The potential of blockchain to boost social impact across the world is tremendous. But most examples often sound rather abstract or will only be realized in the distant future. So for more people to understand the true impact of blockchain on society, it’s key to look at use cases that are already taking place right now.

One such use case is the application of DLT and blockchain-based smart contracts for decentralized equity crowdfunding for social impact projects.

In this article we’ll look at the technical specifications of such a project, its benefits as well as limitations, and finally, examples of organizations that already work on this solution.

Technical specifications and workflows

Using an “environmentally-friendly” blockchain technology such as Tezos or Ethereum (once it switches from PoW to the more energy- and cost-efficient PoS), smart contracts are set up specifying:

• The min. funding goal
• The max. funding goal
• The max. total equity offered in return
• The duration of the crowdfunding campaign
• The social impact goal
• How the investment will be distributed to the venture and under which conditions

Once the campaign is launched, crypto money collected from investors is paid into a smart contract wallet which freezes the capital until the campaign is over or other automatic triggers defined in the smart contract are met. An example for the latter would be to declare a campaign as completed and pay out funds immediately as soon as the max. funding goal is met instead of waiting for the last day of the campaign to pass.

If the campaign ends and the funding goal is not met, participants are returned their funds, minus the transaction costs.

If the campaign is completed with the funding goal having been met, the following applies:

• Funds are processed right away into the venture’s wallet according to the pre-defined distribution model in the smart contract. For instance, the smart contract can specify that 50% are made available to the venture right away, while the remaining 50% will be paid out over 5 years in instalments subject to the company meeting pre-defined social impact goals and using the funding in accordance with the outlined rules in the contract.
• Investors receive equity tokens (based on the pre-defined equity % made available) in accordance with their monetary crypto investments.

After funds are transferred and tokens are issued, the social venture has to update the blockchain smart contracts with clear evidence on the progress of their social impact goals and usage of funds. This is a necessary condition to unlock the remaining funds from the wallet in the future.

On the other hand, token holders are allowed to participate in specific votes on the project. For instance, this could relate to things relating to their investment, like adjusting the distribution settings in the smart contract to enable funds to be provided earlier, or to other things such as the application of the investment raised (i.e. whether to invest it in R&D, marketing, HR, …).

Benefits

The benefits of this use case are improved traceability, transparency, confidentiality, governance, efficiency (speed and costs), liquidity and potentially regulatory compliance.

Traceability, in combination with collected funds being made available subject to compliant usage of funds and meeting promised social impact goals, ensures that funds can only be used in accordance with the pre-defined application use cases.

Increased transparency is achieved by making all smart contract rules, social impact development progress and funding status available in real-time 24/7.

Confidentiality is guaranteed by protecting the anonymity of investors on the blockchain (only the investment amounts are visible, but not the name of the investor)

Governance is supported by enabling investors to use their tokens in order to participate in votes.

Efficiency is gained by using the blockchain technology. In particular, funds can be made available much faster and also much cheaper, as intermediaries like notaries etc are removed.

Liquidity is improved as ventures gain access to funds quicker but also investors can more easily liquidate their investments on the secondary market by simplify selling of their token whenever they wish (24/7 trading availability on the blockchain)

Finally, regulatory compliance could be achieved as well by stipulating mandatory KYC/AML proof for each investor before their money is transferred. This could be done by either bringing a third party on board to execute this check (traditional method) or, preferably, by allowing users to simply use their self-sovereign-identity wallets to share recent KYC/AML checks or easily initiate a new one. Moreover, the project could also be defined in a way to give tax authorities a unique key allowing them to access user information for tax purposes (i.e. automatically gathering and using investor and investment data to facilitate the next tax declaration for them).

Challenges and risks

Potential challenges and limitations are:

• making sure a scalable, secure and ESG-compliant blockchain technology is used,
• defining social impact goals in a way that progress can be verified and tracked by and on the blockchain,
• overcoming the usual risks associated with blockchain and smart contracts (especially if oracles are used for sourcing information that can trigger smart contract conditions),
• ensuring legal compliance with regulators

Personal view

Besides the benefits outlined above, the use case solves obvious limitations of the current equity crowd-funding model which are all mainly tied to high fees and a lack of trust in terms of both, the project you invest in and how it can be held accountable to fulfil its promise, as well as the crowdfunding platform used.

It is true that this use case, for obvious reasons, has limited advantages for traditional financial institutions such as banks, besides potential branding benefits related to being perceived as innovative and fostering relationships with potential prospects such as (relatively) wealthy private investors and ventures. However, amongst established niche crowdfunding platforms, we observe a lot of genuine interest and action in this space, with Crowdcube, Republic and Kickstarter all ramping up investment in an attempt to get on the blockchain.

Therefore, this use case will probably be developed and led by “younger” financial organisations already operating in this niche space (as shown above) or completely new innovators such as SeedOn or Tecra Space.

It will be interesting to observe though how this will be executed. Whether in the form of an entire new blockchain or rather as a layer 2 solution on top of an existing smart contract blockchain (such as Ethereum) or else. How an organisation initiating this project will be set up, for example as a traditional company or NPO or rather as a decentralised autonomous organisation (DAO). And also, to what extent and how other blockchain-based solutions can be integrated, such as SSI digital wallets.

This article is based on my course work during the Blockchain Executive Program at European Tech School which was reviewed by DLT, blockchain & crypto expert David Creer. I hope it helps to spread knowledge on social impact use cases of blockchain and to initiate a discussion that will further enhance my learning on the subject.

Featured image credits: Photo by Hannah Busing on Unsplash