How’s your green finance IQ? Are you up with crypto, down with green bonds? What’s the difference between sustainable finance, ESG investing and impact investing? And how is your Web3, blockchain and AI savvy?
Pass the above tests? Then what about DeFi, NFTs, DAOs, khaki bonds, double materiality, green shorting, impact insurance, stablecoins and smart contracts?
You can look up the definitions of these and other terms making up the lingo of green finance — and you had better do so 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 far-off date.
The main driver is cryptocurrency, digital currency that uses cryptography such as blockchain to manage transactions. “Crypto is money built for the internet,” was the speakers’ mantra at “The Future of Finance” panel I attended. “It’s the new baseline for the transformation of value,” asserted moderator David Bennell, chief sustainability officer of Hyphen Global AG. This is the next generation of value to manage assets, whether stored or transferred: a digital token economy.
The premise is that digitalization makes investment more efficient — more available to more people, with more transparency via blockchain accounting. Just as the rewiring of the internet, a transformation called Web3, is aimed at decentralizing monopoly controls by Big Tech, so it goes with digital finance. This results in decentralized finance, or DeFi, an umbrella term for financial products and practices developed for use with the blockchain, including many for green finance investing. 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. One example given by Jamie Chapman, principal of ESG for Superlunar, was that of Big Green, a nonprofit that was originally a school garden project but, under COVID restrictions, converted into a DAO that democratizes their grant giving, thereby disrupting traditional philanthropy. Big Green claims to be the first nonprofit-led, philanthropic DAO.
The main argument underlying the logic of DeFi is for resiliency through a widely distributed system. Put another way, it takes advantage of the wisdom of crowds rather than guidance from a small, concentrated group of traditional financial professionals (such as those who brought us the global financial crisis in 2008-09). The qualities of enhanced transparency and data-driven digitalization should especially amp up the ability of green investors to manage risk and volatility while maximizing potential benefits.
This paradigm-shifting investment disruption is well under way.
Sounds great — but there are issues that throw some shade on the bright picture of this futuristic finance landscape. For example, digitalization depends on data — and to judge by the current concerns about the inconsistency, incompleteness and non-comparability of ESG data, this is a major challenge.
The biggest issue may be crypto itself. Created as a way to handle money outside of traditional banking systems, it has its own transparency and accuracy problems. Recent headlines about crypto are rife with bankruptcies, fines, hacks, fraud, insider trading and opaque practices within crypto world. The crypto crash has resulted in a drop of $2 trillion in valuation across the sector since January. Crypto companies have loaned to other crypto platforms, leveraging bullish buys with insufficient collateral. Some apparently paid early investors with incoming revenue from new inflows, a model resembling a classic Ponzi scheme. This is an industry ripe for regulation, and it appears that is imminent, with the U.S. Securities and Exchange Commission levying criminal charges against fraudulent crypto practices.
DeFi — decentralized finance — gets a large portion of the blame for the current meltdown. Forced selling by retail depositors of crypto who invested for yield are the culprits, Martin Green, CEO of quant trading firm Cambrian Asset Management, told CNBC. “2020 onwards saw a huge build out of yield-based DeFi and crypto ‘shadow banks.’ There was a lot of unsecured or undercollateralized lending as credit risks and counterparty risks were not assessed with vigilance. When market prices declined in Q2 of this year, funds, lenders and others became forced sellers because of margins calls.”
There are also external issues: Inflation, bearish market conditions and a looming possible recession are macro-economic dampers on innovative products and practices.
Then there’s soaring energy prices, and the fact that crypto mining is an energy hog of huge proportions. The tens of thousands of specialized computing machines that create cryptocurrency and manage trades run 24/7. Bitcoin, the world’s largest, uses an estimated 150 terrawatts of electricity annually — more than Argentina, a country of 45 million. And that energy production is also emissions-heavy, putting out 65 megatons of carbon dioxide, comparable to the emissions of Greece. In Texas alone, crypto miners may increase energy demand by mid-next year by 6 gigawatts, the equivalent of adding another Houston to the grid.
It’s important to remember this brave new world is a work in progress, and it is early days. Many of the above issues — transparency, volatility, data accuracy and regulation (or the lack thereof) — also bedevil traditional finance as a matter of doing any investment business. And efforts are well underway for solutions to the above problems. For example, the ongoing consolidation and harmonization of ESG data by the Values Reporting Foundation aims to answer questions about the data that is needed for digitized investing to work properly.
DevvESG, a company represented on the panel, was defined as “a verifiable source of truth for ESG data and tokens” by Belem Tamayo, director of international partnerships for parent company, Devvio. Its approach, called the AIR methodology, offers ESG “better” in baseline 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 to green finance values across its various products and goals. If crypto is to serve as the foundational currency of FutureFi, then its issues must be addressed so that these aspects can effectively drive innovation, allowing the many varieties of green investment products and services based on crypto to flourish to their full potential.
Here’s the thing: This paradigm-shifting investment disruption is well under way. The enthusiasm, smarts and drive to push it forward by a young generation of financial professionals that I saw at GreenFin 22 gave a big clue as to what will drive its eventual success. I don’t doubt the speed bumps in its developmental phase will be flattened out. Prep yourself for a learning curve while catching up with FutureFi, now in progress.