Impact Credits -- Supporting open and continuous development
The Topl protocol is both conceived and designed to be a technological infrastructure enabling socially-beneficial investment into any region in the world, and in particular into developing countries. The design of this infrastructure is driven at least in part by our belief that there are currently two serious shortcomings in development finance. First, the vast majorities of both attention and capital are focused on investing directly in individual projects or initiatives, resulting in an ecosystem of isolated silos, with participants failing to leverage shared knowledge and allow for sufficient specialization and proper resource allocation. Second, when taken in isolation, direct economic or social aid often work well for acute crises. However, these efforts falter at their transition; they fail to prepare an economy for actually being developed and create environments of sustained dependency, where crisis has been dealt with but advancement has stalled. We therefore present our proposal of an open blockchain protocol for continuous (or multi-stage) development, built to enable a system of actors and instruments that can be employed at every stage of development.
While this proposal is focused, in part, on the specifics of the Colombian context, the tools utilized, the relationships among involved parties, and the model defining how to account for and leverage non-financial returns should prove extensible to many situations.
In November of 2016, the Colombian government ratified a peace agreement with Revolutionary Armed Forces of Colombia (the FARC), marking a significant step in ending the civil war that has gripped Colombia for more than 50 years. While there are several armed groups still acting in opposition to the government, sufficient progress toward complete peace accords has been made to justify the commencement of work to ensure this peace is sustained and prosperous. Headline numbers for this conflict are often limited to the nearly 200,000 civilian deaths and the 5 million people displaced. However, these numbers do little to reflect the ongoing impact of the war in terms of the portion of the Colombian economy that has become linked, directly of indirectly, to the conflict, the loss of domestic and foreign investment, and the severe erosion of trust in the Colombian government.
Importantly, the situation in Colombia is just one many around the world where conflict, systemic poverty, oppression or disenfranchisement have resulted in a severe shortage of investment into communities or entire regions. This shortfall in investment may last for years after the original cause has been alleviated either due to damaged perceptions or because of lasting damage to trust and financial, social, and human infrastructure.
The impact of blockchain technology
In many ways, 2017 could be considered a significant year for blockchain technology. Mass awareness has increased dramatically as major news outlets have begun covering Bitcoin and other blockchain technologies with rapidly growing frequency and the total value of all cryptocurrencies has exploded, growing by more than 30x. However, despite or possibly because of this, the locus of blockchain interest is centered firmly around citizens in relatively wealthy countries discussing the latest price spikes and what new token to buy. While this may be the current focus of the blockchain space, we firmly believe that the primary impact of blockchain technology will not come through such channels. Instead, we focus on the incredible potential of blockchain technology to bring a trusted and robust financial and information infrastructure to those regions of the world most currently lacking in these things.
Specifically, there are a number of aspects of blockchain technology that should be of great interest to those charged with supporting and promoting economic (or other forms) development in developing countries and regions around the world.
Trustless setup -- As an architecture, the blockchain is designed to operate without the need for users to trust an operator. Each user fully controls their own account and both forgery and account compromise are computationally infeasible (practically impossible) without a user's access credentials. This is significant to the development context because of the often limited trust that exists either between varying institutions or, more unfortunately, between institutions and those they are tasked with assisting.
Traceable transparency -- Transparency initiatives, for good reason, have recently become major talking points in development circles. When money, time, and resources are being devoted to an endeavor purported to provide some positive and measureable impact, that endeavor is borrowing on the good faith of its supporters. To ensure that this good faith is repaid, transparency must be demanded. While the maintenance of publically accessible databases by governments and other actors is an good first step, too often it offers more of the appearance of transparency than rigorously enforced standards. This is because traditional data stores (such as SQL databases) can be edited or even erased by administrators at any time. In contrast, a blockchain's history is immutable, meaning that no one can make changes to or delete anything that has been written into the blockchain.
Decentralized and open -- When it comes to internet and network technologies, it is easy to confuse infrastructure and protocols with services and closed, centralized platforms. While services and platforms can make fine businesses, they are very poorly suited to any endeavor where multiple actors have the same mission, as is the case with development. When development actors work independently on initiatives without leveraging common infrastructure, work is duplicated and performed without specialization. Instead, if all parties can work through a common structure and protocol, significantly better outcomes can be achieved. Because anyone can access an open blockchain, this technology can act as a common infrastructure and set of protocols to bring greater levels of coordination and efficiency to development initiatives.
