Blockchain and sustainable finance: how smart contracts integrate technological innovation and sustainability

Blockchain and sustainable finance: how smart contracts integrate technological innovation and sustainability

Introduction

Blockchain is a revolutionary technology that has transformed several industries, including financial transactions, supply chain management, healthcare, electronic voting systems and even the sustainable energy sector. Blockchain is essentially a decentralized and immutable digital ledger, which records transactions transparently and securely. Unlike traditional databases, which are centralized and managed by a central authority, blockchain is distributed across a network of computers (nodes) that work together to verify and record transactions. Each block of data is cryptographically linked to the previous one, forming a chain of blocks, hence the name “blockchain”. This structure makes it extremely difficult to alter existing data, ensuring the integrity and security of the information. In recent years it has been clear how the concept of blockchain is playing an increasingly important role in the field of sustainability. An example could be green cryptocurrencies. These are cryptocurrencies or digital assets that have been created or designed with the specific goal of being environmentally sustainable. This category of cryptocurrencies focuses on aspects such as energy efficiency, reduction of carbon emissions and global environmental impact, in response to growing concerns regarding the intensive use of electricity associated with the mining and operation of cryptocurrencies. However, the most relevant example in the field of sustainability are the so called “Smart contracts” or programs that run autonomously according to transactions when certain conditions are respected.

 

Blockchain

The blockchain technology stands as a groundbreaking innovation, revolutionizing various facets of computing, economics, and society. It represents an inventive solution with the potential to reshape multiple industries, enhancing security, transparency, and efficiency in both transactions and processes. Its adoption continues to surge across diverse sectors, ushering in fresh prospects and complexities for technological progress.

Key attributes of blockchain include:

Decentralization: In stark contrast to centralized databases overseen by a singular authority, blockchain operates across a distributed network of computers (nodes), collaborating to validate and record transactions. This decentralization eliminates the necessity for a central governing body.

Immutability: Once information is securely inscribed within a block and incorporated into the blockchain, it attains a state of immutability. This means that it cannot be modified or eradicated without the consensus of a majority of network participants.

Security: Blockchain employs cryptographic techniques to safeguard transactions and data, rendering it highly secure and resistant to manipulation.

Transparency: All transactions conducted on the blockchain are observable by every participant in the network. This transparency serves as a bulwark against fraud and manipulation.

Smart contract

Smart contracts, or intelligent contracts, represent one of the most exciting innovations in blockchain technology, and their sustainability implications are equally interesting. These automated contracts allow agreements and transactions to be executed autonomously and transparently, eliminating the need for intermediaries and ensuring the immutability and security of operations. A question arises spontaneously: how can smart contracts contribute to greater sustainability? Smart contracts can improve efficiency across multiple industries by reducing resource consumption and associated costs. An example can be found in the supply chain management sector where these contracts can automate the monitoring and recording of product origin, helping to reduce waste and prevent fraud. All of this promotes sustainability through better management of resources and the promotion of greener products and services. This form of contracts can be used, for example, in the energy sector for the management of renewable energy sources. These contracts can automate the production, distribution and sale of energy from sustainable sources, helping to reduce the use of fossil fuels and greenhouse gas emissions. In this way, smart contracts play a key role in the transition to a more sustainable future. Carbon markets are another area where smart contracts can promote sustainability as they can monitor and verify carbon emissions and enable the trading of carbon credits in a transparent and efficient manner. This creates incentives for businesses to reduce their emissions, contributing to climate change mitigation efforts. Another important aspect is traceability and responsibility. In fact, they allow information on the origin of products to be recorded in a secure and immutable way, ensuring that they are produced in a sustainable way and this transparency can push companies to adopt more environmentally friendly and responsible practices. It should be underlined that, despite the positive potential of smart contracts in the field of sustainability, there are also challenges to face. The growing adoption of blockchain and smart contracts has raised concerns about the energy use associated with extracting and validating transactions, especially in cases where energy-intensive consensus algorithms such as Proof of Work (PoW) are used and therefore the need arises to develop more energy-efficient consensus algorithms. Smart contracts represent a powerful lever to promote sustainability in various sectors by automating processes, increasing transparency, improving efficiency and creating incentives to adopt more sustainable practices.

 

Conclusion

We can therefore say that smart contracts represent a significant step towards a more sustainable future, with the power of blockchain technology redefining our view of transactions and agreements. Albert Einstein’s words seem more relevant than ever: “Crisis is the best thing that can happen to people and entire countries because it is precisely the crisis that brings progress.” The emergence of smart contracts use and their integration into the sustainability space are a concrete example of how challenges can be transformed into opportunities, helping to improve efficiency, transparency and accountability in various sectors. Using this technology to track, validate and automate sustainable transactions paves the way for greater environmental and social responsibility. However, it is essential to remain vigilant and address the challenges inherent to energy consumption and large-scale adoption. With a constant commitment to optimization and innovation, smart contracts can become a key pillar in promoting global sustainability, helping to create a future in which technology serves not only economic interests, but also the common good of our planet and future generations.

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Bibliography

https://corpgov.law.harvard.edu/2018/05/26/an-introduction-to-smart-contracts-and-their-potential-and-inherent-limitations/

https://www.consob.it/web/investor-education/criptovalute

https://www.ncbi.nlm.nih.gov/pmc/articles/PMC9979138/

 

How ESG has changed modern finance

How ESG has changed modern finance

Edoardo Mollo

 

Introduction

The ESG criteria represent a set of very important indicators that allow the analysis of a company or a State taking into account not only the financial aspects but also the environmental, social and governance factors. The acronym ESG stands for Environmental, Social and Governance:

Environmental: This aspect specifically concerns the attention that the company has towards the environment, taking into account factors such as the emission of greenhouse gases, pollution, the use of clean energy and all those factors that aim to safeguard the ecosystem.

