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Doesblockchainhavearoleinthefinancingofinfrastructure?

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Acknowledgement

ThisreportistheresultofajointinitiativeofthePublic-PrivateInfrastructureAdvisoryFacility(PPIAF)andtheWorldBank’sInfrastructureFinance,PPPs&Guarantees(IPG)GlobalPractice.

ThisreportwaspreparedbyaWorldBankteamledbyLucianaGuimaraesDrummondeSilva(ProgramOfficer)andcomprisedofFidaRana(SeniorInfrastructureFinanceSpecialist),VincentLaunay(SeniorInfrastructureFinanceSpecialist),theInternationalInstituteforSustainableDevelopment–IISD(includingSafaRahimandDavidUzsoki),YuliaLesnichaya(Consultant)andPabloArmandoAlfaroChavez(design).

Thereportdrawsonbackgroundpapers,casestudies,andontheexpertiseofArnaudSalomon(FounderandCEO,MtPelerin),MarkusAbbassi(HeadofTokenization,SygnumBank)andDanielAhmed(Co-FounderandCOO,Fasset).1

TheteamwantstothanktheWorldBank’sITSTechnology&InnovationLabteamandALLInfrafortheirinsightfulandhelpfulcommentsandforalltheinformationsharedwiththeteam.Morespecifically,theteamwouldliketothankStelaMocan(Manager,ITSTI),MaheshChandrahasKarajgi(SeniorITOfficer,EngineeringI,ITSTI),RaunakMittal(BusinessSolutions,ITSTI),BillKentrup(ALLInfra),andDaveSandor(ALLInfra).

TheteamisthankfulforthesupportreceivedfromImadFakhoury(GlobalDirector,IPG),FatoumaToureIbrahima(ManagerofthePPPGroup,IPG),ShyamalaShukla(SeniorPublic-PrivatePartnershipSpecialist,IPG)andJennyJingChao(SeniorPublic-PrivatePartnershipSpecialist,IPG).

ThisworkwasmadepossiblebythefinancialcontributionofPPIAF:.

1MtPelerinisafinancialintermediarydulyaffiliatedwithVQF,aSelf-RegulatoryOrganization(SRO)officiallyrecognizedbySwitzerland'sFederalFinancialMarketSupervisoryAuthority(FINMA).Thegroupspecializesinfinancingsolutionsusingblockchain.Theyseektocreateanecosystemthatwillpropeltheneweraoffinancialdigitalizationthatblockchainfacilitates.

Sygnumistheworld’sfirstdigitalassetbankandadigitalassetspecialistwithglobalreach.Thebankisindependentlycontrolled,scalableandfuture-proofdigitalassetbankingsolution.

Fassetisaplatformfortheethicalfinancingofsustainableinfrastructure.Theplatformleveragesmodernblockchaintechnologytoallowinfrastructureowners(governments,utilities,public-privatepartnerships,etc.)tosecurelyofferasset-backedinvestmentstoinstitutionalinvestors,includingsovereignwealthfunds,government-linkedinvestmentfunds,infrastructurefunds,privateequityfunds,realestatefunds,andbanks.

TableofContents

*AllcurrencyinthispublicationisinU.S.dollarsunlessotherwisenoted.

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ExecutiveSummary

Thepurposeofthisreportistoassesswhetherdigitizingtheequityordebtfinancingusedforinfrastructureprojectsusingblockchain,i.e.,tokenizedinfrastructure,providesenoughbenefitstojustifytheuseofthistechnology.TheinformationpresentedhereaimstoinformtheWorldBankwhetheritshouldexplorethepossibilityoftokenizingoneofitsinfrastructureprojects.Theconclusionsarebasedoninterviewswithtokenizationstart-ups,experts,andthereviewofcurrentandplannedregulatoryframeworksinselectedjurisdictionsandusecases/pilotstodate.

