In pursuit of its visionary aim to lead the charge towards climate neutrality by 2050, the European Union (EU) has embarked on a transformative journey. One of its recognizable pioneering initiatives to curb the Greenhouse Gas (GHG) emissions has materialized since 2005 when it implemented the carbon pricing mechanism on EU corporations through the EU ETS cap-and-trade system. This system, however, has brought about disadvantages to manufacturers in the EU, leading to unfair competitive edge for companies in regions with more relaxed environmental regulations.In 2019, the European Green Deal was established to further enhance and accelerate the EU’s climate and sustainability efforts. The European Green Deal encompasses a wide range of strategies and measures, among which stands the Cross-Border Carbon Adjustment Mechanism (CBAM), which in one way will assist the EU in realizing the climate neutrality goal, and in another way will protect EU industries from unfair competitions caused by higher environmental costs.

CBAM, an acronym that carries immense significance for businesses, policymakers, and stakeholders around the globe, represents a pivotal component of the EU’s commitment to addressing climate change. As we delve into the intricacies of CBAM, we’ll unravel its impact on various industries, explore its timeline and implications, dissect the methods employed for emission calculation under CBAM standards, and delve into the ways manufacturers can measure, reduce, and offset emissions in the face of this transformative mechanism.

But CBAM is not just a challenge; it’s also an opportunity. As manufacturers navigate this dynamic landscape, financial institutions find themselves in a position to offer critical support and expertise. Together, they can accelerate the transition towards a cleaner, more sustainable future. Join us on this journey as we decode CBAM and illuminate the path forward in the realm of cross-border carbon adjustment.

What CBAM is

CBAM is a part of several initiatives introduced under the European Green Deal in support of the goal to be the first climate-neutral continent by 2050. Following that aspiration, the EU is imposing various carbon tax regimes on European manufacturers, and introducing CBAM to even the playing field and eliminate price advantage for imported products from regions where carbon measurements may not be as stringent. In short, CBAM is a carbon tax applied on carbon-intensive products imported into the European Union, the amount equivalent to the tax applied to identical domestic goods for the same amount of GHG being emitted.

During its initial phase, importers will only need to report the emissions associated with the imported goods. However, in the later stage of the regulation, importers will have to purchase CBAM certificates to compensate for any difference in the carbon price paid in the country of origin as compared to the carbon price charged to producers in the EU. To implement this framework, the following data will need to be collected by importers:

1. 1. Total quantity of imported products
   2. Carbon price paid for the product in the country of origin
   3. Actual direct and indirect emissions of GreenHouse Gas (“GHG”) of the imported products

CBAM’s scope and timeline

The CBAM’s transitional phase will be enforced from October 2023 to December 2025. During this phase, importers will only need to report the data related to their imports as specified above. No data verification or purchase of CBAM certificates is needed. The scope of products covered during this initial phase is 6 emission-intensive sectors which are more susceptible to a risk of carbon leakage: cement, aluminum, fertilizers, iron and steel, electricity, and hydrogen.

The permanent system will enter into force in January 2026. Importers will not only be required to report CBAM-related data, but will also be required to have the data verified by an accredited verifier and purchase CBAM certificates for any gap in the carbon price paid. An extension of the product scope for CBAM after the transitional phase will be reviewed to assess practicality and feasibility of such inclusion. Potential product categories to be covered in the second phase include organic chemicals, plastics, and ammonia. The extension is planned for full implementation by 2030.

 

Deconstructing calculation of GreenHouse Gas emission under CBAM

The scope of GHG emission under CBAM guideline closely aligns with the emission scope set out by the GHG Protocol Corporate Standard (“GHG Protocol”). The GHG Protocol distinguishes between three scopes of emissions:

Source: Zevero

• Scope 1 refers to GHG emission from own operation or asset that the company emits directly such as use of fossil fuel energy used in production or transportation
• Scope 2 refers to GHG emission that company indirectly emits from supporting business activities such as electricity used in air conditioning or lighting
• Scope 3 refers to all GHG emission that the company may induce along its value chain, such as providing financing to GHG emitting businesses or the purchase of office supplies that may emit GHG during production

Source: European Commission

More specifically, direct emissions under CBAM equals to scope 1 emissions under the Greenhouse Gas Protocol, including GHG emitted directly during the production from combustion of fuel, or other byproduct emission incurred from material chemical reaction or heating and cooling process critical to the production. Accounting for the emission can either be based on actual measurement of the emission or calculation of emission using emission factor.

Indirect emissions under CBAM covers scope 2 and scope 3 of the GHG Protocol. Scope 2 reporting under CBAM only concerns electricity consumed during the manufacturing process of products, such as the lighting and air conditioning of the plant. As for scope 3, the biggest emission which is toughest to measure, CBAM only requires importers to report emissions from manufacturing of precursor input materials which are already under CBAM scope (cement, iron/steel, aluminum, hydrogen, and fertilizers). This initial stage does not necessitate complicated accounting of emission from activities like employee commuting or customer use of products. For more details on how to measure emissions for each sector, please find the European Commission’s guidance here.

 

CBAM: Shaping the Future of Trade and Sustainability – Implications for the Thai Economy

According to the Office of Industrial Economics, in 2022 Thailand exported $201 million of iron and $111 million of aluminum to countries in the EU. Although these only represented 1.3% of the total export in 2022, the scope of the extended CBAM covering other categories such as plastics will have greater impact as it accounts for $676 million or 2.4% of the total export.

All exporters for the above product categories will have a responsibility to report emissions to the EU, except products with value below €150 or products used in the military. After the transition period, Thai exporters will face an additional process of submitting the report to accredited verifier before the report will be deemed valid. They will also have to pay an additional cost of carbon tariff to the CBAM, net of any amount already paid in countries of origin.

Economic disadvantages to the Thai exporters

The price of carbon in the EU Emission Trading System, according to Statista, that will be used for carbon price reference in the initial implementation stage, has been fluctuating in the range of €80-€100 per ton of CO₂ during the first half of 2023. The price is predicted to jump even higher when the full CBAM mechanism comes into effect as there will be more demand to purchase allowances under the EU ETS when the free allowances gradually phase out. One way to illustrate how this translates into economic disadvantage for Thai exporters is to calculate the difference in emission cost per ton of product between Thailand and other competing exporters. Examples of carbon tariff comparison for iron products and primary aluminum are shown in the table below.

	Iron: Thailand	Iron: Global	Iron: EU	Aluminum primary: Thailand	Aluminum primary: Global	Aluminum primary: EU
1Carbon price (USD/tCO2e)	96.3	96.3	96.3	96.3	96.3	96.3
2Emission (tCO2e/ton)	1.55	1.40	1.14	12.24	12.50	6.20
Carbon Tariff (1*2) (USD)	149.48	134.82	109.78	1,178.32	1,203.75	597.06
Compare to Thailand (%)	N/A	-10%	-27%	N/A	2%	-49%

As can be seen from the table above, Thai exporters are at a disadvantage in terms of higher carbon tariff. This is even more accentuated when compared to the EU manufacturers. This additional cost which will eventually lead to higher price charged to the European buyers, or the exporter will have to take profitability hit by absorbing the increased cost. This will likely shift Thailand’s export of CBAM goods to other locations outside of the EU in the short- to -medium term, given that there’s other buyers. However, manufacturers will need to gradually upgrade their production technology to a greener one to stay afloat as other countries like the United States will soon be implementing a similar mechanism to curb GHG emissions.

Current progress from Thai government agencies

In response to this significant change, the Department of Trade Negotiations (DTN), the Federation of Thai Industries (FTI), and the Thai Greenhouse Gas Management Organization (TGO) collaborated to host a seminar on CBAM. This seminar aimed to educate stakeholders and gather feedback regarding concerns during the initial implementation phase. Thai manufacturers have specifically requested support for reporting technology, permission to utilize Thai accredited verifiers for cost-effective report verification, and leniency in penalties for unintentional reporting errors during the adaptation phase. Currently, the DTN and FTI are engaged in discussions with EU representatives to explore potential solutions that can mitigate adverse impacts on Thai industries. We anticipate learning more about the outcomes in the near future.

Earlier this year, TGO made a significant stride by forging a collaborative partnership with the Ministry of Higher Education, Science, Research, and Innovation, in conjunction with five prestigious universities, including Chulalongkorn University and Thammasat University. Together, they are crafting an innovative curriculum tailored for sustainability professionals, equipping them with specialized knowledge in carbon footprint management and carbon credit utilization. This educational initiative aims to provide invaluable support for businesses as they transition seamlessly into the CBAM.

In addition to this pioneering educational endeavor, TGO is also developing a platform designed for embedded emission calculation. This platform serves as a vital tool to assist Thai manufacturers in accurately reporting carbon emissions, thereby ensuring compliance with CBAM regulations. The platform is now in the pilot testing phase with the active participation of several volunteer companies. Once fully realized, this forward-thinking initiative is poised to significantly reduce costs associated with emission reporting for Thai exporters.

 

Navigating the Transition: Challenges and Manufacturers and Opportunities for Startups

To remain competitive in the long term, manufacturers must address three key activities: measuring GHG emissions accurately, reducing GHG emissions effectively, and transacting carbon offsets. Each of these activities comes with its own implementation challenges, which startups can seize as opportunities to provide solutions.

1. Accurate Measurement of GHG Emissions

Accurate measurement of emissions serves as the bedrock of CBAM and any effective emissions reduction strategy, echoing the timeless wisdom of Peter Drucker: “You can’t manage what you can’t measure.” Worldwide, startups are diligently working to address this pivotal task by introducing innovative solutions through carbon accounting platforms. Prominent players in the carbon accounting space, such as Terrascope, RIMM, Unravel Carbon, and others, have emerged to tackle this challenge head-on. In Thailand, TGO is actively engaged in the development of an embedded emission calculation platform, poised to bring substantial advantages to Thai exporters upon its completion. However, it’s crucial to acknowledge that this endeavor is anything but straightforward, as it grapples with a multitude of formidable challenges. To shed light on this complexity, let us explore some of the most salient hurdles.

1.1  Lack of Data Integrity which mainly stems from lack of accuracy in measuring scope 3 emissions and difficulty standardizing data from various sources such as different equipment types and different factories. Nonetheless, integrating these features into carbon accounting tools can both improve accuracy and reduce standardization problems.

