics behind it, which is exactly what blockchain does extremely well.
Scaling Carbon Markets With Web 3.0
Among the use cases outlined in the Chainlink report are tokenized carbon credits, which companies buy to offset emissions. The idea is that by storing carbon credits as digital tokens, the tokens can be more easily tracked and traded, and oracles can then issue and audit them.
Another interesting approach raised in the Chainlink report is the blockchain tokenization of climate bonds and green bonds.
There is no shortage of innovation in the blockchain carbon offset tokenization space. Promising blockchain offset projects like KlimaDAO, Toucan Protocol, and Flow Carbon have already created significant impact. The economic potential in this space is also clear — Flow Carbon just closed a $70million raise in the midst of an economic recession to scale their solution of putting Carbon on a distributed, transparent, immutable ledger. Toucan and KlimaDAO alone managed to bring millions of carbon credits on-chain since October 2021.
Roadblocks To Scaling
However, these crypto on-chain carbon markets cannot currently scale any faster than the carbon offset credit supply they can access from the legacy system. They are effectively limited by the fact that they rely on a highly centralized legacy carbon markets and an inefficient verification and supply-side system.
As Andrew Chow wrote for Time Magazine recently, Crypto Thought It Could Change the Carbon-Credit Market, Until It Hit a Major Roadblock. Toucan’s core business case was that by pushing carbon markets onto the blockchain they could turbocharge the climate fight with crypto economics, provide a global infrastructure data layer, and force polluting companies to either pay higher prices for carbon credits or seek more environmentally friendly approaches to their businesses. Toucan’s aim was to create infrastructure to facilitate the buying of carbon credits, which would be retired and then placed on-chain in the form of a new token.
However, there was criticism from some scientists and watchdogs about the quality of the credits used, and panic among traditional carbon-credit issuers and buyers over the potential for disruption caused by these revelations of the existing quality issues within the legacy system. This even led to market panic and wild price fluctuations across carbon credit markets.
On May 25, Verra, the largest carbon standard by number of credits issued, appeared to move directly against Toucan’s activity. Verra announced it would ban the conversion of retired Verra credits into crypto tokens, effectively scuttling Toucan’s central mechanism. This would give Verra greater centralized control and oversight over the flow of credits throughout these new markets. To make matters worse, as Robin Rix, the chief legal, policy, and markets officer at Verra, told TIME, Verra definitely wants to scale up the carbon-credit market, it is now leaning towards trying to do so through bank-led initiatives, like Carbonplace, as opposed to crypto ones.
As Chow puts it “After just seven months, the first phase of the crypto’s supposed carbon-credit revolution is over.” However, the Revolution itself is far from over. Verra did open the door for a potential new chapter of collaboration with the blockchain industry, in which only live Verra credits could be tokenized and announced a consultation with blockchain Carbon credit industry stakeholders about how to create a two-way bridging system with a specific focus on matters such as enabling measures, KYC checks, and what fees they will charge. However, KlimaDAO noted that there was no consultation from Verra with the sector before making this decision:
“This ‘closed doors’ approach to development is quite anathema to the Web3 ethos of transparency, and is clearly a thorn between both sides of this market.”
Reaction from the industry has been mixed at best. Toucan and others agreed the focus on quality control, security and fraud prevention is seen as admirable, and they look forward to working with Verra on developing a system specifically built for blockchain based credits.
However, this move will cause serious problems in the short-term as it essentially prevents any further tokenization of carbon offsets which dramatically limits supply for blockchain carbon offset markets in the short-term.
Many believe it also appears to continue the trend of favoring the centralized legacy system approach to verification of carbon markets which cannot scale adequately (and suffers from the same quality control issues as outlined above). In a Blistering Tweet thread Ellie Young from CommonAction states the limitations of this approach:
“The problem isn’t crypto: it’s the underlying system of production for carbon assets which is nearly nonexistent. Verra has done a good job of elevating good projects. But that’s not going to scale: not just because there aren’t enough good projects right now to reverse climate/biodegradation, but also because of the overhead costs of Verra’s approach. Blockchain, and automation more broadly, can open up the market: empowering a whole lot of people to make, buy, & yes, trade carbon and biodiversity assets. To solve climate, this is what we need. The world is too large for a few great corps to solve this, or for teams of scientists & administrators to vet every project, to detect fraud…”
Open Forest Protocol (OFP) is hyper-focused on solving the supply-side issues with carbon credits by creating the infrastructure for an on-chain carbon economy and creating real-world value and impacts. This project opens up access to this infrastructure enabling just about anyone on the planet to participate as a supplier. OFP is making it easy for people and projects to transparently measure, verify and fund forestation projects using decentralization and a crypto-powered incentives and reward system. As they state here:
Climate projects and solutions are stalled by a lack of support and carbon financing due to the current carbon market environment being bottlenecked by centralization, inaccessibility, and an inability to scale. OFP is tackling this by building a transparent Measurement, Reporting, and Verification (MRV) solution via a decentralized, highly scalable open platform that can affordably and quickly verify carbon data for climate projects anywhere in the world.
