ESG and Blockchains – Exploring Corporate Governance and The Potential for Change

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Cryptographically secured peer-to-peer systems and distributed ledger technology, while not a panacea, offers opportunity to address many of the structural and ethical issues present in our current governance models. These newer systems offer a level of transparency and participation that has never been possible. 

Traditionally, the purpose of corporate governance is to facilitate the effective and prudent management of a company, ultimately driving it to success. Boards of Directors are responsible for the governance of their companies.  Shareholder’s role in governance is to appoint the Board of Directors in hopes that they will set the company’s strategic goals and hire appropriate leadership to act on those goals.

When we look at today’s world of governance, nepotism and self-serving tendencies continue to be a growing and persistent issue. A relatively small group of influential and often powerful individuals bounce from one government role, where they influence and even craft legislation for their industry, back to the private sector where compensation is superior. This is easily seen by the amount of overlap in individuals on multiple boards, blatant regulatory capture, and the lack of diversity in stakeholders present on these boards.

When it comes to the pillar of Governance in ESG focused investing the broader scope can often get lost. In public markets, quantifying governance typically revolves around metrics such as board diversity, pay practices, board independence, and less on the qualitative and embedded ethos of leadership teams. This pillar of ESG, objectively, is biased toward “box checking” as much of the policy and practice data is readily disclosed in annual and other required reports. In most ESG screening, companies score higher in the governance field due to the required transparency of this quantitative data, unlike many social and environmental metrics which are typically more voluntarily disclosed. While more disclosure equals more transparency, and ultimately that is a good thing, it does little to shine light on the structural issues embedded in corporate governance culture. Current ESG analysis on corporate governance systems often fall short to examine the larger stances of a corporation’s role in society and in setting and determining internal, and by proxy, national policy.

Numerous ethical issues have been intentionally, though not always malignantly, built into our current governance models. While lobbying came from noble roots to inform legislators what advocacy groups, businesses, and communities needed to thrive, what it has transformed into was not the original goal. The revolving door between regulators and business executives’ ends up stifling innovation, increasing barriers to entry, protecting and insulating the incumbents, obfuscating accountability, and ultimately creates a situation where those in positions of power stay in power and accumulate more of it regardless of what the needs of a healthy economy and society are to thrive.

Consumer demand is the traditional scapegoat for what drives the supposed rational behind governance decision making. After all, good managers put in place by good boards of directors generate good profit to benefit shareholders.  But while consumption keeps demand alive, often the decisions of boards are ignored in their role of creating that demand in the first place. Large governance structures embedded in multinational and large corporations have the ability to influence demand at scale – directly impacting social narratives and guiding public opinions – whether that is to shine light on social issues or make you believe you need the latest and greatest new widget. Massive developments in technology, communication power, and social media platforms (web 2.0 in general) have exponentialized and concentrated this power through subtle and not-so-subtle marketing campaigns and directives that these organizations use to strongly influence the way we think, consume, and spend. 

It is this power to influence, left unchecked, that has become a threat to keeping a cohesive society. Our social contract is being reshaped by those organizations, mostly without our consent. In these structures, the consumer becomes the product and altering consumer behavior to benefit the bottom line and increase shareholder value becomes the main goal. The consumer’s data becomes currency and in this vein the incentive to form a cohesive society around shared goals facilitated by centers of power (e.g. businesses and governments) become increasingly complex. The algorithms of industry have one goal, maximize profit and shareholder value at all costs, everything else is just an externality. This is the model held in place by governance structures that the corporations of today follow. The policy, incentive structures, and current ways of doing business are all built in a way to facilitate this as efficiently as possible, without regard to societal and environmental consequences.

Some deep questions should rise from all of this around what we want our future to look like. How accountable should the organizations who influence public opinion, set policy, and determine what the course of our future be?

Our current governance models are plainly misaligned with ESG goals. Yes, diversity and appropriate pay practices and board independence are all very important, but if we want to see any real change in our world, the governance structures themselves must be challenged. Typical governance ESG metrics and approaches tackle symptoms of much larger structural issues in how we as people and society want to organize and live our lives.

Cryptographically secured peer-to-peer systems and distributed ledger technology, while not a panacea, does offer opportunity to address many of the structural and ethical issues present in our current models. These newer systems offer a level of transparency and participation that has never been possible. 

One example is seen in the financial sector, where instead of a very opaque network of financial institutions controlling everything, gatekeeping who may or may not participate, legally front running retail, and obfuscating accountability, we have an option for a much more transparent, democratic, accessible, and open system, with equally applied rulesets based on code and math, that can plainly tie in accountability.