1.1.1 Carbon calculators using emission factors (EF) – unlocking the power of granularity: One of the fundamental hurdles in accurate GHG emission measurement lies in the granularity and availability of data. EFs are industry-specific proxies that can be used to estimate the actual carbon emission, such as the amount of raw materials used or the production method that the manufacturer adopts.

1.1.2 Integration across supply chain – connecting the dots: To achieve accurate GHG emission measurement, we must track a product’s entire lifecycle, extending beyond individual factories to encompass a web of suppliers. Integrated supply chain tracking is the key. Imagine a system where emissions data from every supplier seamlessly merges into a comprehensive picture. This integration ensures the accurate measurement of scope 3 emissions, offering a holistic view of a product’s carbon footprint.

1.1.3 Blockchain carbon ledger – enhanced data integrity: Data integrity is paramount in GHG emission measurement. Inaccuracies often arise due to a lack of trust and transparency. Enter blockchain technology, promising enhanced verifiability and transparency. A blockchain carbon ledger securely records, time-stamps, and links emission-related transactions across a decentralized network. This not only bolsters the credibility of reported data but also allows stakeholders to trace emissions data origins precisely.

1.2  Labor Intensiveness. Current practice of emission measurement involves extensive manual processing which leads to excessive costs and is prone to errors. However, these can be solved by using automation and technologies.

1.2.1 Integration with systems and equipment – the power of automation: One of the pressing challenges in current emission measurement practices is their labor-intensive nature, often leading to high costs and error-prone outcomes. By integrating carbon accounting systems with tools like IoT (Internet of Things), ERP (Enterprise Resource Planning), or machinery, businesses can unlock the potential for automatic data retrieval based on activities. This shift towards automation significantly reduces the manual workload, making the process more efficient and cost-effective.

1.2.2 Optical Character Recognition – bridging the digital-physical gap: Physical documents have long posed challenges in the realm of GHG emission measurement due to their manual processing requirements. However, optical character recognition (OCR) technology provides a compelling remedy. OCR can automatically transform physical documents into digital formats, opening the door to efficient, automated processing for emissions calculations. By digitizing these documents, the entire process becomes faster, more accurate, and cost-effective.

2. Effective and Sustainable Emissions Reduction

Once emissions are accurately measured, manufacturers must reduce emissions during their processes to lower carbon tariff payment. However, this is hampered by technical limitations and economic constraints.

2.1  Technical Limitations. Addressing technical limitations in emissions reduction calls for a multifaceted strategy. Manufacturers grapple with three core challenges: the search for durable green material alternatives, the need for an ample supply of renewable energy for energy-intensive industries, and the imperative to mitigate high-emission manufacturing processes. In response, ongoing research and studies are relentlessly pursuing innovative solutions that encompass various aspects of emission reduction.

2.2.1 Innovative materials – pioneering more sustainable inputs: Promising alternatives are emerging, exemplified by initiatives like ELYSIS‘ development of inert anodes for aluminum smelting or HARBOR Aluminum‘s dedication to recycled materials. These innovative materials aim to reduce emissions and improve sustainability across industries.

2.2.2 GHG compound mitigation – preventing emissions at the source: Another avenue of exploration is the development of technologies that mitigate the formation of greenhouse gas compounds during manufacturing processes. Initiatives such as Analytics Shop‘s work on nitrification inhibitors in fertilizers and Hybrit‘s pursuit of hydrogen reduction in iron ore processing hold promise in this regard.

2.2.3 More efficient facilities management – smarter operations: Smart buildings, pioneered by companies like AltoTech, TIE-Smart, and Zenatix, are reshaping facilities management by optimizing energy usage and reducing emissions, contributing to sustainable manufacturing.

2.2.4  Use of renewable energy – filling the energy gap: Addressing the shortfall in renewable energy supply, especially for energy intensive industries, is critical. According to the Office of Natural Resources and Environmental Policy and Planning, Thailand, for instance, lags behind the EU, with only 11% of its energy consumption sourced from renewables in 2021. Thailand still has a lot of room to grow when compared to almost 40% in the EU. Providers like Clover Power and First Korat Wind offer renewable energy solutions that can help bridge this gap.

2.2.5 GHG capture technologies – seizing emission: Manufacturing plants are notorious sources of greenhouse gas emissions, particularly carbon dioxide (CO2), which is a primary contributor to global warming. By capturing these emissions at the source, we prevent them from being released into the atmosphere and exacerbating the greenhouse effect. Solutions such as carbon capture, utilization, and storage by Technip and Linde, along with direct air capture technologies developed by companies like Carbon Engineering and Climeworks, play a crucial role in capturing and mitigating emissions right at their source.

2.2  Economic Constraints: The economic constraints that often accompany the adoption of new and cleaner technologies pose significant challenges for manufacturing businesses in their efforts to reduce their carbon footprint. These constraints can manifest as high upfront investment costs, the need for workforce reskilling, and downtime of factories. However, manufacturers have several valuable options to navigate these economic challenges while advancing their sustainability objectives:

2.2.1 Sustainable Finance – accessing transitionary funding: One key strategy is to tap into sustainable finance options. Providers like GoParity and BluePath Finance offer gateways to sustainable financing, facilitating access to the capital necessary for investing in cleaner technologies. This approach not only aids in overcoming the initial financial hurdle but also aligns with broader sustainability goals.

2.2.2 Data Analysis and Tools for Emission Optimization – maximizing return on impact investment: In a world of budget constraints, where companies must make strategic decisions about where to invest for emissions reduction, data analysis and specialized tools play a pivotal role. The goal is to pinpoint precisely where within operations every dollar spent will yield the most significant reduction in carbon emissions. This approach empowers business owners to prioritize their budget effectively and make informed decisions about which areas to target for maximum impact on their carbon footprint.

2.2.3 Supply Chain Analysis – connecting the dots: Supply chain analysis plays a critical role in managing economic constraints while reducing carbon footprints. Manufacturers can seek out low-emission suppliers for raw materials within the scope of the Carbon Border Adjustment Mechanism (CBAM). Companies like Pantas and Terrascope specialize in supply chain analysis, helping manufacturers make informed decisions about sourcing materials from environmentally responsible suppliers.

3. Transaction of Emission Offsets

As manufacturers progress through the carbon reduction journey, the third crucial step involves addressing the remaining emissions either by making carbon tariff payments or through the purchase of carbon credits. While both options require a financial commitment, payments for carbon emissions to local organizations that support green initiatives within their own country is often the preferred choice. However, this stage introduces complexities that demand specialized knowledge to navigate effectively. Additionally, the EU has yet to announce clear regulations on framework for carbon credit purchase. We must closely monitor the forthcoming frameworks set to be released in the second quarter of 2025.

If permitted by regulation, the process of purchasing carbon credits operates within specific parameters. Manufacturers are likely to be permitted to purchase carbon credits, which can be deducted from their overall carbon tariff liability. The exact quantity and conditions of allowable carbon credits is subject to CBAM regulations and may vary based on factors such as industry type and historical emissions records.

Providers specializing in carbon credit exchanges, such as T-VER and Climate Impact X, along with renewable energy credit exchanges like Innopower, typically offer comprehensive guidelines and training to support manufacturers throughout this journey. The official CBAM website is also a valuable resource for staying informed about the latest terms and regulations updates. These resources help businesses navigate the complex landscape of carbon offset transactions, ensuring compliance with CBAM requirements and contributing to their sustainability goals.

Financial institutions’ roles to facilitate smooth transition to CBAM

As manufacturers embark on the multifaceted journey of carbon reduction and compliance with the Carbon Border Adjustment Mechanism (CBAM), they encounter a diverse range of challenges. From the meticulous measurement of greenhouse gas emissions to the implementation of innovative technologies for emission reduction, and finally, to navigating the complexities of carbon offset transactions, each step poses unique hurdles.

However, at the heart of these challenges lies a common thread: the need for financial resources to support the development and adoption of sustainable climate technologies. In the initial phases of measuring and reducing emissions, manufacturers often grapple with the financial burden of investing in new tools, processes, and infrastructure. This financial strain can be a significant barrier to progress.

On the other end of the spectrum, when it comes to carbon offset transactions, manufacturers face challenges rooted in knowledge gaps. The intricacies of purchasing carbon credits, understanding CBAM regulations, and effectively managing emissions offset strategies can be daunting without the necessary expertise.

This is where financial institutions (FIs) play a pivotal role in facilitating a smooth transition into CBAM. FIs are well-positioned to address both of these critical challenges.

Addressing Funding Challenges for Climate Technologies:

1. Provider of Low-Interest Green Loans: FIs can act as a lifeline by offering low-interest green loans to both retail customers and corporations looking to fund the development and implementation of climate-friendly technologies. Establishing clear eligibility criteria and monitoring guidelines for the use of these funds ensures they are directed toward emission reduction effectively. FIs can even collaborate with government agencies and regulators to design more favorable incentives at a policy level, specifically tailored to manufacturers under CBAM transition. Many banks worldwide are already participating in this green loan initiative, for example, Deutsche Bank, OCBC, BBL, and KBank.

2. Investor in Climate Tech Startups: FIs can further accelerate technology development by investing in climate tech startups through corporate venture capital arms. These investments not only inject capital but also foster innovation and growth within the climate tech sector. Examples of FIs who already committed funds for impact investing include HSBC and KBank.

3. Manager of Sustainability Funds: FIs have the capability to manage sustainability-focused funds designed for public investment. These funds can target companies that are actively involved in climate tech development or adhere to sustainability best practices. Such investments promote the growth of climate-friendly technologies and sustainable practices. FIs who are already in the space include UOB, Blackrock, SCB, and KBank.

4. Partner of Climate Tech Solution Providers: Collaborating with climate tech solution providers, FIs can offer emission reduction solutions, such as carbon accounting systems, at accessible prices to their clients. These partnerships expand the availability of essential tools for manufacturers seeking to reduce emissions.

Addressing Knowledge Gaps for Carbon Offset Transactions:

1. Trainer and Educator: FIs can organize knowledge-sharing sessions and seminars focused on CBAM and other sustainability-related topics. These educational initiatives empower manufacturers with the knowledge required to navigate the complexities of carbon offset transactions effectively. Examples of FIs who are already active in sharing knowledge with the public include Commonwealth Bank of Australia, Santander Bank, and KBank.