Broadly speaking, the goal of innovative finance, when applied to economic development and social welfare, is to increase the amount, efficiency, and quality of investment by leveraging different sources of capital. With this end in mind and inspired by the ideas and weaknesses of other innovative financing efforts including blended finance, results-based aid/financing (RBA/F), and development impact bonds (DIBs), we propose the creation of a new tool for innovative finance, Impact Credits.
Like other innovative finance programs and tools for economic development or social welfare, Impact Credits are designed to leverage socially motivated resources to incentivize, de-risk, or otherwise support profit-seeking investment into projects that an entity (often philanthropic or governmental) wishes to see funded. While this basic alignment of philosophy is important, we draw two crucial distinctions between our thinking and that which gave rise to other tools of innovative finance. We believe that these distinctions, along with our focus on developing infrastructure rather than isolated projects, substantially enhance the value of this proposal.
First, when speaking of innovative finance, it is common to draw a line between public and private investment. However, the key distinction between pools of capital is not their sources but rather their goals or mandates and whether they are willing to de-risk other investment or must themselves be de-risked. This is illustrated well in the contrast between RBF and DIBs. In the former, public funds are used to de-risk private outlays while in the latter, it is the public funding that is conditional on being de-risked. Therefore, when designing a development instrument, we believe it is more prudent to consider and categorize pools of capital in light of their goals and ability to assume the risk inherent in development rather than their source. Second, we're aware of the fact that when it comes to development the greatest challenges are likely to be encountered at times of transition. As a situation, economic, social, or otherwise, improves, one's approach to that situation much adapt, and it is these flux points that present the greatest challenges to those who consider themselves architects of such progress. Therefore, we must ensure that Impact Credits can be applied across the many stages of development progress, acting as a consistent tool, applied simply with a varying degree of intensity as a situation improves (or even regresses).
Having defined the principles that guide the design of Impact Credits, let us now explore their actual function while looking specifically at Peace Credits, a type of Impact Credits intended to promote peace in post-conflict Colombia.
We begin with the suggestion that there are a number of specific, micro-scale metrics which can be linked to the overall level of peace in Colombia. For example, the amount of acreage devoted to the illegal production of coca could easily be classified as one such metric. Based on this connection, it follows that any parties who value promoting and encouraging peace in Colombia possess an incentive to decrease the acreage devoted to illegal coca production. While there may be many, both within and outside Colombia, who place value on peace and therefore have an incentive to decrease the acreage devoted to illegal coca production, it is virtually certain that this group does not include all (or even a significant fraction) of those actually growing or supporting the growth of this coca.
Therefore, we must devise a mechanism to allow for those with one set of values to transfer their incentive to another group. Persuasion may come to mind as a potential strategy to achieve this aim, but it is at best a slow and resource intensive process to bring an entire group to the acceptance of a new set of values. Instead, it is simpler and more expedient to rely on economic incentives, and this is exactly the role of Impact Credits, to allow for one group to achieve their social aims by incentivizing another group economically.
Peace Credits, therefore, function as follows:
- A group of farmers is using their land to illegally grow coca.
- A group that values peace approaches the farmers to have the land used for other (legal) crops.
- The peace group offers the farmers a number of Peace Credits if they will stop growing coca, along with an implicit agreement that the Peace Credits can be sold at some price in the future.
- The farmers accept the offer to repurpose their land, receiving a portion of the offered Peace Credits at the commencement of the agreement.
- At the end of the growing season, the farmers, having fulfilled the social aim demanded by the peace group, are then granted additional Peace Credits based on the number of hectares successfully converted.
- The farmers sell the Peace Credits they were granted.
While the above example of Peace Credits provides a very cursory description of the basic function of the Impact Credit instrument, we have not yet addressed how Peace Credits (or any other form of Impact Credits) fit into a more complete development financing framework or what roles must be filled and how parties occupying these roles would interact with each other. Answering these questions will be the focus of this section, beginning with an overview of roles involved and how they utilize the Topl protocol.
