How’s your green finance IQ? Are you in favor of crypto, down with the greenbacks? What is the difference between sustainable finance, ESG investing and impact investing? And how is your knowledge of Web3, blockchain and AI?
Pass the previous tests? So what about DeFi, NFTs, DAOs, Khaki Bonds, Dual Materiality, Green Short, Impact Insurance, Stablecoins and Smart Contracts?
You can look up the definitions of these and other terms that make up the language of green finance, and you’d better do it quickly, if you haven’t already. As I heard more than once at GreenBiz’s recent GreenFin 22 conference, this lexicon refers to practices, products and strategies that are in play today: “FutureFi” is happening right now, not at some distant date.
The main driver is cryptocurrency, digital currency that uses cryptography such as blockchain to manage transactions. “Crypto is money made for the internet,” was the mantra of the speakers at “The Future of Finance” panel I attended. “It’s the new baseline for value transformation,” said moderator David Bennell, chief sustainability officer at Hyphen Global AG. This is the next generation of value for managing assets, whether stored or transferred: a digital token economy.
The premise is that digitization makes investing more efficient, more available to more people, more transparent through blockchain accounting. Just as the rewiring of the Internet, a transformation called Web3, aims to decentralize Big Tech’s monopoly controls, so too is digital finance. This translates into decentralized finance, or DeFi, an umbrella term for financial products and practices developed for use with blockchain, including many for investment in green finance. They include items such as tokenized carbon credits, non-fungible tokens (NFTs) and stablecoins.
DeFi also produces decentralized autonomous organizations (DAOs), which guide allocations through smart contracts executed by artificial intelligence algorithms. An example given by Jamie Chapman, director of ESG at Superlunar, was that of Big Green, a non-profit organization that was originally a school garden project but, under the restrictions of COVID, became a DAO which democratizes its grantmaking, thereby disrupting traditional philanthropy. Big Green claims to be the first non-profit philanthropic DAO.
The main argument underlying the logic of DeFi is resilience through a widely distributed system. In other words, it taps into the wisdom of crowds rather than the guidance of a small, concentrated group of traditional financial professionals (like those who brought us the global financial crisis in 2008-09). The qualities of enhanced transparency and data-driven digitization should especially expand the ability of green investors to manage risk and volatility while maximizing potential profits.
This paradigm-shifting investment disruption is underway.
It sounds great, but there are problems that cast a bit of a shadow on the bright picture of this futuristic financial landscape. For example, digitization depends on data, and judging by current concerns about the inconsistency, incompleteness and non-comparability of ESG data, this is a significant challenge.
The biggest problem may be the cryptography itself. Created as a way to manage money outside of traditional banking systems, it has its own transparency and accuracy issues. Recent crypto headlines are full of bankruptcies, fines, hackers, fraud, insider trading, and shady practices in the crypto world. The crypto crash has resulted in a $2 trillion drop in valuation across the industry since January. Crypto companies have been lending to other crypto platforms, taking advantage of bullish purchases with insufficient collateral. Some apparently paid early investors with income from new inflows, a model that resembles a classic Ponzi scheme. This is an industry ripe for regulation, and it appears to be imminent, with the US Securities and Exchange Commission bringing criminal charges against fraudulent crypto practices.
DeFi, decentralized finance, bears a large part of the blame for the current crisis. Forced selling by retail crypto depositors who invested for yield are to blame, Martin Green, CEO of quant trading firm Cambrian Asset Management, told CNBC. “From 2020 onwards there was a huge build-up of performance-based DeFi and crypto ‘shadow banks’. There was a lot of unsecured or unsecured lending as credit and counterparty risks were not they assessed with vigilance. When market prices fell in the second quarter of this year, funds, lenders and others became forced sellers due to margin calls.”
There are also external issues: inflation, weak market conditions and a possible looming recession are macroeconomic brakes on innovative products and practices.
Then there are the rising energy prices and the fact that crypto mining is an energy hog of enormous proportions. The tens of thousands of specialized computer machines that create cryptocurrency and manage operations run 24 hours a day. Bitcoin, the world’s largest, uses about 150 terawatts of electricity annually, more than Argentina, a country of 45 million. And this energy production is also high in emissions, producing 65 megatons of carbon dioxide, comparable to Greece’s emissions. In Texas alone, cryptominers can increase power demand by the middle of next year by 6 gigawatts, the equivalent of adding another Houston to the grid.
It’s important to remember that this brave new world is a work in progress, and it’s in its early days. Many of the above issues, transparency, volatility, data accuracy and regulation (or lack thereof) also affect traditional finance as a matter of doing any investment business. And efforts are underway to resolve the above issues. For example, the Values Reporting Foundation’s ongoing consolidation and harmonization of ESG data aims to answer questions about the data needed to make digitized investing work.
DevvESG, a company represented on the panel, was defined as “a verifiable source of truth for ESG data and benchmarks” by Belem Tamayo, Director of International Partnerships at parent company Devvio. Its approach, called the AIR methodology, offers “best-in-class” ESG in benchmark analysis, guidance, tools and data through an open platform, according to the company’s marketing materials.
Credible data, open platforms, democratization: these are qualities that lend themselves particularly well to the values of green finance in its various products and objectives. If crypto is to serve as the foundational currency of FutureFi, its issues must be addressed so that these aspects can effectively drive innovation, allowing the many varieties of crypto-based green investment products and services to thrive the most.
Here’s the thing: This paradigm-shifting investment disruption is underway. The enthusiasm, intelligence and drive to drive it forward from a young generation of financial professionals I saw at GreenFin 22 gave a great clue as to what will drive its ultimate success. I have no doubt that the speed drops in their development phase will flatten out. Prepare for a learning curve as you get up to speed with FutureFi, now underway.