2. Sustainability Advisor to Clients: FIs can equip their relationship managers with expertise in climate tech and CBAM. This enables them to provide informed advice to clients and guide them toward valuable sources of information and third-party climate tech solution providers. FIs such as HSBC and KBank have already pledged resources to help advise clients in this field.

3. Resource Hub for Trustworthy Climate Tech Solutions: Leveraging their knowledge and extensive networks, FIs can curate a list of trustworthy third-party climate tech solution providers. Conducting due diligence on these providers and referring them to clients in need of emissions reduction solutions ensures that manufacturers receive reliable and effective assistance.

 

Closing thoughts

In the approaching era of CBAM, manufacturers are not embarking on this transformative journey alone. There is a collective effort involving various stakeholders, including business owners, SMEs, startups, investors, and financial institutions, all gearing up to navigate the changing landscape. The challenges and opportunities presented by CBAM are not isolated to a single industry or region; they resonate globally.

Startups, in particular, stand at the forefront of innovation to assist companies during this transition. Their pioneering spirit and fresh perspectives can play a crucial role in addressing the complexities of CBAM. By leveraging the solutions and expertise of these startups, manufacturers can avoid the need to reinvent the wheel, accelerating their path to compliance and sustainability.

While the initial impact of CBAM may seem modest for regions less reliant on carbon-intensive exports to the EU, it’s essential to recognize the broader shift occurring worldwide. The cross-border carbon tax era is dawning, with countries like the United States considering similar measures through legislation such as the Clean Competition Act, which will impose carbon taxes on carbon-intensive products imported into the country. This legislation is planned for enforcement in 2024. Iron products exported to the US in 2022 totaled $4,510 million and aluminum products totaled $1,433 million. This global movement towards carbon pricing underscores the inevitability of higher costs associated with emissions.

Manufacturers, in response, are already redirecting their efforts towards greener manufacturing technologies. While this shift may initially impact costs, it serves as a crucial step towards a more sustainable future. Ultimately, these higher costs will be reflected in the products reaching end consumers. As awareness grows and preferences evolve, the public is increasingly inclined to favor low-carbon products, paving the way for a more environmentally conscious marketplace.

In embracing CBAM and its associated challenges, there is a collective opportunity for positive change. Manufacturers, startups, investors, and financial institutions are poised to collaborate in shaping a cleaner and more sustainable future. As we collectively adapt to this new era, the transition towards a low-carbon economy offers not just challenges but a compelling vision of a greener, more environmentally responsible world.

 

Author: Benjamas Tusakul

Editor: Woraphot Kingkawkanthong

 

References

• • https://www.consilium.europa.eu/en/press/press-releases/2022/03/15/carbon-border-adjustment-mechanism-cbam-council-agrees-its-negotiating-mandate/
  • https://kpmg.com/xx/en/home/insights/2022/08/carbon-border-adjustment-mechanism-impacts.html
  • https://taxation-customs.ec.europa.eu/carbon-border-adjustment-mechanism_en
  • https://www.pwc.ch/en/insights/tax/eu-deal-reached-on-the-cbam.html
  • https://www.europarl.europa.eu/legislative-train/package-fit-for-55/file-carbon-border-adjustment-mechanism
  • http://env_data.onep.go.th/reports/subject/view/128
  • https://watchwire.ai/5-carbon-accounting-challenges-and-how-address-them/
  • https://www.pwc.com/m1/en/services/tax/me-tax-legal-news/2023/eu-carbon-border-adjustment-mechanism.html
  • http://www2.ops3.moc.go.th/
  • https://mgronline.com/business/detail/9660000048165
  • https://carboncredits.com/congress-introduces-us-cbam-clean-competition-act/

Image by Finboot

Blockchain and its underlying technologies have been around since the late 1970s and were brought to life from the introduction of Bitcoin in 2008. The general public might associate blockchain technology with just cryptocurrency, but the application of blockchain technology goes beyond that. As people see that blockchain is a valuable technology due to its nature of transparency and traceability, automation (from smart contracts) and decentralization, the technology has been evolving tremendously over the past years to include new use cases in several sectors such as banking, supply chain, healthcare, etc. The technology is considered to be on the path to mainstream adoption in coming years.

On the other hand, the topic of Environmental, Social and Governance (ESG) has been a growing topic of interest and businesses have to fine-tune their operations to raise the standards and accountability to comply with the current and upcoming regulations. Blockchain offers a great fit for organizations that have a desire to initiate and/or incorporate ESG initiatives to their existing operations and manage relevant reporting requirements.

In this article, we will discuss the current use cases of blockchain in Environmental, Social and Governance aspects, current and foreseeable challenges from leveraging blockchain to tackle the ESG issues and implications to financial institutions (FIs). 

 

When Blockchain Collides with ESG 

Conceptually, the key strengths of blockchain of traceability, automation, and decentralization could be translated to an increase in transparency, efficiency and accountability across Environmental, Social and Governance elements in several meaningful ways.

Nevertheless, the intersection of how blockchain and ESG could work together is only at the beginning of formation, as blockchain is still considered as an emerging technology and the ESG impact measurement and reporting practices are still under development. Due to the urgency of the problem and suitability of using blockchain technology, there are a number of use cases on the Environmental aspect, compared to Social and Governance elements that are still in the exploration phase. 

Image via  iStock by Sakorn Sukkasemsakorn

Environmental x Blockchain 

There are growing use cases in the Environmental aspect by utilizing blockchain technology particularly the infrastructure levels to promote transparency and efficiency such as energy management, deployment of renewable energy, recycling etc. Nevertheless, there are three main use cases of blockchain technology consisting of tracking, trading and compliance, which are currently implemented across different industries. 

Tracking: 

The immutable ledger of blockchain enables a better transparency to the supply chain. The companies can track the movement of materials from the point of origination to the destination, leading to the opportunity to pinpoint the area of inefficiencies, energy usage, and carbon emission. The traceability allows the companies to better reduce waste and carbon footprint, control that the production is operated in a sustainable manner and promote economic circularity from recycling materials and transparency to consumers. For example, Food Trax is a farm-to-fork traceability solution provider enabled by blockchain technology to eliminate food waste from storage and improper operations and offers better visibility of consumers. The company is developing a solution to collect and monitor various data points leveraging RFID, variable data printing, scanners, mobile computing platforms, and et cetera to cover all steps in the supply chain. The transparency yields an increase in revenue and higher brand loyalty from clients.  

Trading: 

One of the main advantages of blockchain is its ability to provide a more effective and efficient settlement process as the nodes/validators certify the transaction and all members in the network have the same record, reducing the need for reconciliation. Blockchain could be the backend technology for the trading of sustainable financial products such as green bonds and renewable energy credits including renewable energy certificates (RECs). Additionally, tokenization of real-world assets such as carbon credits can enable more efficient trading by reducing the investment ticket size from fractionalization, increasing price discovery and liquidity to the market and performing almost real time settlement. Consequently, businesses and individuals can participate and promote the growth of renewable energy and sustainable production. For instance, Toucan Protocol is developing technology to bring carbon credits to an open blockchain, allowing everyone to have an access to the carbon markets. The protocol has built Carbon Bridge to tokenize the carbon credits by transferring certified carbon credits onto Toucan’s system and mint TC02 carbon tokens. TC02 carbon tokens can be staked into Toucan’s carbon pools with each pool linked to credits with similar characteristics and receive carbon pool tokens, a fungible token backed by one tokenized carbon credit. This mechanism allows carbon pool tokens to be traded in decentralized exchanges and used as collateral in the lending markets, paving the green building block in Web3. 

Compliance: 

The transparent nature of blockchain as well as smart contracts, a self-executing program that automatically executes the required actions if the conditions are met, could help companies to comply with the ESG standards. As the companies are able to trace its supply chain, they could report the emission and trading of carbon offset in a more accurate manner. Furthermore, smart contracts could help automate the enforcement of sustainability and ethical practices. This could help smaller companies with limited time and resources in their ESG monitoring and reporting endeavors. One of the companies helping companies to comply with ESG reporting using blockchain technology is Diginex. Its DiginexClimate integrates climate-related data to the existing ESG reports that companies have to do and comply with the company’s reporting requirements covering different frameworks such as GRI, SASB and TCFD. The solution could greatly save time and cost for businesses following the ESG standards. 

Social x Blockchain 

It is undeniable that the general media usually ties cryptocurrencies with criminal activities. However, according to Chainanalysis, in 2022, only 0.24% of all cryptocurrency transaction volume is associated with illicit activity. In contrast, cryptocurrency and blockchain could bring the ‘good’ to society by providing solutions to promote financial inclusion and facilitate humanitarian causes. The most developed use case is payment for cross-border payments, domestic transactions and payment for humanitarian causes. 

Cross-border Payments

Due to Blockchain’s decentralized nature and the ability to transact without intermediaries, crypto transactions could be faster, cheaper, inclusive and censorship-free. This means that cross-border transfers can be made with smaller amounts at a much lower cost than the traditional money transfer. A report by Oliver Wyman and J.P Morgan found that digital currencies could save global corporations $120 billion a year in transaction costs for cross-border payments. They are arguably a better alternative than cash in countries with volatile and/or depreciating local currencies. 

Domestic Transactions

Nations are separated into two schools of thoughts regarding regulations of crypto as means of payment. Thailand and China as examples of viewing crypto as means of payment on a stricter side. While Thailand has regulations supporting digital asset businesses, the country banned cryptocurrencies as a method of payment. The Thai Securities and Exchange Commission (Thai SEC) stated that digital assets do not provide improved efficiency to the payment market because of their volatility and high transaction fees. China wiped out trading and cryptocurrency mining. 

El Salvador and Ukraine, on the other hand, legalized crypto transactions. El Salador has made bitcoin a legal currency and aimed to become a hub for crypto activity. Additionally, in 2022, Ukraine passed a law that creates a legal framework for the cryptocurrency industry in the country. The first use case was accepting donations toward its military defense against Russia via bitcoin and ether.

Payment for Humanitarian Causes

Apart from the commercial use case of payment, cryptocurrency could also support humanitarian causes. One of the prime examples is a project by the United Nations High Commissioner for Refugees (UNHCR) and the Stellar Development Foundation, a nonprofit that supports the growth of the Stellar blockchain network. UNHCR realized that some refugees do not have a bank account and cash is difficult to move around. The two organizations are working alongside MoneyGram, a money transfer company, and Circle Internet Financial, an issuer of the USDC stablecoin, to deploy an alternative system to send aid directly to Ukrainian refugees using cryptocurrencies. The UNHCR delivers USDC through the Stellar network to a refugees’ digital wallet installed in their smartphones. The refugees then exchange USDC for local currency at the MoneyGram facilities.