Note that each of the roles listed below may be fulfilled by multiple actors at once or that one actor may occupy multiple roles.
Venture -- From the standpoint of the Topl protocol, a Venture is any group or company (profit-seeking or not) that needs and therefore requests investment through the Topl protocol to undertake a project. We should note that partners to a Venture, other organizations that may assist in the endeavor, are also included in this role. More information regarding the flexibility of Ventures can be found in the Appendix.
Economic Investors -- An Economic Investor may be an individual, a group, a fund, or other pool of capital that seeks to invest in a Venture with the goal of an economic return or based upon an efficient allocation of resources. Importantly, Economic Investors can actually come together to pool their capital in a Fund managed entirely inside the Topl protocol, a process detailed in the Appendix
Impact Credit Issuer -- Impact Credit Issuers, likely organizations similar to Organic Certification Bodies, issue specific Impact Credits to Ventures at their commencement or completion. When an Impact Credit is issued by a specific Impact Credit Issuer, it is marked with that party's signature. Therefore, Impact Credits issued by different Impact Credit Issuers are not intended to be fungible since they are issued for different reasons and based on different criteria.
Impact Investors -- In the context of the Topl protocol, Impact Investors are any individuals, governments, or organizations that purchase Impact Credits. They are therefore the group responsible for attaching an economic incentive to a social aim.
Arbiters -- Arbiters act as participants in Topl's information markets, providing analysis of Ventures seeking investment through estimates of production or revenue estimates.
Hubs -- Hubs act as the physical logistical component of the Topl blockchain protocol. These regionally focused entities may act to source Ventures, disperse and collect capital, and serve as an entry point to a transparent supply chain for Ventures.
Certification Bodies -- When a Venture seeks to produce an agricultural product or craft or extract minerals, there are various standards that they may choose to hold themselves to, regarding either the quality of their product or the environment in which it was produced or extracted. In such cases where a Venture seeks to be certified, they must be audited by the Certification Body (or more likely an approved auditor) for that standard.
Distributors / Wholesalers (Manufactures) -- Distributors purchase physical products such as agriculture products, crafts, textiles, or minerals from a Hub later selling them to Wholesalers or Manufactures. These transactions are carried out through the Topl protocol to ensure full transparency and traceability for any certified products. This full-traceability makes the involved products more valuable thereby increasing the price that can be obtained by the Venture that produced them.
Having introduced all involved roles, let us now consider in detail how this system will function, extending our earlier example involving a farming cooperative transitioning from illegal coca production, breaking the entire system into three distinct parts.
When a Venture requires investment, the first step is the negotiation and signing of a contract. In the context of the Topl protocol, this contract is actually both a legal contract and a program stored and executed by the blockchain. As illustrated in the diagram below, there are four parties to this agreement, the Hub, the Venture, the Economic Investors, and the Impact Credit Issuer. These four parties must negotiate the terms of their arrangement and digitally sign the Smart Contract before it can be considered valid or enter into operation.
For the purposes of development financing, these Smart Contracts are structured in a manner similar to profit-sharing agreements, with Impact Credits serving to de-risk Economic Investors. Returning to the example of Colombian coca farmers, we can see the structure of a Smart Contract and how it operates.
Based on assessments by Arbiters participating in the Divine Information Markets, the Parties believe that the farmers can produce approximately 50,000 kg of coffee beans over a 5 year contract term using the 10 hectares of land currently being used to produce coca. Additionally, since there is a link between the number of hectares illegally producing coca and the level of peace in Colombia, the issuer of Peace Credits pledges 10 credits to the contract up front with an additional 2 credits for each hectare successfully converted from coca to coffee.
|Hub||Actual sale of produced coffee to buyers||2% of coffee produced; 2 Peace Credits||In exchange for its role in facilitating the contract and actually selling the coffee to buyers, the Hub is compensated.|
|Venture||Production of coffee||75% of coffee produced; all Peace Credits issued for successful conversion of land||It may strange to describe a Venture as having a claim, as opposed to other parties having a claim against the Venture but this results from the fact that all Peace Credits and production are actually pledged to the Smart Contract itself.|
|Economic Investors||85 million Colombian pesos||23% of coffee produced; 8 Peace Credits|
|Peace Credit Issuer||up to 30 Peace Credits||N/A||Credit Issuers are expected to be public or philanthropic groups and are therefore not usually compensated. However, if they are, this compensation would come by assigning it as part of the Venture.|
Note that these terms can be substantially more complicated with claims varying either through time of based on the actual yield of the Venture.