Social: This aspect concerns the influence of a company on the community, its employees and any interested parties. It involves evaluating issues such as social diversity, inclusion, working conditions, responsibility and community involvement.

Governance: Investors evaluate leadership competence, level of transparency, business ethics and effectiveness in managing conflicts of interest.

 

Sustainability and Finance

In the last few years, the adoption of ESG criteria in investing has grown significantly. This is because more and more investors are looking to integrate their financial decisions with sustainability factors. ESG criteria provide a framework for identifying companies committed to sustainability and social responsibility, helping to generate a positive impact on both the environment and society. This impact manifests itself in various ways:

-Risk reduction: Investors are increasingly considering ESG criteria as indicators of risk. Financial instruments associated with companies that employ sound ESG practices tend to be less risky. These criteria can prevent critical issues related to the environment, social or governance issues that could compromise investment returns.

-Increasing demand: Investors themselves are increasingly looking for financial instruments that comply with ESG criteria. This growing demand has pushed financial institutions to offer a wider range of ESG investment options, including mutual funds, green bonds and shares of sustainable companies.

-Improving corporate practices: As companies seek to attract ESG-sensitive investors, many are improving their environmental, social and governance practices. This has contributed to greater corporate responsibility and greater transparency.

-More stringent regulations: Many jurisdictions have introduced laws and regulations requiring companies to disclose ESG-related information. This has made it easier for investors to evaluate a company’s ESG impact.

 

Historical evolution

The financial sector has undergone notable changes before and after the introduction of ESG (Environmental, Social and Governance) criteria. In the past, investments were predominantly oriented towards achieving maximum financial profit, with little concern for environmental and social issues. However, as global concerns around climate change and sustainability have intensified, investors have begun to consider ESG factors as essential indicators for evaluating investment opportunities. The introduction of ESG criteria has resulted in greater transparency and accountability within the financial sector. Investors today seek financial instruments that adhere to ESG standards, rewarding companies that demonstrate a commitment to sustainability and punishing those that do not. This has triggered a rise in sustainable investing and pushed numerous companies to improve their ESG practices. Furthermore, regulatory authorities, as highlighted in the document cited in the bibliography and published on the Bank of Italy’s website, have begun to consider ESG factors in the financial system and to exercise supervision over the way in which financial institutions manage these aspects. The introduction of ESG criteria has led to a profound change in the financial sector, promoting more sustainable and responsible investments, with notable implications for investment decisions and business practices.

 

What are the most sustainable financial investments?

Before discussing which investments are more sustainable than others, we need to understand what an SRI is. According to the ‘Working Group of the Sustainable and Responsible Finance Forum’ the definition of this acronym is: «Sustainable and Responsible Investment aims to create value for the investor and for society as a whole through an investment strategy oriented towards medium-long term which, in the evaluation of companies and institutions, integrates financial analysis with environmental, social and good governance analysis”. To finance SRI investments, companies normally use Green Bonds, Social Bonds and Green Loans. However, profits for investors can be limited if these tools are used and not everyone aims to get rich by doing exclusively ethical finance. However, ESG criteria have also had an important influence on widely used instruments such as shares and ETFs whose sustainability score psychologically influences the average investor’s choice to purchase the security.

 

How ESG scoring works

ESG scoring involves the collection of data and analysis of several indicators, which may vary between rating agencies and the tools used, but typically include financial data, information on company policies, and data relating to environmental and social performance. ESG scores can change from one agency to another, but in general, they are expressed either on a scale of 0 to 100, with higher scores indicating greater sustainability and social responsibility, or on the letter scale ranging from “A” to “F”, where “A” represents the highest score and “F” the lowest score. For example, a company with an ESG score expressed as “A” or “A+” indicates strong adherence to sustainable and socially responsible practices, while a company with an “F” score shows significant deficiencies in these areas.

This letter scoring system makes it easier to understand a company’s ESG performance, allowing investors to quickly assess its commitment to sustainability. It is important to note that variations in scoring criteria may occur between different rating agencies and therefore it is essential to consult reliable sources for an accurate assessment.

 

 

Let’s now take as an example a company that has put a lot of effort into sustainability: ENI. In fact, here on the right we can see the ESG score evaluation graph published on the MarketScreener.com website. It can be seen how all the mentioned factors contributed to the assignment of the final score.

Unfortunately, a very widespread deceptive practice is the so-called ‘Green Washing’*. This phenomenon occurs when an entity, organization or company tries to appear more sustainable than it actually is through claims that exaggerate social efforts, false advertising and other shady scams. The authorities try to combat the phenomenon as much as possible through rigorous regulations in order to have much more reliable information.

 

But the final question is: How much have ESG criteria influenced investors’ purchasing habits?

ADEPP states that more than half of institutional investors (around 52%) have chosen sustainable investment policies. The increase in confidence on the part of institutions towards sustainability reverberates directly on the average investor who has changed his investment selection habits also based on ESG factors. According to an analysis carried out by CONSOB and consultable in the bibliography**, a significant increase in the propensity to choose sustainable investments for both ethical finance and purely profit-making purposes was found. This data was found to be present in all age groups, in every geographical position and independent of financial education and of the investor operating independently or followed by consultants.

 

 

*word that derives from Green and washing which refers to the verb ‘to whitewash’

**number 4 of the bibliography

Article written by Edoardo Mollo: a law student graduating from Luiss Guido Carli with a strong interest in finance, sustainability and digital innovation.

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Bibliography