On the surface, decentralized finance (DeFi) and environmental, social and governance (ESG) standards may seem like two completely separate themes with little commonality. DeFi promises to disrupt finance by offering services on the blockchain, thereby eliminating the need for an intermediary like a bank. ESG investing, meanwhile, is on fire, especially among millennials and Gen Z investors. This classification has drawn an invisible dividing line between acceptable and unacceptable investments. Looking at the larger picture, one can see potential for these two emerging concepts — ESG and DeFi — to be combined to accomplish greater results than they could independently.

DeFi, for its part, remains in uncharted territory in many ways as the rules for this nascent market continue to be written. Essentially, it is an emerging financial technology based on secure distributed ledgers similar to those used by cryptocurrencies. Some of the common use cases so far have been lending, borrowing and staking/earning, to name a few. It has become increasingly apparent, however, that DeFi is a natural fit for ESG and charitable endeavors, where it stands to pave the way for even greater efficiencies that these initiatives are meant to deliver.

Matter of Trust

With $256 billion in total value locked (TVL) at last check, DeFi has already commanded the attention of retail and institutional investors alike. Meanwhile, ESG assets under management globally are on the rise and are poised to surpass $53 trillion by 2025, according to Bloomberg data, which could represent more than one-third of the estimated combined AUM across sectors.

Here’s the rub: Not all ESG data is what it seems, as reporting entities have been known to take various liberties when disclosing their commitments to these issues. As a result, skewed data threatens to derail investors’ strategies and leave them disenchanted with this popular category.

Enter DeFi, which by its very nature is designed to provide transparency on the blockchain, an immutable public ledger, so that all parties are on the same page about what the data is and what it is not.

The potential for DeFi in ESG reporting is real, especially considering just how pervasive false reporting has become. In fact, according to Finastra experts, the misreporting of data represents a “huge problem area within the ESG data space.” It is not uncommon for fund firms to embellish their commitment to investing in green companies as well as avoiding any trace of fossil fuels. In addition, companies might attempt to make themselves appear greener than they are by throwing around the term sustainable without any real accountability.

In fact, this misleading behavior is so common that there is a name for it: greenwashing. As ESG continues to gain traction, especially among the younger generations, the pressure for companies to skew their data in favor of ESG becomes greater. Worse, there are not any clear-cut regulatory guardrails for industry participants to follow.

As it stands, companies disclose their own ESG data through governance and impact reports. In addition, third-party firms have emerged that seek to create an industry database comprising this information. But the industry is lacking any formal regulation not only requiring companies to disclose this information but also to determine what qualifies as ESG criteria.

The United States has taken a more back-seat approach to ESG reporting, while the European Union is not leaving as much to chance. Meanwhile, groups like the International Organization of Securities Commissions (IOSCO), which represents regulators from the Americas, Europe and Asia, are pushing for greater regulatory oversight of ESG-related issues. The Bank of England (BOE) recently revealed that it would adopt a green strategy for its bond-buying program, potentially setting a model for other countries to emulate.  Here we see the promise of DeFi to centralize documents and formatting, and the power of the blockchain to provide an irrefutable ledger.

Charitable Giving: Slashing Costs

A key feature of distributed ledger technology, like blockchains, is its trustless nature. These networks reach what is known as consensus through computer algorithms that do the work for humans. In addition, the use of smart contracts, which are software-fueled agreements that are automatically executed on the blockchain, there is no need for organizations to engage any third-party entity to manage things. Plus, as alluded to above, the blockchain is immutable in nature, meaning that data on the network becomes part of the code and cannot be altered. This is also one of the key characteristics of DeFi that makes it so attractive for ESG-related and charitable giving.

When it comes to charitable giving, transparency and traceability are paramount. Nobody wants to direct their savings to a cause only to learn that the funds were misappropriated. Unfortunately, scams pop up — including on crowdfunding websites that attempt to profit from other people’s tragedies.

