Expanding Sustainability Through Blockchain-Based Project Bonds

This paper explores options for mobilizing domestic savings through fintech solutions to scale up sustainable investments, and discusses how fintech can help complement traditional capital markets and mobilize financial resources for sustainable infrastructure investments.

This paper explores the options for mobilizing domestic savings through fintech solutions to expand sustainable investment. Most developing and emerging economies face an urgent need to expand sustainable financing for low-carbon and climate-resilient infrastructure investments, but underdeveloped capital markets often inhibit domestic resource mobilization for infrastructure investments. At the same time, domestic savers in many developing and emerging economies face a scarcity of “safe” assets in local currencies, leading to an export of capital to the financial centers of developed economies. This paper discusses how fintech can help complement traditional capital markets and mobilize financial resources for sustainable infrastructure investment. The Institute of Financial Technology of Renmin University of China compiled the core part of the study.

I. Introduction
Countries around the world are facing an urgent need to scale up investment in sustainable infrastructure, including renewable energy infrastructure to facilitate a low-carbon transition and align their economies with the Paris Agreement and the 2030 Agenda. The International Monetary Fund (IMF) recently estimated that additional annual public investment needs in infrastructure, low-carbon technologies, and other areas to achieve the Sustainable Development Goals (SDGs) will exceed $20 trillion (IMF 2020). Particularly in developing countries and emerging economies, financing is a key challenge.

While the international discussion on financing for development – under the slogan “from billions to trillions” – has highlighted the need to unlock domestic resources, much of the discussion has focused on private capital from advanced countries to finance investment in developing countries and emerging economies. While foreign aid and foreign private capital can play an important role in financing development, the role of foreign investment in financing infrastructure is limited, as well as the risks of financial vulnerability associated with foreign loans. It is also important to make better use of the domestic savings of developing countries and emerging economies. Developing countries and emerging economies must also make better use of domestic savings.

Therefore, enhanced domestic resource mobilization is critical and a concerted effort to this end is necessary. Beyond the mobilization of funds, a central issue in infrastructure investment is corruption. the IMF (2020) estimates that “one-third of the world’s public infrastructure financing is lost to inefficiencies.” Therefore it is important to find ways to reduce this slack, if not eliminate it.

In this context, this paper will discuss how fintech – or financial technology – and blockchain-based solutions can facilitate domestic resource mobilization for sustainable investments and simultaneously enhance sustainable investments by facilitating processes and blockchain in the entire lifecycle to improve the implementation of infrastructure projects and enhance transparency. In particular, this paper explores how fintech can help complement traditional capital markets and mobilize financial resources for sustainable infrastructure investments. This approach will not only provide investors of all sizes the opportunity to purchase local currency assets and raise capital for sustainable infrastructure investments for issuers such as municipalities. Once a project is operational, it will also facilitate project management, for example through metering and billing, and create full transparency throughout the life cycle of the investment, reducing issues involving misuse of funds.

II. Mobilizing domestic resources for sustainable investment
The International Monetary Fund (2020) estimates that the annual need for additional public investment in infrastructure, low-carbon technologies, and other areas to achieve the SDGs is 1.3 percent of world GDP (Figure 1). Cumulatively, over the period 2020-2040, the additional investment needs are estimated to exceed $2 billion. To scale up financing for the SDGs, multilateral development banks (MDBs) have advanced an agenda of “billions to trillions” to “unlock, leverage, and catalyze private finance and domestic resources” (African Development Bank, 2015). The idea is to use ODA or “blended finance” to mobilize private capital to invest in sustainable development.

Expanding Sustainability Through Blockchain-Based Project Bonds

(pictured above)

Critics of blended finance have expressed concern about the financial stability risks associated with “multilateral development institutions escorting international capital to frontier and emerging market environments”. A fundamental problem with initiatives to leverage private investment through “de-risking” is that the risk itself does not disappear, but is simply transferred to the public balance sheet (Mazzucato et al. 2018). The United Nations Conference on Trade and Development (UNCTAD, 2019) notes that “the focus of the development finance agenda on complex – and mostly opaque – new financial instruments and securitized finance is critical to its ability to be delivered at the required scale to provide reliable financing where it is most needed does not bode well.”

Instead of trying to attract international capital for blended financing programs – which has not been very successful so far, as reflected in the small size and low leverage – efforts should be focused more on mobilizing domestic resources than on building complex financial structures. While foreign capital has played a role in the economic development of many countries in the form of direct investment or foreign aid, historically no economy has financed its infrastructure and development primarily through foreign funding. No economy has developed its infrastructure and financed its development primarily through foreign funding. Therefore, mobilizing domestic savings for local investment is a key part of economic development. The good news is that for many countries, especially middle-income countries, domestic savings are not a major bottleneck.