Financingofinfrastructureusingblockchaintechnology:tokenizationofassets

Infrastructureinvestmentisameanstogeneratelong-termbenefitstosocietywithinclusiveeconomicgrowthandwell-beingwhilecontributingtoalow-carbontransition.2However,thesectorisfacedwithseveralchallengesincludingpoorgovernanceandmanagementofinfrastructuresystems.3Projectsarealsooftenlarge,capitalintensive,andnotimmediatelyprofitable.4Therefore,innovativemechanismsarerequiredtoleverageprivatefinancingandlowerthecostsofcapital.Itisalsocrucialtomaintaininformationsymmetryamongststakeholdersandprovideinvestorswithtransparentdatatomakeinformedinvestmentdecisions.Oneoftheforemostimpedimentsismatchingabundantsupplyofprivatecapitaltothedemandforinfrastructure.5

Theuseofdistributedledgertechnologies(DLT)likeblockchaincanpotentiallyovercomemanyofthechallengesthathinderthescalingofinfrastructure.Theefficiencyoffinancingandmanagementofinfrastructureprojectscanimprovebyleveragingcorefeaturesofthetechnologylikedecentralization,immutability,andtransparency.67Theblockchainisanimmutabletechnologicalinfrastructuredesignedtoenablesimultaneousaccess,validation,andrecordupdatingspreadacrossseveralnetworks.8Thesefeaturesmakeblockchainadisruptivetechnologycapableoftransformingbusinesses.Themostcommonapplicationofthistechnologyinfinancecouldbecapital-raisingthroughSecurityTokenOfferings(STOs),andinpost-tradeprocesses,likeclearingandsettlementofsecurities.

Anotherapplicationofblockchaintechnologyisthetokenizationofrealassets.Tokenizationistheprocessofconvertingrights,aunitofassetownership,debt,orevenaphysicalassetintoadigitaltokenonablockchain.9Thisenableshistoricallyilliquidassetstobebrokendownintosmallerunitsrepresentingownershipandencouragingthedemocratizationoffinance.

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3/news/world-bank-report-illustrates-benefits-of-resilient-infrastructure/

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5/media/abfer-events-2020/specialty-conf/12_paper_Tian_Asset-Tokenization-A-Blockchain-Solution.pdf

6/environment/blockchain-technologies-as-a-digital-enabler-for-sustainable-infrastructure_0ec26947-en

7/articles/10.3389/fbloc.2019.00016/full

8/terms/d/distributed-ledger-technology-dlt.asp

9/us/en/insights/all-insights/tokenization-opening-illiquid-assets-to-investors.html

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Thepotentialadvantagesoftokenizing“real-world”assetsinclude:efficiencygainsdrivenbyautomationanddisintermediation,transparency,andgreaterliquidityandtradabilityofilliquidassets.Thetokenizationofassetscandemocratizetheownershipofcertainassetsasawiderrangeofinvestorshaveaccess.Asopposedtoblockchainnativetokens,likebitcoin,thatonlyhavevalueontheblockchain,real-worldassetshaveanunderlyingvalueoff-chainaswell,backedbytherealassetsexistingoutsidetheledger.Themostprominentuseoftokenizationofreal-worldassetsaresecurities(bondsandstocks),commodities(likegold),andnon-financialassets(likerealestate).

Thetokenizationofinfrastructureisclaimedtoaddressthreeobjectives:financinginitiatives,10democratizinginfrastructure,11andincreasingtheefficiencyofinfrastructuremanagement.12Theseobjectivesareinterconnectedandenabledthroughthecorefeaturesofblockchaintechnology—decentralization,immutability,andtransparency.Thedataderivedfrominfrastructureuseandperformanceresultscanuncoveroperationalinefficienciesaswellasunlocknewrevenuestreamsforthird-partyplanningonbuildingnewservicesandcapitalappreciationopportunities.13

Thefollowingaresomespecificactivitiesrelatedtoinfrastructuredevelopmentthatblockchaintechnologycanimprove:

1.Improvedprojectmanagement

-Contractualstandardization

-Financialstandardization

-Projectpreparation

-Bridgingdatagap

2.Improvedinvestmentenvironment

-Financialengineering,riskallocation,andmitigation

-Regulatoryframeworksandcapitalmarkets

-Qualityinfrastructure

Theuseofsmartcontractsininfrastructureprojects:

Infrastructuremanagementisoftencomplicated,involvingseveralcontractorsandsubcontractors.Contractorsareusuallyentrustedwiththeresponsibilitytosubmitthecorrectsubcontractamounts.However,contractorsoftenoverstatetheamountdrivenbythevestedinterestofincreasingthemark-upchargeablebythevendor.Overstatingamountscanoccurasincorrectrecordingsofthesub-amountorapplicationoftax,unionfees,orotherstatutorycharges.Manualeffortisthenrequiredtoverifyandrectifytheseamounts,whichisbothcostandtimeintensive.

