Emerging Technologies

How can blockchain principles help improve ESG systems?

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What can ESG reporting learn from blockchain? Image: Unsplash.

Aya Miyaguchi
Executive Director, The Ethereum Foundation
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  • A third of total global assets under management are ESG assets.
  • Current ESG ratings are problematic as they are not coordinated globally.
  • Blockchain principles could offer insights into how to improve ESG systems.

The term Environmental, Social, and Governance (ESG) brings awareness. It encourages us to pay more attention to today’s pressing global challenges. I would like to share a higher-level view of blockchains and how their design and coordination systems might be a source of inspiration to ESG efforts.

ESG investing is rapidly growing and already represents a third of total global assets under management. ESG ratings firms create corporate social credit scores that rank companies’ negative effects on the world, such as pollution and modern slavery.

The problem with ESG ratings

Current rating systems fall short. For example, companies from the cigarette industry - responsible for more deaths per year than the global COVID-19 pandemic – can at present receive a solid “BBB” rating from MSCI, one of the leading ESG ratings firms. Examples like this are raising questions and doubts about ESG ratings, but the system is rather opaque and not easy for those who care to help improve them.

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In fairness, ESG ratings are hard to design. Why? First, rating systems attempt to solve a global problem that requires global coordination, and they are not managed by one company or country. Second, key stakeholders involved are corporations, investors, and ratings firms whose interests as businesses are ultimately to generate a profit. The system has to somehow incentivise these stakeholders to act responsibly without regulation.

The problems with ESG ratings are typical of global coordination issues. When we try to solve hard global problems without relying on one company or country, coordination is often difficult, and global missions suffer from the tragedy of the commons.

Blockchain faces similar issues

Public blockchains such as Ethereum and Bitcoin handle coordination globally (over the internet) without having any single company or team managing the effort. The incentive mechanisms, backed by mathematics and cryptography, encourage participants to help secure the networks. There will always be attempts to abuse and manipulate systems, so mechanisms that incentivise participation and ensure decentralization are crucial.

There are other essential factors relevant to coordination issues outside of mathematics and technology. While Ethereum is still evolving and is far from perfect, it is a unique case study on solving coordination issues related to building public goods.

How Ethereum built global consensus

Ethereum is the most used public blockchain, and it allows for anyone to build decentralized applications and solutions. Ethereum isn’t owned by anyone and is an open-source public good that anyone can use. In the code, there are incentives for participants to help secure the network.

When Ethereum was launched in 2015, its open-source community sought to transition away from proof-of-work (PoW) to a proof-of-stake (PoS) mechanism. Early blockchains came to consensus using PoW, which requires excessive energy consumption and is widely criticized for ESG-related concerns. The shift to PoS would cut 99.9%+ of energy consumption, while making the network’s validation process even more secure.

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This initial idea of this transition was one thing, but maintaining that vision while executing on it, and coming to consensus as a global Ethereum ecosystem has never been an easy job. There are stakeholders with different intentions, including miners that have benefited from the PoW mechanism. After years of work, Ethereum is finally completing the switch to PoS this year. How did the ecosystem manage to get here?

Ethereum principles

There are fundamental principles that are shared by everyone in the Ethereum ecosystem when building the infrastructure that help to incentivize coordination. Here are a few examples:

  • Open: Ethereum is open by design – the code is open-source. The research is openly discussed on sites like EthResearch, and development happens in public on repositories like Github. Since it’s open-source, anyone can also learn from successes and use Ethereum-related code elsewhere. For example, the source code for Geth (Go Ethereum), an Ethereum client that allows anyone to connect to the network, has been copied many times for use in other blockchains and scaling solutions.
  • Permissionless: Participation in Ethereum is open to everyone. No permission is required. The network is powered and secured by nodes that anyone can run. Anyone can send a transaction, deploy a contract, or suggest improvements through an Ethereum Improvement Proposal (EIP).
  • Emergent consensus governance: Improvements to the Ethereum network require reaching broad agreement on changes to the protocol. No decision is made without sufficient consensus. These changes are governed through “emergent consensus”, in a process that is similar to how consensus emerges amongst mathematicians on the validity of new proofs. It encourages free debate and criticism in discussing important changes.
  • Forkable: What if someone does not like the result of this “emergent consensus” process? What if someone doesn’t earn consensus and does not believe in the decision? Anyone can try to fork Ethereum to create an alternative version. One example is what happened after an early Ethereum application called The DAO was exploited in 2016, when ideological differences and security concerns created a divide, and one project became two. While having multiple chains can be confusing, the ability to fork an organization or network is another important part of an open design. It keeps Ethereum’s governance healthy and more importantly accountable.

ESG systems can learn from blockchain

While Ethereum has gone through (and will continue to go through) important changes, these principles allow anyone to participate and verify that the shared vision is maintained at every stage.

I am not in the position to suggest how exactly the ESG system should be designed, but I hope this encourages free discussion and further debate, within the spirit of emergent consensus. The consequences of ESG systems that do not work are less obvious or immediately noticeable than in blockchain, but that is why we need to be even more proactive about being open, in order to achieve true positive impact in the long term.

This blog is part of an Agenda series led by the World Economic Forum’s Crypto Impact and Sustainability Accelerator (CISA). With special thanks to Vitalik Buterin and others from the Ethereum Foundation for feedback.

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The views expressed in this article are those of the author alone and not the World Economic Forum.

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