Governance x Blockchain 

Blockchain advocates argue that decentralization promotes good governance from the absence of a single point of failure. No single entity has control over the network. Nevertheless, to fully and properly govern the networks, it will take time for stakeholders to participate, design and enforce rules to ensure stability, and penalize bad actors. There are two emerging use cases for the Governance aspect that blockchain could provide value-adds on the transparency consisting of measuring and assessing ESG milestones and blockchain voting. 

Measurement and Assessment of ESG Milestones

Blockchain networks with decentralized databases could help entities measure and prove ESG milestones. Participants in the network may include vendors, suppliers, internal business divisions to share information such as product tracking, carbon emissions and labor conditions. Smart contracts embedded in the blockchain networks can be applied to automatically disclose the data, all without the need for human intervention. The regulators or a credible third party could securely access the collected data and verify whether the organizations are meeting standards as claimed. Blockchain could act as a tool to boost transparency.

Blockchain Voting 

Blockchain voting has been in discussion globally. This use case is still in its early stages, and there are many challenges to be addressed through several pilot testing before implementing nationwide. However, several countries have put efforts and endorse blockchain voting. In October 2022, Cointelegraph reported that Greenland was exploring an online voting platform, which may be based on blockchain. In November 2022, South Korea became the first country to set up an online voting system based on blockchain making sure each vote is secured and cannot be manipulated. In India, blockchain-based voting has been tested for Telagana’s municipal election in 2021. The pilot showed positive signs; however, more pilots are needed to fully implement the system. 

 

Challenges of Utilizing Blockchain in the ESG Space

Despite a lot of benefits that blockchain technology could bring to support ESG initiatives, there are a few points that also need to be considered as blockchain is not problem-free. The current challenges of using blockchain can be seen from both the technology layer and its applications across Environmental, Social and Governance aspects. 

Technology Layer of Blockchain 

Blockchain is mainly a backend enabler

Blockchain technology does not help businesses determine what kind of data to collect, measure or verify but it is rather an enabler to make the process more efficient. It is important to determine which types of data, verified or unverified, to be uploaded to a distributed ledger or set rules on how to differentiate them as the uploaded data cannot be changed and can affect business’s data usage and compliance with the ESG standards. 

Blockchain technology is still in its early days

Blockchain technology is considered as an emerging technology. The infrastructure is yet to be fully developed despite its proposed potential to disrupt several industries. Additionally, companies across verticals are still at the beginning stage to integrate blockchain to their current operations. Therefore, the technology is still evolving and it has to be developed in parallel with the initiatives in the ESG space through trial and error. 

Applications of Blockchain Across ESG Aspects 

(E) Utilizing energy-inefficient blockchain create environmental impact 

By using blockchain with Proof of Work (POW) consensus like Bitcoin, it is very energy-inefficient as the miners who compete among themselves need to use a lot of electricity to tackle computational problems to get a chance to validate the transaction and receive reward. It creates more problems than trying to solve the environmental impact. Therefore, it is crucial to use energy-efficient blockchain, which can be Proof of Stake (POS) consensus, to decrease carbon emission or use POW blockchain that uses electricity from renewable energy sources. 

(S) Crypto space has been plagued with fraud and cybercrime

Given the nature of blockchain, it attracts fraudsters to continue to exploit user’s funds as crypto transactions could not be reversed and no personal data is required to receive cryptocurrencies for the non-custodial wallet. The safety of user’s funds is often compromised and causes tremendous loss to the users. It is very important for both centralized and decentralized platforms to step up in the game to enhance their technology stacks/codes to increase platform securities, improve ID-proofing without increasing onboarding friction and/or utilize data enrichment tools to get to know more about the users. These solutions could help prevent scammers from participating in crypto activities. 

(G) Blockchain also subjects to risks of bias and conflict of interest

Despite blockchain’s benefits of transparency and automation, the design of the blockchain that involves human decision-making can be flawed with human biases. Conflict of interest also arises when people behind the code design do not put the users at heart. Certain groups of users, especially minorities or marginalized populations, might be treated differently and not have the access to a particular product/service or users’ data might not be properly managed. Ethical code of conduct and regulations could potentially solve the issues and govern blockchain technology. There is no bullet-proof solution at the moment and awareness on these risks is needed to be able to utilize the technology in a fair and appropriate manner. 

How the Concept can be Applied to Financial Institutions 

Apart from using blockchain as a backend technology for financial institutions (FIs), the institutional adoption of Web 3.0 is becoming an increasingly popular topic as digital assets are seen as a portfolio diversifier and can create more yields in a portfolio and treasury account. A relatively new concept such as Regenerative Finance (ReFi) is also being discussed on how Web 3.0 and FIs could play in the space such as responsible lending by taking into account environmental and social factors. 

While Web 3.0 gives people sole control over data and assets, it comes with complexity. Unclear regulations, complicated user experience and limited scalability and interoperability hinder the growth of institutional adoption in the space. Web 2.5 may help solve the issue. Web 2.5 is used to describe blockchain businesses that operate in between Web 2.0 and Web 3.0. “The idea behind Web 2.5 is that consumers want the advantages of a blockchain-based platform. However, they don’t want the complexities and friction that often come with blockchain-based systems.”, DropChain explained.

Web 2.5 takes advantage of both worlds by prioritizing privacy and decentralized nature while maintaining the ease and accessibility. Blockchain technology is used at the infrastructure level and appropriate Know Your Customer (KYC) measures take place to mitigate the risks for sensitive financial data.  

With the concept of Web 2.5, blockchain could help solve the challenge of FIs and their customers across ESG aspects.

• Improve Internal Infrastructure

Financial Institutions could build and/or integrate blockchain-based Infrastructure for collecting, tracking and tracing data for ESG-linked bonds, green loan origination and credit rating embedded with ESG factors. As multiple parties are involved in ESG measurement from data collection to validation, Web 2.5 could bridge the gap by providing a secure and transparent platform with ease of use to all parties.

• Collaborate with External Parties

Financial Institutions can collaborate with external parties by leveraging their solid compliance capabilities or partnering with blockchain companies to expand reach of existing businesses or build new products/services. FIs could provide modular services such as KYC services to partners and clients to reduce risks and comply with current regulation and ESG standards. FIs could also partner with trusted blockchain companies to support open finance initiatives and improve financial inclusion such as providing access to low-cost cross-border payment for foreign workers or unsecured personal loan. 

Conclusion

Although blockchain proposes a lot of potentials to support the growth of sustainability going forward, the technology is not a panacea for tackling all the sustainability issues and there are a number of challenges that blockchain has to overcome to maximize its capabilities. The organizations including financial institutions need to define their sustainability goal then initiate strategies which involve the identification of which tools, technologies and partners would work best for them to accomplish impactful outcomes for the organizations and the society. 

 

Authors: Wanwares Boonkong (Pin), Panuchanad Phunkitjakran (Pook)

Editor: Woraphot Kingkawkantong (Ping)

The World with Carbon Tax: Impacts and challenges to businesses, consumers and governments

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The world is getting warmer 🔥

The world is getting warmer, and has been for 46 consecutive years. 

We, humans, are the main cause of the change. We cause climate change by emitting greenhouse gas (GHG) from activities like burning coal or flying airplanes. Climate change matters because it affects the lives and safety of all living organisms on earth. People have already had to relocate due to a rise of sea-level or droughts, and animals and plants face the danger of going extinct. With an ongoing emission rate, the United Nations expected that the number of “climate refugees” will further increase. 

In December 2015, countries signed the Paris Agreement to limit global warming and to reduce greenhouse gas emissions (most commonly tracked as carbon emissions) as soon as possible. According to the IMF, 140 countries (accounting for 91 percent of emissions) have already proposed or set carbon net-zero targets for 2050.

While government support is vital for hitting carbon reduction targets, continual subsidies are not sustainable. Market mechanisms like carbon taxes and trading systems are arguably among the easiest and most cost-effective ways to achieve the targets by shifting the burden to those who are responsible for it.

Carbon taxes provide economic incentives 🤑 to reduce emissions 

Large-scale capital and financing is required to significantly reduce emissions. The Intergovernmental Panel on Climate Change (IPCC) reported that all countries are massively short on decarbonization funding. Carbon credit markets, where carbon credits are bought and sold, could solve this issue by shifting funds from heavy emitters to people and organizations decarbonizing the economy. Broadly, there are two types of carbon credit markets: compliance (regulatory requirement e.g. cap-and-trade in which factories are allowed to emit specific amounts of emission and trade emission-reduction to others) and voluntary (to issue, buy and sell carbon credit on a voluntary basis). A carbon price stimulates clean technology projects and innovation. However, building integrity in carbon markets is key, as the ultimate goal is to reduce emissions, not just force emitters to pay for it.

Illustration A: Carbon credit market allows reallocation of capital to carbon-reduction projects

Source: Beacon VC

Generally, carbon credits are generated from verified carbon or GHG reduction projects, and can be traded to a carbon emitter who wishes to offset their carbon emissions. For example, solar panel deployment or tree planting projects are converted into tonnes of carbon dioxide equivalent or tCO2e. Those offsets are priced in USD or Euro per tCO2e for trade. There are two main types of offsets: carbon avoidance (reducing emissions from existing or future operations) and carbon removal (removing carbon or equivalent GHG from the atmosphere).

Under a carbon tax, emitters must pay for each ton of greenhouse gas emissions they emit. Taxes act as financial incentives for corporations and individuals to reduce emissions, switch fuels, and adopt new technologies to reduce tax burden. 

According to the World Bank’s carbon pricing dashboard, carbon pricing (carbon tax and emission trading system) initiatives have been implemented globally (see Illustration B). As of April 1, 2022, 103 national jurisdictions have initiated carbon pricing, covering 24.30% of global GHG emissions. Of those, 47 have implemented or considered implementing carbon tax. In Europe, carbon credit pricing ranges from less than €1 per metric ton of carbon emissions in Poland to more than €100 in Sweden. The tax rate and tax scope can vary based on the types of GHG and countries’ policies; for example, while carbon tax in Spain only applies to fluorinated gasses, other countries cover most types of GHG emissions. 