Having defined the terms of the Smart Contract, we can now turn to the diagram above to and see the actual flow or steps of the Smart Contract's execution.
- All 4 Parties submit their digital signature to the Smart Contract signifying their agreement over the terms.
- The Economic Investors supply their investment to the Smart Contract.
- Initial Peace Credits are issued to the Smart Contract.
- The investment is transferred from the Smart Contract to the Venture so that work may begin.
- Upon certification by the Peace Credit Issuer, additional Peace Credits are issued to the Smart Contract based on the number of hectares that have been converted.
- The Hub begins to take delivery of coffee from the Venture.
- The Hub subsequently sells this coffee to a Distributor with the Smart Contract collecting payment for all sales.
- This revenue is paid out to the Hub, Venture, and Economic Investors by the Smart Contract according to the previously agreed distribution.
- Steps 6-8 repeat until the completion of the contract.
- As part of the final disbursement from the Smart Contract, Peace Credits are also distributed to the Hub, Venture, and Economic Investors.
A crucial part of the process described in the preceding section is the involvement of the Hub in the sale of whatever is produced by the Venture. The choice to involve the Hub in this process is driven by two considerations.
First, market access is a substantial barrier to new or growing Ventures in developing countries and regions. Buyers, who are frequently much larger and more sophisticated than those groups from whom they purchase, are able to underpay for the goods they purchase. By introducing the concept of a Hub to this process, we are both removing the burden of accessing markets from producers and shifting the relative bargaining power away from buyers. Second, the source and quality of agricultural, textile, and mineral goods are increasingly becoming major influences on price. It should come as little surprise that organic food or responsibly sourced precious metals and gemstones can be sold at substantial premiums. Therefore, the integration into a traceable supply chain to ensure quality and source allows the goods produced by Ventures to be sold more profitably. As the first point of aggregation for these goods, Hubs play a critical role in these traceable supply chains.
The process through which goods pass through Hubs to Distributors and other buyers is outlined in the above diagram, with orange arrows representing the flow of goods and green indicating the flow of money. More information on the details of Topl's supply chain implementation can be found here.
Impact Credit value
As has already been discussed, the purpose of Impact Credits is to allow for the transfer of value from one group with certain social aims (Impact Investors), such as the promotion of peace, to another group whose decisions are driven by expected economic return or the efficient allocation of capital (Economic Investors). This transfer of value is carried out through the purchase of Impact Credits by Impact Investors from Economic Investors, as well as Hubs, and Ventures. Through this process, Impact Investors compensate Economic Investors for the impact their investment had, which is attested to by the number of Impact Credits the Economic Investor received.
Returning once more to our example of the former coca farmers, we look at the final stage of the process (marked 3 in the above diagram). At this stage, those Parties which received Peace Credits from their involvement can sell, via a decentralized exchange, their credits in exchange for monies. Provided that, at the time of the initial investment there was either an existing market price for these Peace Credits or an outstanding pledge to purchase them at a set price, we have provided a mechanism through which Economic Investors are de-risked. This is because at least some of the Peace Credits they received were in no way contingent upon anything more than the signing of the Smart Contract.
More precisely, Impact Credits are a unique form of asset that can only be transferred based in certain conditions. At most, Impact Credits can be exchanged twice:
- From the original Party (to whom they were issued by the Smart Contract) to an Impact Investor;
- From an Impact Investor to a Purchase Agreement.