A Worldview Shift: From Compliance to Regeneration
As the preceding example from the carbon offset markets points to, this is a highly complex issue and the challenges faced for a blockchain enabled ESG system are many. What is needed will be nothing short of an updated worldview (or operating system) for our economy. This values shift towards a mindset of decentralization (and the web 3 technology that enables it) will be required to help us move the ESG sector from a compliance approach to one where the focus is on creating real world value through distributed environmental and social impacts. This could be achieved through the following approaches.
8 Principles of a Regenerative Economy — CAPITAL INSTITUTE
By harnessing Regenerative Design Principles to the ESG sector, we can ensure it is more squarely focused on addressing the environmental and social problems we need to solve.
Regenerative Economics has been defined by Multi-Award Winning Author & Regenerative Paradigm Educator Carol Sanford (with the Regenerative Economy Collaborative). For Sanford, the distinction of this economic framework is the focus on growing not only wealth, but also building the continuous evolution of wealth-generating capacity of all of its participants.
“The practice of regenerative economics is the art and science of building this wealth-generating capacity into living systems at all levels and scales.”
Applying these principles to ESG would ensure that we design for more empowered participation, greater innovation and adaptiveness, and harness ‘the edge effect’ between the economy and environmental and social systems.
Kevin Owocki and co-authors of the book GreenPill have outlined how blockchain can enhance this Regenerative Economics approach through what they term ‘Regenerative CryptoEconomics’:
“Regenerative CryptoEconomic systems are systems that:
- Satisfy human needs.
- Create positive externalities and are net-positive.
- Create balance and find equilibrium.”
The Regenerative CryptoEconomics approach does this by harnessing the global, incorruptible coordination substrate of blockchain to solve global coordination failures.
Taking this approach to redesigning the ESG Investing policy framework would ensure development of accessible and transparent metrics and markets, creating a more level playing field for any person to take action on addressing environmental and social issues in return for incentives and rewards.
It is also empowering a new breed of organizations and collective organizing that are supercharging the ability to pool efforts, raise funding, and work together towards shared impact goals in the ESG sector. It is clear that the traditional top-down and centralized approach to ESG is not working as it should be, so ensuring this decentralized approach scales throughout society could be the best shot we have at regenerating our planet and social systems.
Source: ImpactDAO Book Alejandra Borda, Kevin Owocki
Perhaps the most promising blockchain-enabled innovation already having an impact on building public goods in the environmental social and governance space is the Impact DAO model. Kevin Owocki defines Impact DAOs as follows:
“ImpactDAOs, defined as any DAO that creates net positive externalities for the ecosystem around it, are the scalable, atomic building blocks of the Regenerative CryptoEconomic movement.”
Owocki and co-authors believe DAOs can help to build a parallel opt-in system for funding digital and real-world public goods that can scale and attract funding and community energy to regenerate the environmental and social spheres.
Environmental Impact DAOs
Environmental Impact DAOs are decentralized organizations in which groups of people use Web 3 technology to come together to pool their time, energy and money on environmental regeneration projects and impacts.
KlimaDAO is a leading example of an Impact DAO in the environment space. Their mission is essentially to create positive price pressure on Carbon Credits by tokenizing credits and creating secondary markets. So far they have already managed to reach amazing scale in a short time with over 14 million in on-chain carbon offsets, sucking up supply of these credits from legacy verified offset markets.
Social Impact DAOs
There are many Impact DAOs operating in the social space, by restoring public goods that improve citizens social cohesion and quality of life. DAOs create new ways to organize community projects to harness human potential for a common goal. They provide a structure that communities can take advantage of to organize, raise funds, and deliver important social services or mutual aid in parallel to steadily decreasing government-funded social services.
DAOs are revolutionizing social impact by: creating new models of accountability, flipping traditional fundraising models, creating new incentives for social impact, and enabling greater community agency and collaboration.
ImpactMarket is a good example of this, it is a crypto-UBI platform that, to date, has disbursed $2.5M in UBI to over 43,000 beneficiaries with a unique community-driven approach that enables communities to take ownership of their own UBI programs. Impact Market has a token $PACT and holders of this token govern the DAO and can influence the future health, direction, growth, and impact of the protocol.
A key general lesson from blockchain and web 3 is that decentralized governance is possible, and if done well can lead to far more sustainable and innovative organizations and far greater opportunities for financial inclusion.
When most people think of good governance they think it means a diverse board. In fact it should go a lot further, and take into account substantive issues including how decentralized, inclusive and robust the governance system of a particular company is.