Illustration B: Carbon Pricing Implementation Globally

Source: State and Trends of Carbon Pricing 2021. (World Bank, 2021)

In Thailand, more progress has been made on carbon markets than on taxes. In 2014, Thailand Voluntary Emission Reduction Program (T-VER), a voluntary carbon credit market, was introduced by the Thailand Greenhouse Gas Management Organization (TGO), a public entity set up by the government to promote sustainable low-carbon economy and society. Since 2015, T-VER has issued and certified (to measure and verify carbon reduction) 141 projects. The amount of GHG reduction from the projects grew at 45% CAGR from 2015 to 2022. 

Most T-VER projects are carbon avoidance projects, which commonly replace coal energy with green energy such as wind or biomass. Other projects such as forestation are nature-based carbon removal projects. There is also growing interest in technological solutions for carbon removal such as direct air capture technology. This technology pulls carbon dioxide from the air and safely stores it. For example, Climeworks AG captures carbon and stores it underground. Carbon Limit produces cement that absorbs carbon from the air. However, the challenge for technological solutions is scalability, which could lower the cost of adoption and encourage mass deployment.

On the one hand, the timing and scope of carbon taxes in Thailand are still being debated, though there are positive signs that Thailand will implement a carbon tax economy. Mr. Ekniti Nitithanprapas, ex-Director General of the Tax Revenue Department said that “Thailand cannot avoid collecting carbon tax because many other countries have already started doing it. If Thailand does not collect carbon taxes on these goods, exporters will have to pay the tax at the destination EU nations. If we collect the tax in Thailand, we will negotiate with the EU to exempt the goods from double carbon tax.” It seems likely carbon taxes will be implemented, but the big questions are when and how. 

Illustration C: Statistics of Issuance of T-VER 

Source: TGO, adjusted by Beacon VC

Carbon Post Tax Economy 🌏 

Carbon tax will drive higher costs of energy-intensive goods and shift the way consumers and businesses make decisions. However, the quantifiable effect of the carbon tax is still debatable. While it is believed that carbon tax would positively impact emissions, policy makers may have  concerns about a negative impact to the economy. However, most economists who have analyzed the situation argue that there will not be a negative impact on the economy.

Since carbon taxes will drive costs of energy-intensive goods, The National Institute of Economic and Social Research expects carbon taxes to drive inflation in the short term and lower GDP by 1-2% in carbon-intensive countries. In the longer term, the effect on the economy depends on how revenues from the tax are used. The UN’s ESCAP is also optimistic that the tax revenue will have a positive effect on GDP in the long run by increasing economic activity and reducing poverty and GHG emissions. Other economists believe there will be little or no impact on GDP and unemployment. They believe that long run GDP growth rates are driven more by fundamentals than by policy variables such as tax rates, and therefore unlikely to face negative impact from implementing carbon tax policies.

GDP measures production capacity and economic growth; however, it does not explain the market trend and behavioral shifts. Carbon tax could potentially accelerate changes of consumer behavior. Consumer behavior changes overtime and changes fast. Robert H. Frank wrote in The New York Times about behavioral contagion that even though the carbon tax could affect a small group of consumers, the behavioral change could spread like “infectious diseases.” Similar to cigarette taxes, carbon taxes affect a small group of people which could expand rapidly by network effect. In turn, consumer preferences impact business decisions. 

With or without a carbon tax, businesses will already face various risks ranging from climate change, price of raw materials, consumer preference and regulation. Carbon tax would likely increase administrative burden and costs of running business especially in carbon-intensive industries such as oil and gas, power generation, transportation, and construction. The costs may translate into higher prices to end customers, so businesses must identify the risks and design strategy going forward.

Challenges

The big challenge is to align incentives to truly reduce emissions. Carbon credits (especially in Thailand) focuses on monetizing existing projects, not building new ones. Those credits, therefore, do not contribute to carbon reduction. Additionally, with different tax policies, businesses may seek to move to operations with less stringent policies and, as a result, increase total emissions. Other complex issues include double-counting of emission reduction, and greenwashing (companies falsely market their green credentials).

Stakeholders are trying their own ways to solve those issues. Some startups are trying to solve these problems. ImpactScore and Good on You provide a “green” score for shoppers to check and help alleviate greenwashing issues. Companies are looking to create data solutions such as IoT devices for greater traceability and apply ESG information disclosure and standards. Governments, together with non-profit organizations, are working on policy alignment to reduce emissions worldwide. Financial institutions are designing mechanisms to alleviate initial high ESG adoption costs to businesses and consumers. 

Closing Thoughts

It is abundantly clear that global warming poses a major threat to society. Nations worldwide have agreed to slow down and ease the threat of global warming, leveraging various initiatives to incentivize reduction of the GHG emissions which are the cause of global warming. Carbon tax policies may be a catalyst for speedier adoption of green energy and technology to reduce or avoid carbon emissions in the private sector. Consumers and businesses are also paying more attention to carbon reduction and ESG risks. Based on the shift in consumer preferences, it is expected that more goods and services labeled ESG will be sold, though the challenge of how to prevent greenwashing and ensure that consumers can effectively express their preferences remains. 

Beacon VC is excited and ready to support its parent company, Kasikornbank, across a wide variety of impact initiatives, particularly with regards to sustainability and net zero carbon targets. Beacon VC has recently launched the “Beacon Impact Fund” to invest in startups seeking to create a positive impact on ESG issues. The Beacon Impact Fund is part of Kasikornbank’s overall sustainability strategy and leadership vision in the field of ESG finance.  Both Beacon and Kasikornbank are committed to upholding ESG principles and paving the way for Thailand’s transition into the new world.

 

Author: Panuchanad Phunkitjakran (Pook)

Editors: Krongkamol Deleon (Joy), Pajaree Prasitsak (Wan), Woraphot Kingkawkantong (Ping)

Digitalization has influenced banking services around the world to move online. It is common these days to see bank branches closing down as many commercial banks have shifted their focus to digital banking in order to better serve customers’ demands and satisfaction. However, even in countries like Thailand, which is known for having high smartphone and social media penetration rates, many people are still needing to wait in line at bank branches to conduct their own financial transactions or to seek assistance in obtaining government financial aid (aid which is provided via an online system such as “Khon La Khrueng” or คนละครึ่ง). Understanding why these situations occur helps to highlight the fundamental problems that need to be fixed to ensure that everyone is included in the new digital economy.

 

What are the Causes of Digital Inequality?

Digital inequality refers to the disparities in knowledge and ability to use digital and information technology based on different demographics, socioeconomic backgrounds, and information technology experience and competencies. The problem is not merely one of access, as disparities also exist among people who have access to digital technology. The digital gap is also caused by lower-performance computers, lower-speed wireless connections, and limited access to subscription-based content.

 

These disparities stem from barriers in three areas: availability, affordability, and adoption.

1. Availability: digital infrastructure needed to access online services through alternative channels, such as wireless data plan, wired broadband, and fiber services.
2. Affordability: to stay connected, individuals must pay for device acquisition and service subscriptions, which are continuous expenses. 
3. Adoption: people are prevented from utilizing the internet by knowledge hurdles, such as a lack of digital literacy or educational constraints.

 

Digital Inequality is a Human Rights Issue

Computers and smart devices have become vital to almost every aspect of daily life, from fundamental activities like paying bills and shopping, to more enjoyable activities like entertainment and socializing. They are also essential for maintaining relationships with loved ones. Access to the internet has opened up new opportunities for employment, health care, financial support, and pursuing both informal and formal education. Those without access to the internet are missing out on information that may help them find jobs, online entertainment, and many other essentials. Research shows that households that adopted broadband are on average 8.1% more likely to be employed, and earned on average 2,202 USD higher annual household income. Lack of internet access has also been consistently linked to a high risk of mortality from COVID-19. Hence, the capability to access and work with data and digital technology should be considered as fundamental human rights. Without it, there are no opportunities to access what the knowledge economy and digital connectivity can provide.

 

Is Inequality Persistent in Thailand?

Thai people are renowned for being active online with some of the highest proportions of social media users in the world. Approximately 50.05 million Facebook users are located in Thailand, representing 71.5% of the country’s population. The smartphone penetration rate was 59.3% in 2022, ranking Thailand the 12th place in the world. Thailand also ranks 87th in the world with 54.5 million internet users (77.8% of the country’s total population).

 

While Thailand’s internet availability is high, affordability and adoption remain problematic. According to the International Telecommunication Union (ITU) and TDRI, only 21% of Thai households have computers, which is lower than the global average and the developing countries’ average, at 49% and 38% respectively. Moreover, computer affordability is worse for low-income households. According to the National Statistical Office of Thailand in 2017, only 3% of low-income households (households with an average annual income of less than 200,000 baht) have Internet-connected computers, compared to 19% of households with higher income. Low accessibility to proper digital devices has caused immense inequality for Thai students’ education, especially since the start of the Covid-19 pandemic. Covid-19 has widened the gap of digital divide among students as learning has been moved online. Recent studies suggest  that learning loss will be the greatest among low-income students as they are less likely to have access to high-quality remote learning or to a conducive learning environment, such as a quiet space with minimal distractions, to devices they do not need to share, to high-speed internet, and to parental academic supervision. 

 

Digital inequality has not only amplified the importance of technology in education, but also affected the wellbeing of Thais. During the pandemic, the Thai government offered subsidy programs to help Thai citizens with their economic hardships. The most well-known package was “Khon La Khrueng”, roughly translated as “Let’s Go Halves”, in which the government subsidized half of all qualifying payments via an e-wallet application. To sign up for government’s aid and make payments, individuals needed to have internet-capable devices, data plans, and access to Wi-Fi to receive the benefit. 

 

Given Thailand’s smart device penetration rate of 59.3%, this meant that almost half the Thai population were excluded from the government program. Challenges also emerged in relation to adoption: elderly and low-income persons who were likely to be targets of such campaigns were also less likely to be familiar with using mobile applications.  

 

Due to these issues, the government was pressured to allow people to register for “Khon La Khrueng” offline at branches of government-supported banks, resulting in lengthy waiting lines. The congestion at the banks made many people lose work opportunities while still not alleviating the struggle to register for the package. This case truly highlights the need for digital education to be able to obtain a fundamental support population in the present world. 