Having already defined Impact Investors, let us now look at the role and mechanism of a Purchase Agreement. A Purchase Agreement is a pool of funds that is bound to purchase a specific type of Impact Credit for a set price at a specific time or once specified conditions are met. In this manner, Purchase Agreements can act to encourage and support long-term aggregate level goals brought about by the incremental gains already incentivized by Impact Credits themselves. It may be helpful to think of Purchase Agreements as acting in a manner similar to DIBs, "yielding" once a condition is satisfied. However, it is important to emphasize the flexibility of Purchase Agreements compared to DIBs:
- Purchase Agreements are an optional part of the Impact Credit ecosystem, whereas the repayment of a DIB is a necessary part of its mechanism;
- Purchase Agreements can be used to only buy a fraction of a given Impact Credit, while still distributing returns equally amongst Credit holders;
- Different organizations or groups of individuals can establish differing Purchase Agreements for the same Impact Credits reflecting their own views of the same macro-level goal.
Comparison to other innovative finance instruments
Impact Credits are differentiated from other development instruments and strategies by their flexibility and their openness, allowing them to be deployed at any stage of development and with various funding compositions or risk profiles. In this section, we will detail how the conflicting strategies of blended finance, RBA/F, and DIBs can in fact all be achieved through Impact Credits.
The purpose of blended finance is to use public or philanthropic resources to entice private (profit-seeking) investment into underdeveloped regions or in support of some social end. To illustrate this, suppose the government of South Africa sought to promote investment in more renewable energy. To achieve this through blended finance, they might sign a contract to provide such projects with technical assistance and a contract guaranteeing a price for the electricity produced.
To implement this same strategy using the Topl protocol and Impact Credits, the South African government would need only to sign on as part of a Venture agreeing to provide technical assistance and then fund a Purchase Agreement to support the price of South African Renewable Energy Credits (South African RE Credits). This method of implementing a blended finance strategy offers a distinct advantage over conventional implementations because RE Credits can be purchased, and therefore the price seamlessly supported, by anyone, not only the South African government.
In results-based aid programs, the government of a developing nation along with philanthropic funds or development banks will set out to achieve some high-level goal such as a reduction in deforestation or increased access to electricity. The government is responsible for funding initial outlays and handling (or contracting out) actual implementations while the participating donor groups agree to compensate the government for these expenses if the goal is met to some degree of satisfaction.
Implementing this strategy with the Topl system is again possible and advantageous. In this case, the government acts as the Economic Investor while either the government, the donor agency, or another party may take the role of Impact Credit Issuer. In its role as Economic Investor, the government still assumes all initial risk and is the only party to suffer loss in the event that there is no beneficial outcome, which would be represented by a zero allocation of Impact Credits. However, the important benefit here is that anyone can now participate in remunerating the government by buying the issued Impact Credits, thus decreasing the burden to the original donors, increasing the government's incentives, and allowing for more flexible standards of success.
Results-based financing can be looked at in an identical manner by substituting an implementing agency for the government and adding the local government to the list of potential donors.
Development impact bonds
Development impact bonds have perhaps generated more excitement than any other development finance instrument, likely due them feeling the most "financial" or "sophisticated". This is why we are extremely pleased that this strategy too can be implemented using Impact Credits.
When an endeavor is funded through DIBs, private investors agree to fund various projects in support of some larger goal with the expectation that when successful the government will repay their investment with the inclusion of interest. This is replicated by Impact Credits in any scenario where a government or donor agency agrees in advance, through the use of a Purchase Agreement to buy Impact Credits at a specified price. We believe that it is important to point out that these Purchase Agreements may be made such that they continuously buy individual Impact Credits, thereby supporting incremental gains (a possibility thus far largely unexplored with regard to DIBs) or such that they purchase all Impact Credits (of the specified kind) only in the event that some macro-level goal is achieved. The use of Impact Credits could even allow for the this process to be applied to the UN Sustainable Development Goals.
Open and continuous development
We have just detailed how Impact Credits are flexible enough to allow for the implementation of the most popular existing tools of development finance. However, we believe what may be even more important is the ability of this architecture to allow for hybrid strategies and to cover cases at all stages of development and potential economic return.