10/environment/blockchain-technologies-as-a-digital-enabler-for-sustainable-infrastructure_0ec26947-en

11/environment/blockchain-technologies-as-a-digital-enabler-for-sustainable-infrastructure_0ec26947-en

12eraxis.io/blog/real-world-assets-defi/

13/media/abfer-events-2020/specialty-conf/12_paper_Tian_Asset-Tokenization-A-Blockchain-Solution.pdf

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Theuseofsmartcontracts14canimprovethetransparencyoftheprocessbyverifyinginvoicesandlinkingthemtomasterdatainreal-timeblockchaindatabase.Thereportproposesathree-waymatchoftheinvoiceforimplementation:

a.Purchaseorder/Scopeofwork:Thiscontainsthelistofactivitiescontractedtosubcontractorsbyamajorcontractor/ownerrepresentative.Theinvoiceshouldmatchandreflecttheseactivitiesapprovedbythecontractor/ownerrepresentative.

b.Certifiedprogress:Thiscontainsactivitiescompletedbythesubcontractorandcertifiedbythesupervisordesignatedbythemajorcontractor.Thisprogressshouldmatchandbeappropriatelydemonstratedascompleted.

c.Masterdata:Thiscontainsthebasisoftheinvoiceconsistingoftheratelist(foreachactivity),activitycodelist,mark-uplist,andacceptableoperationsratios.Forinstance,operatorcosttoequipmentcost,overheadcosttolaborcost,andlogisticcosttooverallcost.

Thisthree-waymatchingwiththeinvoicevalidatesthecontractualdetailsenteredbycontractorsandensuresthecostsandoperationalratiosaresetwithintheestablishedparameters.Blockchainenablestransactionstocontainallaspectsofthecontractandinvoiceswhiletrackinganychangetothescopeofworkandprogressonthemasterdata.Anychangetothecontractorinvoicewillbevisibletotheowner,theprimecontractor,andsubcontractorsimultaneously.

Thiswayofsmartcontractingalsocurbstheriskofnon-compliancebycontractors.Theembeddingofpre-determinedoperatingratiosforeachactivityoptimizestheprocessbytriggeringanalerttoallthestakeholders—theowner,maincontractor,andsubcontractorintheeventofnon-compliance.Thisenhancedtransparencywillreducecasesofnon-compliantspendingandhighlightinefficienciesalongthesupplychain.Basedonthisassessment,companiescanreallocateresourcestowardsactivitiesthatwillfacilitatehigher-qualitysubcontractorwork.Furthermore,anautomatedprocessenablesreal-timeresolutionofchangestoordersandclaimsreducingambiguitiesandpotentialmistakes.

Smartcontractsenabletheprogrammingandauto-executionofvariousoperatingscenariostotransparentlyverifyinvoicesasperthetermsofthecontract.Thisincreasestransparencyincontractadministrationandreducestheneedforafull-timecontractadministrator.

Tosummarize,tokenizationhasthepotentialtotransforminfrastructurefinancingasweknowit.Itcoulddemocratizeaccesstomarketswhileensuringfairnessandsecurity.However,thereareseveralobstaclesincludinglegalandregulatorychallengesthathinderthescalingofthetechnologyandquestionitsapplicability.

14Smartcontractsareusedtoexecuteautomatedtransactionsontheblockchainwhenoneormorepreconditionsaremet.Simpleprogramscanbestoredontheblockchain,forinstance,medicalrecords,E-notary,andcollectingtaxes.Smartcontractsincreaseefficiencyoftransactionsbyeliminatingtheneedforintermediariesandthirdparties.