 

What Has Been Done to Reduce Digital Inequality

As highlighted previously, there are three main obstacles that prevent the realization of digital inclusion: availability, affordability, and adoption. This section will focus on the approaches taken by private organizations, governments, and financial institutions to reduce the gap in each dimension.

 

Availability

Hardware innovation has emerged as a way to improve the accessibility of the internet. Starlink, a low-latency broadband internet system project, has introduced the internet via satellite, which is expected to benefit people in remote areas where telecom cell sites and fixed broadband internet services are inaccessible. The average download speed for Starlink is slightly below the average for the entire fixed wireless internet category, at 105 Mbps and 131 Mbps respectively (though far better than rivals Viasat and HughesNet). Although there is still much to be done (Starlink will likely need at least 10,000 satellites to cover a majority of the globe), rapid progress has already been made, with Starlink available in 32 countries, using more than 2,300 satellites.

 

Governments are also acknowledging and trying to solve this infrastructure issue. Net Pracharat, a nationwide project aimed to extend high-speed internet to all villages in Thailand, covered 24,700 villages with free public Wi-Fi hotspots in 2017 and reached 6.6 million users in 2019. However, problems remain. Internet use from community locations declined during the pandemic as a result of concerns regarding the spread of Covid-19 in public areas.  Similar projects have been developed to increase internet connectivity, including National Broadband Plan (Philippines) and Palapa Ring (Indonesia). This highlights the need to expand internet connectivity programs to households, not just public areas. 

 

Recently, Kasikornbank has introduced “Solar Plus”, offering a free of charge service of solar roof installation for Thai households. Proven by Teltonika and Bartech, the service could be combined with cellular routers, offering internet connectivity for households. This self-sustained technology would provide the end-users superior internet connection in places without access to the power distribution grid. It would therefore allow expansion of internet connectivity at a more affordable price.

 

Affordability

Although the price of internet devices has been declining, upfront costs remain a major barrier for the low-income population. Thus, some governments have implemented smartphone and computer subsidies for low-income or senior citizens to increase adoption. For example, Singapore has a program called “Mobile Access for Seniors” which provides subsidized smartphones and mobile plans to low-income seniors.  The Singaporean government has also offered affordable-price computers to students or persons with disabilities who come from low-income households via the project “NEU PC Plus”. The Vietnamese Ministry of Information and Communications in collaboration with smartphones’ manufacturers launched a universal smartphone program, aiming to push smartphone penetration to 100% by reducing the price of a smartphone to approximately 20 USD. 

 

Private entities have also begun finding ways to reduce this gap. For example, UOB launched a project called “UOB My Digital Space” which provided students in Singapore with digital learning devices including a new laptop and a Wi-Fi dongle with monthly data usage together with online learning resources to take them beyond the school curricula for their longer-term development.

 

Adoption

To date, most efforts aimed at closing the digital inequality gap have focused primarily on availability and affordability problems. Although investment by government and private sector players to build out the requisite infrastructure and make internet service affordable are critical, the benefits will not be fully realized if households lack the knowledge to use and fully realize the benefit of these services. Accordingly, several startups have emerged to tackle this challenge. Jules, a Singapore-based startup, works with 200 preschools in Singapore, Malaysia, Vietnam, Taiwan and China to train children between the ages of four to eight in computational thinking. The company runs a “School of Fish” curriculum where children are taught digital skills such as programming, animation, and game design through games and animated storytelling. Ruangguru is an Indonesia-based startup that collaborated with the country’s Ministry of Communication and Informatics (Kominfo) to create Indonesia’s Digital Literacy Space Program in 2021. The company created content that covers digital security, digital ethics, and digital culture. The program is expected to train 50 million students by 2024. In addition to startup efforts, Saturday School, a Thai educational non-profit foundation, creates the Saturday Film camping program aiming to equip students with the skills necessary to convey stories through various kinds of media. The foundation has also partnered with corporations to foster children’s digital literacy via several projects including Young Safe Internet Leader Camp Version 1.0.

 

Financial institutions are also launching initiatives to increase digital literacy. KLOUD is an example of a project by Kasikornbank that aims to facilitate individuals’ learning by offering a co-working space to offer an alternative space to students who lack internet access or appropriate learning environments. KLOUD also hosts knowledge sharing events for the public, including financial literacy, cyber literacy and green awareness. 

 

The adoption barrier is also a huge threat for ASEAN nations competing in the digital economy. Despite having the third largest population in the world, the sixth highest GDP, and the fourth highest trade value, ASEAN’s digital economy only accounts for 7% of its GDP, lagging behind China’s 16%, the EU-5’s 27%, and the US’s 35%. Accordingly, the Go Digital ASEAN program was launched to increase digital skills participation across all 10 ASEAN nations, reaching everyone from farmers and home-based handicrafts producers to small-scale hotels, restaurants, and shops. The project has already reached Phase 2, which will provide more advanced training for up to 200,000 underserved MSMEs on skills like business and financial literacy.

 

Closing Thoughts

Digital inequality is not all about internet connectivity. Despite considerable investment to develop the necessary infrastructure, the advantages will not be fully realized until people embrace and use the services. In other words, the affordability of data plans and devices together with digital literacy are essential to cope with the digital divide.

 

Although the situation of digital inequality in Thailand is relatively less severe compared to neighboring countries, many Thai students were still left behind when in-class instruction switched to online learning. Thais from lower socio-economic backgrounds were also left behind with unequal access to government programs intended to provide economic relief.

So far, both private and public sectors have made tremendous efforts to narrow the digital gap and include all people in digital transformation. Still, there are countless steps left to reach the goal of digital equality. Research shows that digital agents are crucial for getting people to adapt to digital technology. Banks can utilize their current resources, primarily staff and physical branches, to deploy agents and help close the inequality gap. Particularly in Thailand, bank branches are all over the country and can play a leading role in driving adoption in rural areas. As financial transactions are increasingly executed online, instead of laying off branch staff, banks may consider changing their role from day-to-day transaction operators to digital navigators who can educate banks’ clients in-person about how to make financial transactions online, troubleshoot issues, and other digital skills such as helping them to become familiar with banks’ digital products. This transformation shortens the time to achieve the goal of digital equality. 

 

Banks may also share digital infrastructure to individuals, which could help increase the level of internet accessibility, especially in the rural areas where households rarely have internet access. Since branches and ATMs always need to be connected with the internet, banks might see an opportunity to split the network and share public Wi-Fi to facilitate bank-related activities.  A similar project was seen in New York City in 2015, using payphones instead of ATMs.  In that program (LinkNYC), payphones in New York City were transformed into free Wi-Fi hotspots. 

 

In conclusion, all three factors that contribute to digital inequality (availability, affordability, and adoption) must be considered as part of the transition plan so that all humans have equal opportunity to thrive in the new digital economy.

 

About Beacon Impact Fund

In recent years, society has placed an ever-growing level of importance on social impact.  As seen in the examples above, many of the world’s problems (whether they be categorized as environmental, social, or governance issues) are being tackled by startups, which are well suited for the fast experimentation and innovation needed to address these problems. Kasikornbank, as one of Thailand’s leading financial institutions, has also launched many ESG initiatives to help drive Thailand’s transition to a sustainable economy, including several of the projects discussed previously regarding digital inequality.  It is clear that affecting material change to these areas requires active participation by all.

 

Beacon VC sees a great opportunity to not only support these startups which are seeking to create positive social impact, but also to drive the conversation and collaboration between startups and large corporations to magnify and accelerate that impact, and is proud to announce the launch of the Beacon Impact Fund.  Beacon Impact Fund is a 30 MUSD fund that will invest in for-profit startups that have quantifiable, sustainable, and scalable impact. Beacon Impact Fund intends to invest to accelerate the shift to a sustainable economy, improve social equality by promoting financial inclusion, digital literacy, and equal-opportunity growth, and to support good governance and privacy protections in both business and consumer markets.  The hope is for the Beacon Impact Fund to inspire new generations of innovators to solve the planet’s biggest challenges, and to inspire investors and institutions to take a proactive approach to creating impact, as achieving meaningful impact will require support by all stakeholders.

 

References:

https://www2.deloitte.com/us/en/insights/industry/public-sector/state-broadband-access-digital-divide.html

https://tdri.or.th/en/2020/05/covid-19-emphasizes-the-need-to-bridge-the-digital-divide-and-reduce-online-educational-inequality/

https://www.mckinsey.com/industries/education/our-insights/covid-19-and-student-learning-in-the-united-states-the-hurt-could-last-a-lifetime

https://www.ookla.com/articles/starlink-hughesnet-viasat-performance-q4-2021

https://thailand.un.org/sites/default/files/2021-12/eBAT-ebat_21-00630_E-learning-Thailand-Mapping-digital-divide%5B95%5D%5B83%5D%5B100%5D.pdf

https://saturday-school.org/partner-with-us/

https://www.iseas.edu.sg/wp-content/uploads/2021/03/ISEAS_Perspective_2021_50.pdf

https://hanoitimes.vn/vietnam-to-universalize-cheap-smartphones-to-entire-population-311236.html

https://www.bain.com/contentassets/37a730c1f0494b7b8dac3002fde0a900/report_advancing_towards_asean_digital_integration.pdf

https://teltonika-networks.com/industries/use-cases/solar-powered-remote-wi-fi-

https://futurumresearch.com/futurum-tech-webcast/the-digital-divide-where-is-the-telco-industry-in-its-journey-to-closing-that-divide-futurum-tech-webcast/

 

 

Author: Supamas Bunmee (Jae)
Editors: Krongkamol Deleon (Joy), Woraphot Kingkawkantong (Ping)

“It is a wild wild west out there right now; there’s no framework” – Vanessa Grellet, Managing Partner of Aglaé Ventures at Permissionless 2022

 

The M&A scene in the crypto market is relatively young. Nevertheless, the industry has witnessed an ever-growing number of deals over the past few quarters. While the crypto M&A industry is still evolving, analysis of the current state of the industry can give readers a basic framework and thought-starters to comprehend this nascent phenomenon.

Market conditions favor a Crypto M&A boom

In the past several months, the entire crypto market has weathered storm after storm, which, although not necessarily started by Luna’s collapse, was definitely exacerbated by said collapse. Nevertheless, many seasoned Crypto Believers remain hopeful, as true innovations are born in crypto winters, learning from the past and paving the way for the next crypto summer.