To illustrate this second ability more clearly, let's look at two potential projects, one at each end of the economic spectrum. First, consider the case of a policy research group which performs research to better understand a conflict in the hopes of offering policy solutions. It is easy to see that this Venture has a cost, and if the research is well-founded then it also will serve to promote peace and reduce conflict. Therefore, just as we did before we can draft sample terms for such an arrangement.
|Hub||Coordination of local information and sources||5% of Peace Credits|
|Venture||Peace research||35% of Peace Credits|
|Economic Investors||350 million Colombian pesos||60% of Peace Credits|
|Peace Credit Issuer||up to 100 Peace Credits||N/A|
We see here that this structure is identical to the one found in our coca/coffee example, the only change is that all claims are now Peace Credits. On the other end of the spectrum we could imagine that our earlier coca/coffee example no longer involved coca and instead the land was previously dormant. As such, this modified arrangement would involve only monies and no Peace Credits (below), representing a state of progress where investment has transitioned to purely economic in its motivation.
|Hub||Actual sale of produced coffee to buyers||2% of coffee produced|
|Venture||Production of coffee||75% of coffee produced|
|Economic Investors||85 million Colombian pesos||23% of coffee produced|
|Peace Credit Issuer||N/A||N/A|
As was described repeatedly, purchases of Impact Credits can both be negotiated and guaranteed in advance and made on an open exchange. By allowing for both of these purchase types, we maximize the amount of capital that can be used to promote development aims. Finally, it is hopefully apparent that by varying the relative value of Impact Credits issued in a Smart Contract compared with its expected financial value, the system can be used for what is essentially aid, traditional economic investments, and every point in between.
It is our belief that by providing a unified infrastructure and toolkit for development finance, the process can become more accessible and attractive to interested governments, projects, investors, and private donors.
Flexible anatomy of a Venture
From the perspective of a Topl Smart Contract, a Venture can include a single actor or any number of parties working in concert. The ability to include multiple parties in a Venture is especially important in a development context. The possibility to include multiple parties in a Venture is important because in addition to the possibility of traditional joint ventures, involving two co-located profit seeking companies, the development context makes corporate in-kind contributions an extremely relevant matter. Initiatives such as Impact2030 and others have made great progress in activating and guiding corporate resources towards development goals. To accommodate and encourage this, Smart Contracts can include and account for any number of in-kind contributions and even allow for such partners to be compensated for their efforts through Impact Credits (or actual funds).
Organization of Economic Investors
As with a Venture, Economic Investor is an extremely flexible role within a Smart Contracts. Within a single Venture, there can any number of Economic Investors and there is no requirement that their terms are the same. For instance, we can imagine that the example repeatedly considered in this proposal actually contained two distinct Economic Investors, with the first contributing 30 million COP in exchange for 8 Peace Credits and the second contributing 55 million COP in exchange for 23% of the coffee production.
In addition to supporting multi-investor functionality, the Topl protocol also allows for the creation of Funds. In a Fund, multiple Economic Investors pool their capital together into a single account which is then managed and makes investments on behalf of those who contributed funds. To those familiar with traditional private investment this should be reminiscent of the limited/general partner structure of private equity and hedge funds. Not only do Funds allow Economic Investors to pool capital to support larger Ventures and delegate the management of their resources, but they can also be used as a mechanism to permanently lock-up capital thus allowing it to be treated as a charitable donation.
Impact Credits and the SDGs
In 2015, the United Nations laid out 17 high level goals relating to human, economic, and social development to be achieved over the next 15 years. Named Sustainable Development Goals (SDGs), they range in focus from poverty to gender equality and the environment. Given the near universal acceptance that each one of these goals is worth a great deal to our collective society, much thought has been given regarding how to bring about each of these objectives. Here we would like to offer that Impact Credits may serve as the mechanism that offers an opportunity for the broadest potential involvement and the greatest understanding that before these end goals are met incremental progress must be made.
As detailed above, Impact Credits are issued based on quantifiable micro-scale progress towards some macro-level development goal and Purchase Agreements serve to provide an additional direct incentive towards that related macro-level goal. Therefore, the ability to support SDGs is already inherent in the Impact Credit system. For example, let's consider Sustainable Development Goal #6, one of the targets of which is "universal and equitable access to safe and affordable drinking water".
To apply our proposed framework to this target, we need only to have Water Credits that are issued based on the number of liters of clean, affordable drinking water produced and a Purchase Agreement (or Purchase Agreements) that will buy these credits at a predefined price based on either complete or fractional attainment of this SDG target.