In fact, many developing countries and emerging market economies, especially in Asia, are net capital exporters. Even countries without current account surpluses tend to invest part of their savings in financial centers in developed countries with low or negative returns, often reinvesting them in their own countries at a higher rate of return, which then benefits foreign investors. This phenomenon is known as “capital round-tripping”. Domestic savings are invested abroad for a variety of reasons, including domestic macroeconomic instability, international portfolio diversification, and tax evasion. Two important reasons for investing savings abroad (which is the motivation for this paper) are better financial services and lack of safe financial products abroad, and lack of safe and sound capital markets in the domestic economy due to underdeveloped capital markets.

Reliance on foreign currency borrowing to finance domestic investments has been associated with two major problems: currency mismatch and maturity mismatch. (Goldstein and Turner 2004). The use of short-term foreign currency credit to finance long-term projects that return in domestic currency creates financial fragility and can lead to financial crises. The currency crisis literature emphasizes the importance of developing local currency bond markets to overcome “original sin”-a problem that most emerging markets have been unable to borrow in the past-and to avoid the financial fragility associated with currency mismatches. financial vulnerability associated with currency mismatches.

Since the emerging market crises of the late 1990s and early 2000s, countries have made progress in developing local currency bond markets. Progress has been made in the development of local currency bond markets. However, there is still a high degree of dependence on foreign investors. the massive withdrawal of international capital from bond markets in emerging economies in March 2020 once again highlighted the vulnerabilities associated with a shallow domestic investor base and a heavy reliance on international portfolio investors. The important question here is: can fintech help by mobilizing domestic savings and channelling them into sustainable investments?

III. Fintech solutions to enhance sustainable investment

  1. Discussion of the current situation

Emerging financial technologies have already had a significant impact on financial development and hold great potential for advancing the sustainable finance agenda (Chishti and Barberis 2016; Jeucken 2010).The G20 Sustainable Finance Study Group (G20 SFSG) has highlighted the emerging practice of applying digital technologies to sustainable finance ( 2018). As shown in Figure 2, the Sustainable Digital Finance Alliance (SDFA) identifies several challenges in linking the financial sector to the real economy and highlights the potential of digital finance to improve information and efficiency. Digital finance has the potential to improve the information and efficiency of the financial sector through better systems and data, and to promote inclusion and innovation in the real economy by expanding sustainability options and providing new sources of finance. Digital finance can help address barriers that limit the scalability of sustainable finance, such as lack of local community power and information asymmetries. Thus, digital finance can help promote goals such as financial inclusion and energy justice, both of which are key issues for sustainable transformation (DemirgucKunt et al. 2018; Aboushady, Gowaid, 2019; Arner et al. 2020; Volz et al. 2020).

Expanding Sustainability Through Blockchain-Based Project Bonds

(Figure 2: Impact of digital finance on sustainable development)

Fintech or digital finance is a business approach dedicated to making financial services available through Internet-related technologies. Typically, fintech companies play two roles in the financial sector. One is as a challenger to traditional financial institutions. In this case, these fintech companies rely on algorithms or machine-based logic to replicate the back-office processes of traditional financial institutions and generate new technology-based business models. The other is as pioneers, providing services where traditional financial infrastructure does not exist. For example, services are provided through mobile banking and other Internet-based automated information platforms. Fintech includes different applications including lending, blockchain/cryptocurrency, regulatory technology, personal finance, payment services/billing, insurance, capital market solutions, wealth management, funds transfer/remittances, and mortgage/real estate financing (Table 1).

Expanding Sustainability Through Blockchain-Based Project Bonds

(Table 1)

Countries have further developed mobile banking to provide access to capital markets for those who have traditionally had neither the ability nor the opportunity to invest in securities. For example, the M-Akiba program is a mobile-based financial technology solution developed by the Kenyan government. The program focuses on small-scale local individual investors and engages them in raising capital for nation-building. In a similar project in Kenya. In a similar project in Kenya, the Central Bank of Kenya enabled users to purchase treasury bills and bonds on their cell phones. However, the value of these bonds and notes of these bonds and notes is questionable, as the government’s power to adjust interest rates is abused.

Digital crowdfunding platforms can provide new solutions for personal finance and wealth management. For example, digital crowdfunding platforms can mobilize financial power and accumulate local resources (Schwienbacher and Larralde, 2012).Belleflamme, Omrani, and Peitz (2015) divide crowdfunding into two categories: investment-based crowdfunding and return- and donation-based crowdfunding. The first category includes equity-based, royalty-based, and loan-based crowdfunding. In this case, the funders are investors in the campaign and may receive monetary benefits through the growth of the company or based on interest rates; in the second category, the funders cannot expect monetary compensation and they fund the campaign because they receive a product or because they support the purpose.

  1. Blockchain

1) Technical characteristics and added value of blockchain.

Blockchain is an emerging technology that has attracted significant attention from financial institutions, energy companies, technology developers, national governments, and other institutions. Blockchain technology, which relies on distributed ledger technology (DLT), provides a cryptographic, tamper-proof, and transparent system that can be used to implement innovative business solutions by integrating different business models.Zheng (2018) summarizes blockchain as having four key characteristics, namely decentralization, network persistence, anonymity, and auditability. He also highlights three challenges: scalability, privacy breach, and selfish mining.