As the market retreats from the high-yield gold rush, innovators must develop sustainable innovations with real use cases, such as decentralized identity solutions or blockchain security and protocol audits, making the crypto market, or the general Web3 industry as a whole, more appealing to institutional investors.

Institutional investor’s appetite for engagement in crypto manifests in many forms, including building a dedicated team to develop solutions in the crypto space (for example, KBank’s Kubix), investing in crypto tokens (an emerging area still under consideration by some regulators), investment into crypto native VC funds (such as Pantera Capital), and conducting Merger & Acquisition transactions (“M&A”).

Despite being a staple in the TradFi industry, M&A in the crypto market is a relatively new but robust phenomenon. According to Blockworks, M&A activity in 2021 tripled to 180 deals from 59 deals in 2020, and the industry already has seen over 92 deals in the first half of 2022. Many industry experts believe that industry participants will witness even faster growth of M&A activity over the next year as crypto winters present an opportunity to shop for companies or projects at a very low valuation.

Crypto M&A helps accelerate innovation within the industry

At its core, decentralization promises the elimination of intermediaries, and Crypto Believers see this as a very important evolutionary step in our civilization. With the industry being in its early days, full decentralization requires a massive attempt to build necessary infrastructures, develop appealing products and services, recruit communities, and unite ecosystems. For these to happen, innovation within the Crypto industry must occur not only for Crypto Believer’s hedonism or altruism but also for economic and financial reasons.

As many people believe that innovation is a way out of this crypto winter, M&A can accelerate the rate of innovation within the Crypto space expanding the possibility for innovators to get incentivized for their endeavors, which is especially important during this turbulent time. More M&A activities in the space create a positive feedback loop for more innovation. In addition, having M&A as one of the exit goals, innovators are required to think about the monetization, economics, and risks of their projects early on, giving the innovation landscape the ability to withstand shocks in the long run.

What types of M&A can the industry expect?

Traditional reasons for M&A typically fall into four categories, corresponding to that industry’s life cycle: capability acquisition, market access & customer acquisition, promoting economies of scale, and market consolidation.

M&A objectives by industry life stage

Source: Beacon VC internal analysis

Despite the shrinking market capitalization during crypto winter, many Crypto Believers think the market is still in the early or growth stage, meaning that most upcoming M&A activities within the crypto space will be for capability acquisition or market access.

Strategic Motives behind M&A in the Crypto Market

Strategic motives seen in crypto M&A transactions can broadly be categorized by who and whom the acquirer and target are (Enterprise vs. Protocol). To clarify, Enterprise refers to companies with a conventional equity structure (either TradFi or CeFi), managing the organization using a centralized top-down approach, while Protocol refers to Decentralized Applications (D’Apps) or decentralized autonomous organizations (DAOs) with governance tokens representing ownership in a decentralized protocol.

The list of strategic motives below is a sampling of what the market has seen, and is by no means meant to be totally conclusive.

Overview of Crypto M&A transaction motives

Source: Beacon VC internal analysis

Gateway

Given regulatory uncertainties, especially for DeFi, not all enterprises are ready to offer on-chain DeFi products or services, but many see the opportunity to capture the value created in the crypto space. Enterprises looking for a less risky way to engage with the crypto market are eying infrastructure provider/ enabler play, which is achievable through acquiring existing infrastructure, blockchain enablers, or CeFi companies. The types of services that will be provided by enterprises for the crypto industry include wallet and custodian services, auditing services, or blockchain-as-a-service, similar to what AWS does for Web2. Paypal’s acquisition of Curv is a great example of this strategy.

CeFi companies can also be acquirers, especially large CeFi exchanges looking to enter new jurisdictions. The target would likely be existing CeFi exchanges with local licenses and hopefully good relationships with regulators. FTX’s acquisition of Liquid Group, then rebranding it to FTX Japan, reflects this strategy.

Innovation Leapfrogging

Innovation happens fast, often faster than blockchain-native CeFi companies can keep up. Acquiring frontier protocols allows companies to leapfrog their competition. In fact, many industry experts expect that CeFi exchanges to be the most active acquirers. Coinbase, for instance, has made more than 20 acquisitions since its inception, accounting for over $800 million in acquisitions.

Traditional enterprises are also developing a clearer picture of their long-term strategy and crashing the protocol acquisition party to accelerate innovation. For example, eBay recently acquired NFT marketplace KnowOrigin as a part of its ‘reimagine eBay strategy’.

Real-world Capability Cultivation

Successful decentralized protocols rely heavily on their communities to push out innovations and build infrastructure. As these projects tend to scale rapidly, many lack sufficient resources to handle the ecosystem. 

Many successful protocols that are cash-rich may take crypto winter as an opportunity to develop internal capabilities for the next crypto summer, by acquiring traditional companies to develop real-world capabilities. The acquisition target for these protocols would likely be an existing vendor or supplier to that protocol, as the community already has buy-in for the value that the target is able to generate. Sandbox’s recent acquisition of Uruguayan tech firm Caulit is a great demonstration of the attempt.

Synergy Building

As previously discussed, successful projects place high importance on their communities and the platform’s ability to maintain the community. During crypto summer, investor goodwill is high, and funding is easy to come by. When investor money is tight, however, projects and their communities turn to each other in the hope of sharing resources and growing their footprint in a more cost-efficient manner.

The acquisition motive for synergy can take many forms. One can be product-driven similar to Uniswap’s acquisition of Genie, an NFT marketplace aggregator, to complement its existing NFT liquidity pool – Unisocks. Another could be efficiency-driven similar to the Rari-Fei protocol merger to create a mega $2B liquidity pool.

Possible Structures of Crypto M&A

There is still very limited disclosed information on the deal structure, therefore the structures described below are solely based on market observations and internal analysis. In addition, there are still several challenges in executing a crypto M&A, and there is no standard playbook. In general, however, the Equity/ Token Direct Acquisition is the default method of M&A for its relative simplicity for all types of M&A motives, while Token Swap and Token Merge happen exclusively within Protocol-Protocol acquisition.

Level of control associated with transaction structures

Source: Beacon VC internal analysis

Equity/ Token Direct Acquisition

The direct acquisition method involves purchasing a controlling stake of the target’s equity or governance token, usually aiming to acquire total operational and directional control of the target. The process is executed similarly to traditional M&As, where both parties agree on the transaction price, draft legal documents, execute the agreements, and transfer the securities (or tokens). 

Unlike traditional M&As, there are still several challenges in crypto M&A such as token valuation, legal recognition of governance tokens as an acquirable asset, governing jurisdiction, and the absence of a legal entity for many crypto protocols. With these complexities, it is not surprising that the deal structure for direct acquisition will vary greatly, depending on the specific challenges of the deal.

Token Merge

Token merge happens when the acquirer and acquiree merge to form a new entity and issue a new token. Under this structure, both parties have approximately similar bargaining power, knowing that each party cannot succeed without the other party’s strength. The aforementioned Fei-Rari Merger is a great example for this case. Token holders of Fei and Rari would exchange their respective tokens for a new TRIBE token, under the project name FeiRari. 

Some other remarkable token mergers include the WRAP-PLENTY token merge into PLY to provide a more comprehensive all-in-one DeFi experience on the Tezos blockchain. More details on the merge mechanics are available here.

Token Swap

Token swap usually happens when the acquirer has a larger market capitalization compared to the target, and is looking to acquire smaller projects to complement or help complete its current product or service suite. Unlike total acquisition, the acquirer wants to allow the target company autonomy to operate and innovate. To put it in simpler terms, as Cointelegraph has put it, token swaps can be viewed as a crypto partnership on steroids, to drive the stickiness of the main ecosystem. TNC’s, a blockchain network company, announcement of 4 token swap transactions is an example of this pursuit.

Executing token swap transactions requires multiple smart contracts to manage both parties’ tokens staking into each other’s platforms, or through a shared wallet. The swap itself is a smart contract design problem, but the real challenge happens pre-transaction, similar to the token merge structure, as successful conclusion of the deal involves an extensive community buy-in program for both parties’ stakeholders, not only to align at the financial level, but also to align on project directions. 

Some Areas with Still More Questions than Answers

There are still many questions in the crypto M&A space that need to be answered. Most remaining questions are related to the execution of transactions, since there is still limited understanding of blockchain economics, and an unclear regulatory framework surrounding the space. Below are some of the biggest questions by stage of transaction that deal practitioners are trying to answer.

Pre-transaction

Valuation: How to value the project as a basis for acquisition? 

At the moment, there is no definitive approach to value crypto-based companies for general investment or M&A, creating tremendous difficulties at the negotiation table. 

Some of the methodologies being used to uncover ‘fair value’ of the project include:

1. Market Approach – use comparable tokens and respective market price/ capitalization ratios;
2. Cost Approach – approximation of input cost to create that specific token or project as a lower bound of valuation range;
3. Income Approach – discount the future economic benefit or utility of such protocol at an ‘appropriate’ discount rate; and
4. TQM or Quantity Theory of Money approach – approximation of equilibrium market capitalization value in the future, discounted to estimate the present value of the project.

These approaches are inherently subjective by nature, and the characteristic of tokens in each project also brings tremendous complexity.  For a deep dive into crypto valuation, follow the link to EY’s report on the valuation of crypto-asset or Crypto.com’s guide to crypto valuation.

 

Utilization of on-chain transparency: How to best leverage the abundance of on-chain data for deal-making?

On-chain data promises to help investors make smarter and more well-informed decisions. However, only a handful of investors really understand how to mine insights from the blockchain. Most investors lack the right tools to conduct on-chain due diligence, and further development of the market requires investors to explore how best to leverage on-chain data.

During-transaction/ Deal-making

Agreement drafting and enforceability: How to ensure that the transaction is legally enforceable and minimizes counterparty risk?

The difficulty of enforceability arises from the discrepancies in how different jurisdictions recognize digital assets or DAO entities, or the lack of recognition in several jurisdictions. Cambridge Judge School of Business provides a deeper analysis of the legal and regulatory framework of different nations. In addition, many institutions are subject to anti-money laundering regulations, requiring that any transactions or activities be free of potential money laundering activities. As decentralized blockchain transactions are anonymous in nature, such institutions may be unable to participate in these transactions. 

