Blockchain and impact tokens could break new ground for impact investing

Despite its mixed reputation due to its association with cryptocurrencies, blockchain holds significant potential benefits for impact investing.

No longer new to the finance industry, blockchain technologies have demonstrated their potential to help Africa attract more impact capital to the continent. The World Food Programme, for example, put blockchain to good effect through its Building Blocks platform, raising millions of dollars for the support of refugees, making it the world’s largest application of blockchain technology for humanitarian assistance.

Blockchain technologies can address problems in the impact investment industry, specifically by converting non-financial values like impact into digital tokens. These can then be tracked and/or potentially sold. Linking specific tokens to impact on the blockchain, ensures transparency and avoids attribution concerns, as the owner of the token can lay claim to that impact. Impact tokens help alleviate concerns around “impact washing”, a deceptive practice where organisations or individuals exaggerate or misrepresent their social or environmental impact to improve their public image.

Impact investing aims to deliver both financial returns (often market-related) alongside a social or environmental impact. The measuring of that impact and the trust that a potential investor puts in a metric can determine whether or not they choose to invest.

This is where Blockchain technology shows significant potential. As the deadlines for Africa’s Sustainable Development Goals 2030 loom ever larger, the shortfalls are beginning to pile up. By the latest estimates, African countries face a funding gap of around US$200 billion per year if the continent is, as a whole, going to get close to those SDGs. The ever-increasing debt burden for African governments means mobilising private sector capital is important to make up the SDG funding gap. Advocating for impact investment is one means to attract private sources of wealth towards the SDGs. And while the impact investment market is now estimated by the Global Impact Investing Network (GIIN) to be worth US$1.571 trillion, it’s not yet at scale.

A number of issues have been identified as potential hurdles. These include the lack and high cost of trustworthy data on the outcomes of impact investments, challenges with attributing impact to a specific investor, and roadblocks in monetising impacts.

Blockchain is increasingly emerging as a potential solution for these concerns. For the foreseeable future, it will likely be associated, for better or for worse, with cryptocurrency, which is a decentralised digital currency enabled by blockchain technology. Bitcoin, for example, is a digital currency that uses blockchain technology, and has recently reached a new all-time high, exceeding $99 000 per bitcoin.

Cryptocurrencies found value in blockchain’s greatest strength, a result of those chains of data – it serves as an immutable ledger. This means that while anyone can view it, no one can randomly modify it, as one might with a shared spreadsheet or PDF document that soon multiplies into countless versions as each individual participant edits it. In blockchain, each amendment is also recorded and tracked, with no bringing together and reconciling of an untold number of spreadsheets, for instance.

Blockchain has other characteristics, including decentralisation, meaning that all the participants in the network have to agree on and verify the data. Its programmability also allows for the creation of so-called smart contracts, a self-executing programme that automates certain actions – such as releasing funds or sending notifications – in a blockchain transaction when predetermined and conditions are met.

On the whole, blockchain’s immutable ledgers offer a number of advantages, notably more transparency, strengthened security, and the ability to track actions and transactions.

Within the context of impact investments, it holds clear-cut and specific benefits. Impact tokens are a digital representation of an asset and impact, and can serve as a common currency for impact investments.

Fishcoin, for instance, uses digital vouchers or tokens to reward those who make the extra effort to capture and communicate data and allows more transparency and traceability in the seafood industry. This means hotels, restaurants and retailers have more knowledge about the value chain when sourcing seafood, a sector under threat of vast exploitation.

Based on a review of 200 cases on how tokens have been used, the International Institute for Sustainable Development (IISD) identified four distinct advantages that such impact tokens can have for impact investment. Firstly, they create opportunities for collaboration by boosting trust between parties, a persistent problem in impact investment involving developing nations with poor institutional capacity. Secondly, they promote financial and social inclusion by appealing to a broader range of investors. Thirdly, they can improve data collection and accelerate monitoring, reporting and verification processes, thereby adding new layers of sophistication to measuring impact. And finally, they can also incentivise positive behaviours for sustainability.

But even at its most zealous, organisations like the IISD preach caution, citing limitations that were identified in the above case studies.

For one, it relies on data inputs from real-world operations, so the “garbage in, garbage out” rule of thumb applies. As cryptocurrencies illustrate, it is also not immune to manipulation and frau and requires proper governance. In addition, blockchain is not well understood, creating the potential for imbalanced power dynamics and the risk that some participants will have more control and influence over a blockchain network than others. And there will be a period of trial and error as its application expands.

But the argument for the use of blockchain in impact investing cannot be denied. By building greater trust in the metrics used for impact, it can entice new capital. For Africa, where demand for more investment is growing daily, blockchain is a technology that we should be willing to explore. The rewards could extend well beyond 2030.

Jason van Staden is a project manager at the Bertha Centre for Social Innovation and Entrepreneurship at the University of Cape Town Graduate School of Business (UCT GSB), responsible for research and training under the Centre’s Innovative Finance portfolio.