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Tokenizationofinfrastructure–RisksandConsiderations

Despitethepotentialadvantagesassociatedwithinfrastructuretokenization,theprocessislegallyandtechnicallycomplicated,whichishinderingtheadoptionofblockchaintechnology.Whileintraditionalsecuritieseachindividualassettypeissubjecttolocalregulations,tokenizationenablesautomatedcompliancewithtokensbeingtraded.Thiscanraisenewconcernssuchasoveruseofcomputationalinfrastructure,speculativearbitragebecauseofunclearregulatoryframeworksforissuanceandcomplianceenforcement,andcommunityparticipationinovercomingpotentialprivacyinfringementissues.Thefollowingarethemostprominentrisksassociatedwithassettokenization,whichneedtobecarefullyconsideredasthekeychallengesareregulatoryratherthantechnologicallyrelated:

•Tokenizingdifferentsecuritytypes:Infrastructuretokenscanrepresentavarietyofsecuritytypesandownershipinterests,includingtheownershipoJaninfrastructureasset,anequityinterestinthecompanyowningtheasset,adebtpositionsecuredbytheasset,ortherevenuestreamgeneratedbytheasset.Thenatureofthesecuritybeingtokenizeddeterminestheregulationapplyingtothetoken.Atthesametime,securityregulationscandifferandareofteninconsistentacrossjurisdictions.Thisraisesthequestionwhetherinfrastructuretokenizationcandemocratizetheassetclass,oritwouldonlytargettheusualprivateequity/debtinvestors.

•Lackoflegalclarityandgovernancerisks:Thelackofagloballyrecognizedcodeofconduct/tokenizationstandardformanagingdigitalassetsremainsthegreatestchallengetodecentralizedtechnology.Thelackofagloballyacceptablestandardpreventslegalclarityonkeyprovisionsrelatingtoclaimingownershiprights,integrationofanti-moneylaunderingandknow-your-customer(AML/KYC)requirements,adminrights,andintegrationwithsecondarymarketsarenotconsidered.Theproblemoftechnologyevolvingmuchfasterthanregulationspreventsthe“borderlessnatureofblockchain”fromtrulyachievingitspotential.

•Legalstatusofdigitaltokens:Tokenizedsecuritieshavetocomplywithlegalregulationslikeconventionalsecuritieslaw.Onlyafewjurisdictionsrecognizetokensasdigitalassets.Thetokenizationofassetsenablesthecreationofaholdingvehicleforthepurchaseofloansandotherassets.Thesharesofthisvehiclearethensoldtoparticipatinginvestorsprovidingdiversificationandreducingtheriskofownership.Liketraditionalspecial-purposevehicles(SPVs),tokensmustalsorepresentalegalentitythatownstheinfrastructureproject(s).However,mostjurisdictionsaroundtheworlddonotrecognizeinfrastructuretokenstorepresentanindependentinvestment,questioningthelegalstatusofinfrastructuretokens.Thesetokenscanbetradedeitherthroughadecentralizedexchange(DEX)orbylistingthemoneligiblecryptoexchangesprovidingsecondarymarketliquidityforanotherwiseilliquidassetclass.Additionally,virtualtokensaresubjecttomorestringentregulationsincomparisontoregularsecurities.

•Legalstatusofsmartcontracts:Smartcontractsarethecoreofmanyblockchainapplications.Theyimplementpre-establishedunchangeableagreementsprogrammedontheblockchainwithoutrequiringhumanintervention.Thesecontractsexecuteinstructionslikereceivingdividends.Despiteitscriticalimportance,thereisnojurisdictionthatprovidesalegaldefinitionforsmartcontracts.Expertshaveidentifiedfewobstaclestoprovidingsmartcontractswithalegal

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status—first,theneedtomaintaintechnologicalneutralityinregulations;andsecondly,themultiplestandardsandfunctionalitiesavailableforspecificcodesandblockchains.Asaresult,thelegalstatusofsmartcontractsisyettobedefinedinmanyjurisdictions,resultinginalackofenforceabilityandgivingrisetoconsumerprotectionconcerns.

