Is DeFi the Missing Key to Unlocking Impact and ESG Investing Potential?
An Equity Investor Perspective
Does the market believe DeFi protocols can boost impact and ESG investing? This is the question we set out to answer, speaking to several equity investors about DeFi’s potential to bring substantial liquidity to sustainable social and environmental development if used as a tool for conscious investing.
The rise of impact investing is proof of a global shift in priorities
Impact investing, part of the broader Environmental, Social, and Governance (ESG) investing landscape, is an institutional response to the continued proliferation of investors who use to “do more” with their money. Impact investing prioritizes profit but doesn’t view it as an antithesis to positive social change. The Global Impact Investing Network (GIIN), a non-profit membership organization, has tracked the growth of this sector over the past 12 years and in its latest 2020 Annual Impact Investor Survey, estimates the industry size at a steadily climbing $715B. The report states:
“Impact investors’ motivations stand at the root of the industry’s development. Unsurprisingly, the top three reasons for making impact investments all concern impact. Nearly all respondents (87%) consider both ‘impact being central to their mission’ and ‘their commitment as responsible investors’ as ‘very important’ motivations. Furthermore, 81% believe that impact investing is an efficient way to achieve impact goals.”
What if we were the saviors we’re waiting for?
Impact investing, despite its potential, is still considered a niche asset class.
Despite impact investing’s stellar rise, there is currently a $7 trillion annual SDG financing gap. On paper, these are clinical figures, easy to brush aside as ‘just another big number’. But consider what failing at the SDGs implies: A world in which access to food, electricity, clean water and sanitation, gainful employment, and gender equality, to name but a few of the pressing issues society has yet to solve. By 2040, this gap could run a yearly deficit as high as $15 trillion. Add in the tremendous pressure on national monetary systems brought about by the Covid-19 pandemic that threatens to decimate already struggling economies and it’s a recipe for even bigger problems than those we already can’t handle.
To many in the global society, in the throes of late capitalism, it’s clear that social change happens not through aid but via industry. Commercialize a problem and it’s not long before an entire industry pops up around the solution. That’s why the Sustainable Development Goals (SDGs) are increasingly on the agenda at boardroom tables, especially as we race against mitigating the effects of climate change hurtling towards us. When it comes to the environment, the hands that bite (industrial pollution) seem destined to, ironically, be the hands that save, as large corporations rally together to “Go green”. However, the green in “eco” stimulates the green in “washing”, and in a stranglehold cycle, sustainability can also act as a thin layer of veneer atop marketing strategies meant to capture (or recapture) a new consumer generation demanding value-driven brands that prioritize the environment and an overarching sense of social responsibility.
The rapid expansion of DeFi creates a new wave of investors that interact with the financial services sector devoid of intermediaries. By decentralizing finance, private money — especially at the retail level — is rising in prominence to a scale hitherto unseen. Establishing a direct line between two parties thanks to trustless smart contracts frees up costs typically collected by banks and other financial services providers. This, as it turns out, may open up a whole new funding model for impact creation.
According to Jason Fernandes, crypto analyst and Chief Business Officer at NFT Technologies:
“Tokenized ESG investments in the form of Defi could free up access to capital for impact and ESG investing. We saw this happen recently when crypto investors worldwide donated vast amounts of cryptocurrency in order to fund Covid relief efforts in India and it’s only a matter of time before this model is replicated across other verticals in the ESG space.”
Could the answer to some of the world’s most pressing funding issues lie not in governmental and institutionalized salvation but instead the market-disrupting decentralized technologies that bring about empowered peer-to-peer (P2P) assistance?
DeFi and the quest for meaning
DeFi is known for its liquidity. Even during the Q2 bear market in 2021, DeFi’s Total Value Locked (TVL) still rose by 13%. At the time of writing, the TVL is shy of $107 billion.
However, Kyle White, angel investor and COO of DeFi liquidity ecosystem Atom Foundation, believes that liquidity alone doesn’t qualify an idea, saying:
“When concepts are placed on the blockchain they don’t inherently have liquidity. It takes an engaged community wanting to create a better future or from solid game theory tokenomics.”