The Web 3.0 innovation of DAOs is a rapidly accelerating model that hints at the possibilities of decentralized governance to transform the future of how we can create value by working better together. The technology and design principles driving DAOs are in fact equally applicable to governance in the corporate world. It is already a fact that more organizations are beginning to explore the greater efficiencies of decentralizing power with surprising benefits.
The question now is, how can we ensure the more positive public goods supporting aspects of crypto transforms the global ESG sector?
Focus Collective Energy and Funding on Decentralized Approaches
NGO and governmental funds should be rapidly divested from the legacy centralized ESG systems into supporting more efficient, transparent and innovative blockchain-based ESG approaches.
Moving from Compliance to a Value Creation Focus
Strong regulation and compliance is essential to the future of ESG, however the carrot is often far more effective than the stick in regulation seeking to achieve real-world impacts. By building the necessary infrastructure to create strong incentives to comply, we can support companies to create and scale their real-world ESG regeneration impacts. Supporting projects like Open Forest Protocol that actually create more supply of carbon credits through supporting and funding real-world nature-based regeneration.
A Decentralized Global Verification System
A permissionless and distributed global verification system on blockchain would be the most efficient and effective way to scale this, rather than the current centralized approach.
Better Transparency on Ratings Systems and Metrics Used
Utilizing an immutable public blockchain ledger would make the metrics that go into determining ESG scores far more transparent. This would remove the confusion and some of the external criticism from those opposed to ESG because of its opaque nature.
Better ESG Tracking and Open-Data
Ensuring that an entire supply-chain’s ESG related data is stored on an immutable public blockchain ledger would make it far easier for verification to take place and efficiencies to be introduced across the entire supply-chain. This would also ensure innovative decentralized apps can be built utilizing the ‘edge effect’ to scale ESG impacts in ways we cannot even begin to predict.
Harnessing CryptoEconomic Incentive Systems
This could help essentially crowd-source an innovative global policy and measurement/ verification system more designed to ensure incentives align with activities likely to drive real-world regeneration results. (For example, utilizing predictive markets to determine more accurate projections for social impact outcomes.)
Separating out E — S — and G elements into different ranking standards with transparent metrics
This would remove some of the Aggregate Confusion. For example, Tesla could still have a great environmental score, but not such great social and governance scores. Consumers and investors have the right to know this level of specificity rather than simply a vague overall aggregate score.
Connecting On-chain and Off-chain Carbon Offset Registries
It must be a priority to enable quick, seamless verified, two-way bridging between legacy carbon markets and the more scalable and innovative blockchain-enabled markets. This will help avoid the quality control and double-spend problem and also allow the markets to scale to the level they need to in order to achieve any impact on the problem.
Industry-Wide Collaboration, Consultation
More substantive and representative consultation at the ESG industry level would enable a more decentralized approach to emerge that can solve the problems holding the sector back from scaling. One approach seeking greater industry-wide collaboration is The Carbon Call. This is an expert advisory group that brings together more than 20 experts from leading organizations in the public, private, and philanthropic sectors to develop a roadmap to strengthen the reliability and interoperability of the planet’s carbon accounting system. The first phase is set to be completed by COP27 in November 2022.
Lobbying For a Web 3.0 and Decentralization Approaches to ESG
One practical step proposed would also be to ensure all political donations and lobbying are transparent and stored on an immutable public ledger. This would enable non-ESG friendly lobbying to be taken into account in aggregating overall ESG scores and would ensure companies are not Greenwashing while simultaneously lobbying against environmental and social measures.
Lobbying Governments at local National and International level — Lobby3 by former US Presidential candidate, Andrew Yang is an innovative Lobbying group using a DAO model to create a decentralized and transparent approach to political lobbying. The ESG investing and NGO sector must actively work with groups like this to ensure that the policy framework and funding is available to scale decentralized solutions to the problems we face, and accelerate the transition away from centralized legacy ESG systems as a society.
We would love to hear your feedback on any potential next steps or solutions we have missed here for the next version of this report.
How Standard DAO Aims to Impact ESG
Standard DAO is a new Impact DAO intending to operate in all three verticals by harnessing a Regenerative CryptoEconomics approach to create impacts across Environmental, Social, and Governance public goods. We will do this by building the enabling infrastructure for communities to come together, form an Impact DAO of their own, access funding and guidance to deliver on shared impact goals in their communities.
Standard DAO’s funding mandates include Environmental Regeneration, Social and Community impact, and providing tools and capacity building around collective governance processes. The output of these mandates and impacts will result in the creation of tangible assets of real value to be held in common by the global community of Standard holders and to serve as asset backing for the token. This will involve providing tokenization services to help communities to bring these impacts on-chain working closely with expert advisers and partners in the blockchain ESG space.