Normie: Bitcoin mining uses more energy than Norway. Crypto is just for guns and drugs. It is basically destroying the world!
DeFi true believer: Ethereum’s moving to proof of stake, which is, like, infinitely less resource-intensive. Crypto is bringing power back to the people. YNGMI!
This is, in a nutshell, the state of the sustainability debate on crypto and DeFi at the moment.
If we want want serious money in our industry from big institutional investors then we must have a better case.
Here it is.
ESG? WTF?
To look good, companies used to do something called corporate social responsibility. You gave some money to the local school, you snapped a few photos of people smiling, you issued a press release. You hoped that this would divert attention away from your other, more questionable corporate practices. It often worked.
But the world in 2021 is different. The climate is boiling, democracy struggling, inequality growing, women and minorities are rising for their rights. CSR is consequently no longer seen as substantive enough. So, along came ESG, a more robust framework that companies can use as a checklist to assess their impact on the world, and investors to evaluate portfolios as they put money into those companies.
"E" stands for Environmental, "S" for Social, "G" for Governance. Here's an example of what falls under a typical ESG assessment:
Photo credit: MSCI
ESG is the sustainability evaluation standard of our time. It's of course just an imperfect framework that your average management consultant came up with. People have dismissed it as a "sham" box-ticking exercise aimed at lowering the firm's cost of capital. Many more have praised it as the revolution that will make all finance "sustainable." Whatever the case, institutional investors care about ESG. So then let's see how DeFi as an industry might score.
ESG and DeFi
If you look at the chart above, your first impression could be that DeFi on the whole has a very good shot at sustainability, given that it produces no physical product, doesn't have to worry about supply chains and such matters, and promises to spread economic and political power. Let's examine this area by area.
Environment
Here, it's basically all about the carbon footprint. Here, defending proof of work (PoW) energy use is just hard. People have pointed out that Bitcoin mining uses resources that otherwise wouldn't be used or that traditional finance uses much more; I find these arguments flimsy - PoW is a huge problem.
But proof of stake (PoS), coming to your neighborhood Ethereum in 2022, does indeed solve this objection, and it solves it for good. It's worth noting though that not all PoS implementations are the same - some are more energy-efficient than others.
Climate action is notoriously complex and DeFi organizations should have a strategy for it. Say, Klima has jumped head-first into carbon offsets. A commendable effort maybe, but offsets are in practice not a comprehensive way of fighting climate change. DeFi has more potent weapons to deploy here, as we'll see below.
Social
Social ESG factors can roughly be divided into two buckets: looking after your people (HR, health and safety, privacy) and looking after the society (access to services, community relations). This is the pillar where DeFi can truly shine. Just a few examples:
Workforce inclusion: DeFi jobs are usually flexible and remote, and you can be part of the industry from anywhere around the world.
Financial independence: entire communities in the Philippines are earning a living playing Axie Infinity.
Financial inclusion: a bankless world where instantaneous, blockchain-based cross-border transfers of value are possible, providing financial services to those who don't have access to them, is indeed a vision worth fighting for.
Supporting citizen action: my years in philanthropy have taught me that the best investment in changing the world is one that funds citizen movements on the ground, not big international NGOs. DeFi can give such movements a way to circumvent oppressive governments. This can literally change the world as we know it.
Governance
Governance factors include board composition, pay, ownership, tax issues, etc. Here, your average company resorts to "tokenism" - appoint a few women and minorities to the board, tick the boxes on ESG ratios, move on. The concentration of power effectively remains the same.
DeFi's solution could be the DAO. In its best incarnation, the DAO is a powerful tool that can change the way organizations are structured, cut bureaucracy and distribute power.
In fact, the DAO can contribute to solving problems normally classified under E and S. If we've learned anything over the past decade it's that many challenges of our society are political, not only economic. Climate change is an example. The science has been settled for decades now. But the arguable failure of COP26 has shown that politicians are simply not feeling enough pressure from below to act. That pressure in the future might come from sophisticated, citizen-led DAOs, a new way of distributing power and resources while coordinating political action.
Keeping the promise
So DeFi has the potential to be the ultimate ESG-friendly industry. This could lead to a several-orders-of-magnitude increase in investment from big institutions.
But, for this to happen, DeFi needs to live up to its promise. For the moment, the jury is still out on whether this will happen. We are still living with PoW on Ethereum. Value and power concentration across the industry is still largely with white and Asian men. Not all DAOs out there are truly decentralized and truly functional. Illicit money happily mixes with the rest of it in DeFi.
Most controversially: to attract serious investment, DeFi will need some regulation - to think otherwise is to be dreaming. If we are smart, we should anticipate this regulation by shaping it ourselves before others do it for us.
Do we make it?
So, can we marry the two uber-trends of our time - ESG and DeFi? Can we open the investment floodgates? This will depend on us, the people in DeFi. I mean the community.
Yes, it's a worn-out term. You're used to hearing people use it over and over again as they shill their derivative PFPs and pump their shitcoins on awkwardly staged podcasts. Yet, for DeFi to succeed community needs to be a thing, and stay a thing.
And the community is you. It's not the traditional VCs who built web 2.0 in the first place and are now talking the talk of web 3.0 but basically hoping to fund the next monopoly. It's not the "number go up" folks who leave when the market turns. It's you, the people building cool things and those supporting them. It's you, the people who understand the power of DeFi fundamentals and are willing to bet on them to transform finance as we know it, even if that takes 10-20 years. With people like you in it for the long run, DeFi wins big.