The blockchain fixes this. Instead of donations going into a bottomless pit, payments can be traced, making it less labor-intensive for charitable organizations to report their expenses and funds. We can point to the use of smart contracts as key to reducing the amount of paperwork required for reporting and disclosures. Considering that smart contract transactions like payments are executed automatically when certain parameters have been met, administrative costs and headcounts alike are likely to be lower.

Cryptocurrency-fueled payments can lead to lower costs altogether. Bitcoin, for example,  is an electronic cash system on which payments are completed in a peer-to-peer way, without the need for a third-party intermediary like a bank or remittance service provider. For example, an $868 million Bitcoin transaction was sent for a fee of a little over a dollar, something that the traditional financial system cannot claim. So crypto-fueled charitable giving could be extremely effective, particularly for international charities and organizations that accept foreign donations across currencies.

Cross-border blockchain startup Ripple, whose platforms are powered by the XRP cryptocurrency, is another example. Ripple’s XRP transaction fees have been known to average fractions of a penny. Even JPMorgan recognizes that Ripple’s network delivers “expedited payments and reduced transaction fees.” Legacy money transfers can drag on for five business days, while transactions using Ripple-controlled XRP can be completed in a matter of seconds. Not only that but traditional remittance payments can be pricey while XRP’s transaction fees hover at 0.0001 XRP.

Greater transparency

As we see, transparency is a key feature of DeFi and the blockchain. The immutable nature of the blockchain network makes it so data cannot be altered after a transaction has been completed, providing a level of security to market participants. DeFi technology is built on the blockchain, and all its transactions’ data and codes are viewable to the public, which provides a level of trust among participants.

Because it’s built on the blockchain, DeFi therefore similarly boasts “immutable, irreversible and tamper-proof” transactions via “verifiable cryptography,” as crypto exchange Gemini explains. As a result, bad actors have less leverage to strike. Additionally, DeFi offers a level of privacy to users that is not available in traditional financial circles. Considering that there is no bank involved in a transaction, there is no need for market participants to provide a credit profile or share other personal details.

With the integration of DeFi into charities, donors get the opportunity to see and track exactly how their funds are being directed. When it comes to ESG, blockchains can help investors to identify responsible companies that have demonstrated a true commitment to sustainability. As the industry matures, investors should have an easier time finding blockchain-fueled products that are dedicated to helping them spot ESG-friendly companies.

Sonic Capital CEO Stefan Rust is quoted by Forkast saying that “an ecological blockchain industry is evolving” and will grow as major companies continue to adopt blockchain strategies in an attempt to promote a more transparent playing field.

Farm to Table

Another way to look at blockchain technology and DeFi for that matter is how it can be applied to specific industries, like agriculture. And with all the problems around the supply chain these days, the blockchain is more important than ever.

The phrase “farm to table” has become popular in supply chain circles and there is no better technology to deliver transparency to the end-user than the blockchain. By integrating decentralized apps (dApps) into farming activities, consumers will get a fuller picture of where their food is coming from and how it got to their table — from the grower to the supplier to the manufacturer to the grocery store shelf to the table.

In addition, the blockchain lends itself to transparency on components such as the amount of water that might be used to grow crops like cotton, all of which supports the ESG cause. While the use cases are still being written, the blockchain clearly could have a role in agriculture, farming and the supply chain so that end users get a better understanding of whether a product or company is as green as it claims to be. Smart contracts can also be used to enforce justification document side by side with ESG metrics strengthening transparency.

Early Innings

DeFi has made a name for itself and is expected to be here to stay. Nonetheless, market leaders agree there is still a long way before this niche reaches its true potential. Meanwhile, 2021 in many ways was the year of ESG, and the momentum is expected to only grow stronger in 2022. As builders continue to find innovative ways to tie these themes together, along with charitable giving, the rules of finance will forever be rewritten in favor of both the investor and the planet.

Shuki Licht is the senior vice president and chief innovation officer at Finastra. He has more than 20 years’ experience delivering innovation-led products and has led global innovation agendas, process, technology and teams from ideation to production, and has implemented artificial intelligence, machine learning, deep learning, computer vision, smart edge devices (IoT), blockchain, platforms, marketplaces and open application programmable interfaces to drive product differentiation, revenue growth, and address emerging markets.