2) Blockchain applications in financial markets.

Blockchain can play an important role in the green bond market. In traditional bond markets, it is difficult for multiple stakeholders to monitor the flow of funds, to obtain or provide real-time updates on the status of developments, or to demonstrate the impact of green bonds. The use of blockchain in the green bond market can help improve the transparency of the system and the traceability of capital.

SDFA and HSBC (2019) identify three directions for integrating blockchain technology with green bonds.

  1. the creation of a blockchain-enabled bond issuance platform, which could digitize the entire bond issuance process. This includes the use of a stablecoin (a digital currency usually pegged to fiat currency) for automated settlement and payments to investors and for setting up transparent oversight nodes.
  2. converting manual reports into data tokens, enabling investors to communicate in real time and creating a shared asset history on the ledger for project aggregation.
  3. provide a “bonds-as-a-service” platform to expand the local community bond market. This means that people can create their green bonds in a blockchain system at low cost and make them available in certain markets through security tokens. This would allow smaller entities (such as medium-sized companies or communities) to issue green bonds directly, without the need for expensive full-service banks.

3) Blockchain applications in industry.

In terms of energy, climate and environment, the main applications of blockchain in the energy industry include the following.

1) Cryptocurrency for funding renewable energy projects.

2) Metering, billing and security.

3) Decentralized energy trading.

4) Green certificates and carbon trading.

5) Grid management.

6) Internet of Things (IoT), smart devices, automation and asset management.

7) Electric vehicles.

8) Development of generic initiatives for the underlying technology (Andoni et al., 2019).

IV. Proposal for a blockchain-based sustainable investment bond
We propose a comprehensive blockchain-based approach that integrates multiple fintech applications to mobilize domestic financing, investment for sustainable infrastructure investments. The approach should take into account the interests of various stakeholders including local residents, public policy, multiple investors, and international development agencies. The possible interests of these stakeholders are outlined in Table 2.

Expanding Sustainability Through Blockchain-Based Project Bonds

(Table 2: as above)

First, in the establishment and funding phase, blockchain applies crowdfunding logic to mobilize domestic savings to invest in the domestic local currency bond money market. The ledger can record the ownership structure and guarantee the user rights of clients. However, concerns about transparency and inflexible investment methods can discourage investment. Applying smart contracts can reduce the risk issue of information asymmetry. By applying blockchain technologies, such as timestamps and public and private key mechanisms, bond issuing entities can record bond issuance, registration and authentication information in a blockchain network, enhancing the credibility of the project.

Second, during the realization phase, all stakeholders can track the use of proceeds and obtain information about the construction status in a transparent manner. By ensuring investor ownership, the issuing entity can collect funds from domestic customers and generate more sustainable projects. As mentioned above, one motivation for using blockchain to track the flow of funds is the disincentive that digitization can have on corruption. Investors face the risk that the issuing entity may misuse the funds and never return the investment. By recording information on the flow of funds during the construction phase via blockchain, investors can better understand the status of the project and decide whether to continue investing. If the funds raised by the offering are misused or the project comes to a standstill, investors can make a decision with near real-time information.

Third, blockchain cannot be used only to finance infrastructure projects, but it can also help manage the project while it is running, for example through metering and billing applications.Downes and Reed (2020) show that transparency should have three components: evidence, disclosure, and access. By recording operational data with blockchain, stakeholders can gain transparent information about the project’s revenue streams, reducing the risk of investors not being rewarded for corruption. The entire data lifecycle management of securities firms offers a new way of financing sustainable investments.

V. Summary
In this paper, we have explored how fintechs can complement traditional capital markets and help mobilize funding for sustainable infrastructure investments. Based on an analysis of the relevant stakeholders, this paper makes a number of recommendations, including: the use of digital crowdfunding platforms to raise funds, and the ability of blockchain to transparently document and prove the use of proceeds, sustainability impacts, and revenue streams for projects. The proposed approach will not only provide investors of all sizes the opportunity to purchase local currency assets and issuers such as municipalities to raise funds for sustainable infrastructure investments, but will also facilitate project management once the project is operational. Finally, this approach would create complete transparency throughout the life cycle of the investment and reduce the problem of misappropriation of funds. This, in turn, would increase the attractiveness of the project in question.

For example, municipalities could issue proposed blockchain-based project bonds to finance local infrastructure, generating returns that could be used to pay coupons and principal. While this approach is suitable for smaller investments, it is possible for smaller assets to be aggregated into bonds and attract the interest of larger institutional investors. Development finance institutions can play an important role in implementing such investments, and their involvement can also increase the confidence of potential investors.

Source | ADBI Working Paper Series

Authors | Yushi Chen and Ulrich Volz

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/expanding-sustainability-through-blockchain-based-project-bonds/
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