Legal practitioners and deal makers have been trying to popularize provisions, which protect both parties, including adverse materials, definitions of digital assets, and agreement termination clauses. Bloomberg Law has published a great analysis piece on crypto drafting trends. 

 

Means of payment and volatility hedging: How to shield parties from the volatility of digital currency as means of payment?

While there is strong demand to use digital currency as means of settlement for crypto M&A (either for tax, transaction speed, or any other reasons), the high volatility within the market prompts both acquirer and target to question how to best shield their position. At the current stage of the market, there aren’t many cost-effective hedging options available, even for institutional investors.

Post-transaction

Integration of technologies and communities: How to ensure successful post-merger community and technology integration?

Many M&A transactions ultimately fail due to a lack of compatibility between entities. Integrating two blockchain projects and work processes is a major problem, as currently there is no standardization between projects. Another problem is how to best handle the two communities, whose interests and passion for the projects may not fully align.

Closing thoughts – the beginning of beginnings

With the industry learning more about crypto M&A, we hope that industry participants are working to close the industry’s understanding gap in good faith and for the sake of innovation, and not in an exploitative mindset. 

While many people hope that decentralization would become one of the most prominent turning points of mankind, there are several pieces of evidence suggesting that M&A activities can adversely affect the rate of innovation in a monopolistic or oligopolistic market environment. Acquirers must strive to remember that these transactions must be done for the sake of value creation for all stakeholders, and in pursuit of the betterment of society. Only with the joint hands of institutions and innovators to lay the groundwork and create meaningful solutions, the pursuit of decentralization dreamworks can be realized.

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Author: Woraphot Kingkawkantong (Ping)
Editors: Krongkamol Deleon (Joy), Wanwares Boonkong (Pin)

The concept of banking first emerged sometime around 2,000 BC in Mesopotamia, where merchants felt the need to give out loans to farmers and traders who roamed the different cities. From then on, as trade and the economy grew, modern financial institutions were built to consolidate the scattering of economic activities and provide trust.

 

For centuries, the financial system has been heavily centralized. Along with other government entities, financial institutions joined hands to govern almost all transactions, from money issuance to lending and investing. They have this power to centralize because they alone can keep track of all financial transactions. The invention of blockchain will change the fundamental mechanics of how this new era of the financial system operates with its decentralized record-keeping feature. Once this technology fully matures, traditional financial institutions as we know them will have a lesser role in the financial system.

 

Blockchain and Its Promise to the Financial System

 

Blockchain is a decentralized record-keeping system that documents all transactions that happened on it. In other words, it is a bank book that everyone can possess and whose content is self-updating with all new transactions and the change in ownership of any assets. It defies financial institutions’ fundamental role as the centralized record keepers who prevent the same money from being spent twice or the same asset being transferred repeatedly.

Fully mature blockchain technology promises to provide greater efficiency, lower transaction costs, better transparency, a speedier rate of financial innovation, and a much lower carbon footprint (still heavily debated) compared to the traditional financial system.

 

The Inception of Blockchain Finance

 

In the early days of blockchain finance, Satoshi Nakamoto (pseudo name – actual identity remains unknown) invented Bitcoin (whose underlying technology later became known as blockchain), a digital currency to aid in the decentralized transfer of money. The transfer data stored in Bitcoin’s blockchain is static – meaning that the blockchain can only record that Entity A transfers B amount of money to Entity C.

Ethereum then came along and introduced smart contract technology, which allows blockchain to be programmable. Ethereum blockchain can instruct that only when Event D happens, Entity A can transfer B amount of money to Entity C. Any transactions can become fully automated upon a defined set of rules.

Both technologies were the foundation of the concept of what is now known as Blockchain Finance.

 

The Blockchain Finance Dilemma

 

While groundbreaking, current blockchain finance is not without limitations. The challenge lies in the Blockchain Dilemma – that blockchains may only choose up to two qualities to achieve: Security, Scalability, and Decentralization. The limitation is the mechanism to how each party in blockchain finance agrees that a transaction is legitimate and therefore should get updated in everybody’s copy of the bank book (referred to as the “Consensus Mechanism”).

 

 

Source: Original framework by Certik, adapted by Beacon VC

 

Since both Bitcoin and Ethereum prioritizes Security and Decentralization, scalability is a challenge for both blockchains. In order for a new transaction to be recorded in everyone’s copy of the bank book, someone who holds a copy of the bank book must confirm that the transaction is legitimate through the computation of a complex mathematical equation. That person is referred to as a miner, and the first miner who gets the equation right wins a monetary reward. This process of solving a mathematical equation to confirm a transaction is called the proof-of-work consensus mechanism (PoW).

 

Other blockchains prioritize Decentralization and Scalability, giving birth to the proof-of-stake consensus mechanism (PoS). Blockchains that adopt PoS include Polkadot and Vechain. Under the PoS concept, a miner can be eligible to confirm a transaction by putting down a ‘ stake’ in the form of coins belonging to that blockchain (think of it as a refundable deposit). The more coins put down by a specific miner, the more eligibility that miner has to validate a transaction. This consensus mechanism works because the miners who are not validating any specific transactions are obliged to check the work of the validating miners. Faulty confirmation of a transaction is penalized by confiscation of stake.

 

Finally, other blockchains prioritize Security and Scalability. While many blockchains use the PoS to validate transactions, we have seen a rise in the proof-of-authority consensus mechanism (PoA). In this case, new transactions are confirmed by a few authorized players in that blockchain. These players are incentivized to keep transaction data legitimate and enjoy the monetary benefit for that blockchain growth. Examples of blockchains that prioritize security and scalability include blockchain consortiums formed by financial institutions (JPM coin), and the Bitkub chain. In reality, there are many other ways that a blockchain can achieve scalability and security, as we also see cases using a hybrid model between PoS and PoA – the delegated proof-of-stake mechanism (dPOS), which we will leave for another discussion.

 

The Two School of Thought of Blockchain Finance (CeDeFi/ DeFi)

 

There are big debates in the blockchain finance space whether blockchain finance should be centralized (CeDeFi or CeFi) or decentralized (DeFi).

 

 

CeDeFi is an evolution of the current financial system where an intermediary helps manage the transaction and regulate the users’ activities in that ecosystem. Under this scenario, if a user wants to make a transaction, the user needs to create an account with the company, deposit cash or any assets into the company’s custodian, and use that company to execute the transaction. In this case, the customer would need to reveal their personal information to participate in the ecosystem. Great examples of CeDeFi platforms include Binance and Coinbase.

 

Conversely, with the growing need to protect own data and distrust in institutions comes the demand for DeFi. Users are required to manage their own funds and financial activities. They must have a personal wallet where they store their assets and use that wallet to carry out transactions by connecting it with decentralized service providers. Since these decentralized service providers execute trades based on smart contracts, the transactions automatically occur when conditions are met. There is zero need for human intervention. This gives flexibility for DeFi users to select service providers whose set of rules they like the most.

 

Which School of Thought Will Prevail?

 

Although there is no guarantee which school of thought will prevail, or that there will be any clear winner, we anticipate that CeDeFi will gain mass acceptance and adoption for real commercial purposes first, despite the current boom in DeFi which has been driven by speculative forces.

It is all about the evolution of public trust. CeDeFi is, by design, a bridge for general customers to start exploring the blockchain finance ecosystem and shifting their trust away from financial institutions/centralized governing entities to service providers (think of Binance, Bitkub, Zipmex, Satang Pro, etc.). These companies excel in replicating the same user experience a customer would have if they were to interact with general fintech that people know and have grown accustomed to. Once more people start adopting CeDeFi, and the infrastructure and interface for DeFi are in place, the public will soon learn to shift trust from said service providers to algorithms (code and rules of how transactions are made), leading to the potential mass adoption of DeFi. It is impossible to say when mass DeFi adoption will happen, but we can definitely see both CeDeFi and DeFi co-existing in the foreseeable future.

 

Such co-existence can take place in a number of manners:

• Gateway: Since value creation in the economy is still largely driven and transacted in the physical world, CeDeFi can exist as a gateway for users to convert traditional assets (such as fiat money) into decentralized blockchain finance. We are already starting to see this symbiotic relationship between CeDeFi and DeFi, in which users convert their money into digital assets using CeDeFi and then transfer it to their personal DeFi wallet. (think of Fiat -> Binance -> Metamask wallet)

• Market Segmentation: It is possible that CeDeFi and DeFi can co-exist by serving different markets in the economy. Segmentation can be based on the need for governance. For instance, CeDeFi can serve segments where visibility and governance are critical, such as corporate clients, while DeFi can serve the retail market. Segmentation can also be based on the type of trust users require. Conventional users can use CeDeFi because their trust system is based on having a single entity to point to when things go wrong, while DeFi users can be more comfortable with the algorithm.

• Business Extension: CeDeFi organizations can use DeFi as a place to experiment with financial innovations and later acquire the know-how to build or integrate similar services to their platform. This is the same model that we already see in the financial industry, in which big financial institutions leverage the capability of startups to enhance the robustness of their offerings.

 

While this migration unfolds, regulators and financial intermediaries incumbents will likely try to slow the migration rate to a minimum. This is because they will first need to find a satisfactory framework to thrive in an entirely DeFi environment. After all, there are certain benefits to centralization, such as the ability for the government and banks to control fund flow, regulate the market, and effectively pull monetary levers to protect the economy or national interests.

 

What’s Next for Financial Institutions?

 

There is no telling when mass CeDeFi or DeFi adoption will happen, but it is paramount that financial institutions start finding their role in this emerging ecosystem. To start from an inside-out perspective, financial institutions were built upon trust and efficiency through consolidation. The critical area of exploration is where financial institutions can continue to deliver benefits both in the CeDeFi or DeFi context. From an outside-in approach, financial institutions can navigate through different blockchain layers and access points in the ecosystem to identify a natural fit for their current products, capabilities, or future strategy and monetization models.

 

While we are racing towards what may be the most significant overhaul of the financial system in modern history, we must strive to remember that different populations adopt technology at different rates and that meaningful innovation must not further marginalize anyone.

 

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Author: Woraphot Kingkawkantong (Ping)
Editor: Krongkamol Deleon (Joy)
Special shout-out: Wanwares Boonkong (Pin), Phanthila Saengthong (Mook), Panuchanad Phunkitjakran (Pook), Napat Nantavechsanti (Jum+), Phongsuphat Kanchanakom (Monn)