The simplest reduction of the benefits presented by what this technology provides can be best described as how and where power lies and is distributed. As a society, do we want a system of gatekeepers, do we want to trade our freedoms for supposed safety while a select few have the opportunity to abide by a different rule set?  Recent examples are the Gamestop/Robinhood fiasco where corporate leaders and regulators cut off retail’s ability to freely participate in markets and changed the rules to protect themselves. This is not indicative of a free market and highlights the inherent fragility and unfairness of non-transparent complex systems.

And that is where blockchains, open and distributed ledgers, peer-to-peer systems, decentralized autonomous organizations, censorship resistant frameworks, and immutable data cut to the core of what Governance in ESG should really stand for. A freer, fairer, more transparent, and more accountable system that provides new, more accessible ways to organize, engages and involves more stakeholders, and gives greater voice around objectives and goals as a society. 

Moving from the theoretical to the more tangible aspects of where we are today and why, when it comes to governance through the ESG lens, crypto assets are already ahead of current structures in tackling these issues (even though they are still in their infant stages and more work must be done).

DAOs or Decentralized Autonomous Organizations offer new ways for people to organize around a cause, a goal, or to conduct business to create value, which necessitates the consideration of stakeholders that are critical to the organization’s success. In these models, employees, customers, suppliers, creditors, and communities all have an avenue to have their voices heard and have a say in the direction the DAO goes. While many of the mechanisms for voting, determining purpose and direction, the actual operations and management, and deployment of capital to meet those goals are still being researched and tested, already they offer a vastly more transparent and accessible way for an individual to get involved. Replacing corruptible figureheads and human failure points with math and code, cannot be understated. Development here will only continue to expand as the use-case of DAOs is already being tested with many governance-based tokens.

These types of systems and their built-in immutability present a vastly superior system for record keeping, ensuring against voter fraud, and verifying ID while maintaining anonymity (check out the research behind zero-knowledge proofs). At the same time access to these networks is much easier and less cumbersome than current structures – all that is needed is an internet connection making voting, strategic proposal propositions, and participation in general much more accessible.

The other undeniable benefit of relying on code or math instead of individuals for governance functions is the built-in anti-fragility especially in times of stress. These systems seek to maximize cooperation while minimizing coercion. While public markets require stop gaps, interference, and functions to halt trading when something breaks due to their inherent fragility and opaqueness, crypto markets are able to operate with ease (and have proven to do so) in times of stress without the need for intervention, which is arguably a much fairer, consumer centric, and free-market centered approach.

Finally, governing monetary policy for governments or organizations themselves is being tested and deployed in different blockchain systems that can prevent a bad actors from eroding away personal purchasing power in native currencies. From monetary policy to corporation treasury management, these systems can provide more efficient, transparent, and inclusive ways to manage, issue, and deploy capital that can most benefit the users or citizens of those organizations.

Imagine democratizing all the aspects of corporate governance while ensuring accountability to allow for a community of users, consumers, or those affected populations to directly participate in a meaningful way with the corporate governance process. That’s what I am getting at here.  While there is still much work to be done, the groundwork has already been laid and thoughtful minds have already taken to task building the infrastructure for these systems. The natural progression of time and human nature will inherently lead to the adoption of these new, more efficient systems piece by piece. As the technical parts get abstracted away over time, the average end user will mostly like have no idea that the systems of the future they interact with have governance back ends built on this revolutionary technology, that will help humanity take the next step forward. I strongly encourage governments and organizations of all sizes to continue working toward embracing and building in this direction as the values inherent in it closely align with our ethos around freedom. While we are still early in the process the implications are quite clear around the benefits of more blockchain integration, especially in governance. Regulation in the space must be thoughtfully crafted. Let us learn the lessons of the past and actually use this as an opportunity to build a better a future while vastly improving upon current governance structures.

Paul Farella ~ Willow Crypto

Paul Farella is the Managing Director at Willow, an independent registered investment advisory firm located in Pittsfield, Massachusetts. He works closely with the firm’s founder Alexandra Dest to manage over $145 million in client assets. Willow is a B-Corp (benefit corporation) and certified Women’s Business Enterprise (WBE) that prioritizes ESG (environmental, social, governance) factors into the portfolio creation process.


Disclaimer: Any views set forth in this article are solely those of the author and do not necessarily represent those of ADCM, LLC or its affiliates. Although the information contained herein has been obtained from sources believed to be reliable, its accuracy and completeness cannot be guaranteed.  Neither the information nor any opinion expressed herein constitutes an offer or a solicitation of an offer to buy or sell securities.