Moving From Innovation to Trust

Impact Reflection | December 2, 2022

Is it appropriate to mix attempts to do good with the effort of finding financially profitable investments? This question has ignited an important conversation as institutional investors increasingly consider social and environmental impacts in portfolio management. Different parts of the financial industry have either cheered or derided efforts to allow “prudent” investment managers to include environmental, social, and governance (“ESG”) considerations in portfolio construction and management. Last week, the Department of Labor announced its decision to do just that, opening the way for 401k and other retirement plans to offer ESG options.1 This stakeholder-centric lens is an important innovation to our capitalist structure. It is also an important counterpoint to the shareholder-centric profit concerns that dominate the early development stages of the technical innovations that drive economic growth.
 
One broad element of this conversation asks whether the continued negative impact is warranted to support technical innovation. In its early phases, innovation often depends on using and even expanding existing infrastructure. If successful, the work scales so quickly that new companies cannot effectively address the negative impacts of rapid growth. The recent collapse of cryptocurrency exchange FTX has focused attention on crypto-centric innovation and its rapid growth, including both the impact of mining on energy use and the lack of regulation and transparency for investors.

A Need for Trusted Intermediaries

We discussed the innovative promise of blockchain technology in an early 2021 post, Another Block in the Chain. A novel and reliable way to track transactions and verify the accuracy of data, blockchain technology’s early potential was broadly applied inside and outside of finance – including healthcare data storage, monitoring supply chains, and creating tamper-proof voting systems. Within finance, cryptocurrencies and the idea of private and scalable payment systems have taken the global finance sector by storm. This disruptive energy has spawned many different “coins” and led both to the embrace of state-regulated digital currency in some countries and bans on the use of cryptocurrencies in others.

As an investment, crypto coins have been very speculative, and their prices volatile.  Over time different coins and companies proliferated, prompting concerns about the environmental and social impacts of digital mining and the lack of effective regulation of the market. Mining quickly became big business, as the rapidly increasing need for energy meant resurging demand for fossil fuel-based production and placement of digital mining facilities in less regulated areas.2 Retail price speculation flourished, along with stories of investors who lost their life savings or lost their passcodes and effectively lost sizable investments.

With any investment, the ability to buy and sell easily is essential to the growth of the market for that investment, and it was not long before cryptocurrency exchanges were created to facilitate trading. Today there are hundreds of exchanges available to investors in the US, including Robinhood, and Sam Bankman-Fried’s recently collapsed firm FTX. Like stock and option exchanges, they provide liquidity and a platform for trading, but the innovation they support can only be sustained if they can be trusted as an intermediary. Robinhood has built out its business model within the current financial regulatory structure; this year, it launched cryptocurrency wallets now used by two million investors. FTX operated outside that structure, and its failure to act with integrity and provide transparency has sullied the reputation of the entire sector.

A likely impact of the implosion of FTX is a more intensive inclusion of cryptocurrencies in the existing regulatory structure headed by the SEC. That, in turn, may shift crypto into a new phase of development with less emphasis on speculative and uncontrolled growth, and better integration of its underlying and useful blockchain technology.  

The Next Phase of Innovation

After the initial phase of explosive growth, the focus shifts to making the innovative product or service more sustainable. This can include expanding beyond the profit emphasis of financial shareholders and considering a wider group of stakeholders. Complex issues that affect multiple stakeholders include issues as diverse as whether to create low-income housing in an affordable but environmentally at-risk area, such as a floodplain, or how to provide reasonable sick time to railway company workers in the context of reduced headcount and profitability challenges.

Outside of the for-profit economy and relevant regulatory structures, there are other efforts to address the complexity of conflicting interests. The world of charitable giving incorporates many of the same considerations of a diligent ESG research team. One specific movement called Effective Altruism (in news stories recently due to Sam Bankman-Fried’s participation) is based on a philosophical exploration of the relationship between morality and affluence.3Their work is but one example of charitable efforts to fix the problematic impacts of economic structures on human communities.

Combining charitable efforts with the ongoing efforts of investors to create positive change from inside the business world holds the potential to make social and environmental considerations a functional norm. In the case of cryptocurrencies, that could usher in a second phase of innovation more focused on the incremental work of engaging with existing, profitable businesses about difficult social issues. That phase can take time to incorporate many voices. The change it brings comes more slowly than the initial wild ride, depending on broad debate to affirm the value of those innovations.

Resources

1 US Department of Labor, “US Department of Labor Announces Final Rule to Remove Barriers to Considering Environmental, Social and Governance Factors in Plan Investment,” November 22, 2022.

2 Earth Justice, “The Environmental Impact of Cryptomining,” EarthJustice.org, September 2022.

3 Their focus is on large-scale, apparently intractable problems that could benefit by research identifying the most cost-effective ways to achieve positive results. The Effective Altruism website highlights as an example their early concern in 2014 of the possibility of a global pandemic, and the relative underfunding of pandemic prevention work compared to counterterrorism, ”What is Effective Altruism?” 2022.  See also Wikipedia, Effective Altruism.

Kate King, CFP - Partner and Chief Investment Officer 

About Kate Campbell King, CFP®

Kate Campbell King is the Founding Partner and Chief Investment Officer at North Berkeley Wealth Management. Kate provides clients with a unique approach to their financial decision-making.

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By |2022-12-16T13:46:38-08:00December 2nd, 2022|