While great strides are being made by a variety of projects to explore, expand, and solidify the potential DeFi can bring to the market, little attention is placed on using the potential of DeFi as a vehicle for social good. From a Maslovian perspective, DeFi’s development has yet to reach the little-known pinnacle psychologist Abraham Maslow conceived for his famous pyramid. In the year before his death, Maslow would add a new dimension to his Hierarchy of Needs, realizing that the penultimate of human development was not self-actualization, but self-transcendence. Typically, as a market matures, a Self-first approach is gradually expanded to include a Self-and-Other philosophy.
Miko Matsumura, General Partner at Gumi Cryptos and co-founder of crypto exchange Evercoin, believes that it’s a matter of time:
“The promise of DeFi for ESG is there, but thus far the leading-edge applications have been in financial services. Adoption is fast but it’s still early.”
The question is whether we can afford to wait out the natural evolution of the industry, at a time when social inequalities and the effects of climate change are ravishing communities around the world. Blockchain and crypto have always positioned itself as a radically inclusive solution that sidesteps the strict social and financial hierarchies put in place by a systemic organization of power that’s hundreds of years old.
What’s needed in the DeFi space is the commercialization of SDG solutions by leveraging private money to enable DeFi investors to contribute to problem-solving at scale through liquidity (via protocols) and technical (via blockchain) that other solutions simply can’t match.
“This gap can to a large extent be covered by the newer DeFi protocols that are creating solutions which are more P2P-driven in the loan and financial space, an indirect value that is created because of wealth creation due to the boom in the DeFi space. Companies in the crypto space are becoming slowly more aware of their responsibility towards society at large. The underlying idea is to create solutions which would cater to the unbanked, as well — considering one of the goals is to empower women in terms of their finances and reducing poverty — DeFi works directly here by creating opportunities for people to not just be a part of this unconventional financial system but also actively look at financial freedom as an attainable goal.”
The great equalizer
Amit Kaushik, Portfolio Manager at quant trading firm SciFeCap and the author of The Crypto Investor maintains that decentralized technology can introduce greater equality to the financial world, stating:
“DeFi can remove biases inherent in lending decisions that are often hard to estimate. The transparency, data integrity, speed, and low cost of DeFi platforms can provide a sustainable platform for micro-finance in the developing world and bring maximum accountability that is impossible with systems where human beings are involved in deciding who gets the credit.”
However, with profit-generation — of which there’s much to be had thanks to DeFi’s meteoric APY returns — still front and center, what steps need to be taken to convert DeFi investors to the sentiment that their investments have the power to fill a gap in impact and ESG that the traditional markets have a hard time compensating for?
This, says Cedric Lehman, co-founder of DeFi impact investing ecosystem Social Impact Network, is precisely what drove the team to create their platform:
“Traditional impact investors generally need to make a hard decision between maximizing profits and making their money work for the greater good. As DeFi investors ourselves, requiring investors to sacrifice APYs isn’t a viable option. Instead, we conceptualized Social Impact Network to meet not only the needs of people in underdeveloped countries who lack access to financial services and impact investors who would benefit from eliminating intermediaries, but we’re inviting DeFi investors to contribute to make an impact and grow the economies of the world’s least developed countries through the same yield farming practices they already do.”
In the Disney movie The Sword in the Stone, the wizard Merlin tells a young King Arthur, “It’s up to you how far you’ll go. If you don’t try, you’ll never know.” In the film, it’s prophesied that England shall remain in the Dark Ages until the rightful heir to the throne pulls a magical sword from its anvil. Arthur, an orphan, rises to meet the challenge. Can DeFi bring about the type of social change that governments and the industrial complex have failed to implement?
The emergence of solutions that offer a win-win solution is sowing the first seeds that DeFi, applied to verticals beyond the standard financial services, just might be the missing piece of the puzzle.