•Cybersecurityconcerns:Theuseofsmartcontractsalsoraisesmajorcybersecurityconcerns.Thecharacteristicfeatureslikeautomationandimmutabilityincreaseitsvulnerabilitytocyberhacksandexposeinvestorstofraudulentpractices.Toensurecybersecurity,itisimportantfortokenstocomplywithAML/KYC.Itiscriticaltomaintainaccountabilityofownershipoftokensthatwouldrequirecollaborationwithsecuritytokenexchangestotrackownership.Thiscompliancerequiresexpertsupervisionandsubsequentlyincreasesthecoststoanissuer.

Examplesofconduciveregulatoryframeworksforimplementingtokenizationofinfrastructure

Theuseofblockchaintechnologyhasthepotentialtodisrupthowinfrastructureiscurrentlybeingfinancedifthereisanenablingregulatoryenvironment.CountrieswithastronglegalframeworkforDLT-basedsecuritiespresentanattractivedestinationforissuingthesesecuritytokensandparticipatinginthetokeneconomy.Thefollowingareafewleadingexamples

•UnitedStates:Asanemergingtechnologicalsolution,thetokenizationofinfrastructureissubjecttodifferentlawsatthefederalandstatelevels.In2019,28statesintroducedlegislationforblockchain,with27billsandresolutionsenactedandadopted.InSeptember2020,theOfficeoftheComptrolleroftheCurrency(OCC)allowednationalbankstoprovidepermissiblebankingservicestoanylawfulbusinesstheychoose,includingcryptocurrencybusinessesaslongastheyeffectivelymanagetherisksandcomplywithapplicablelawincludingthoserelatingtotheAMLandBankSecrecyAct(BSA)provisions.

•Luxembourg:Luxembourgiscurrentlyoneofthemostconducivejurisdictionsforinfrastructuretokenization.Itslegalframeworkisdesignedtoenablethebenefitsofblockchainthatarethemostrelevantandbeneficialforthecountry,suchasusingblockchaintoeliminateintermediariesintheassetmanagementindustry.

•Liechtenstein:Liechtensteindevelopedaholisticregulatoryframeworkdedicatedtothetokeneconomy.InJanuary2020,LiechtensteinbecamethefirstcountrywithcomprehensiveregulatoryguidelinesundertheBlockchainActorTokenandTrustedTechnologyServiceProviderAct,theGesetzüberTokenundVT-Dienstleister54/2019ofLiechtenstein.

•Switzerland:In2020,SwitzerlandpassedtheDistributedLedgerTechnology(DLT)Actenablinginnovationusingledger-basedtechnologies.UnlikeinthecaseofLiechtenstein,thisDLTactisnotaself-containedlawbutisablanketactmodifyingexistentcivillaw(inrespectofsecurities),financialmarketinfrastructurelaw(DLTtradingfacility),theBankingAct,andbankruptcyregulations.Akeyfeatureoftheactistheformalrecognitionofuncertifiedregisteredsecuritiesordigitalsecuritiesthatcanbetransferredwithoutfinancialintermediaries.Thisprovideslegalcertaintyontheownershipandtransferofthosetokens.

•France:Francewasoneofthefirstcountriestoprovidealegalstandingforblockchainandtoallowtheuseofthetechnologyforregistrationandtransferofsecurities.The“BlockchainOrder”

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wasintroducedin2017,aregulatoryframeworkestablishedinFrenchlawtogoverntherepresentationandtransmissionofunlistedfinancialsecuritiesviaDLTs.In2019,thePland’ActionpourlaCroissanceetlaTransformationdesEntreprises,alsoknownastheLoiPacte(the“PacteLaw”),wasenactedinFrancetofosterentrepreneurshipandinnovation,facilitatingthegrowthofbusinessesandcreatingjobs.Thelawissaidtogovernblockchainapplicationsandprovideguidancetocryptoassetserviceproviders(CASPs)ontheissuanceandmanagementofDLTrelatedservices.

•EuropeanUnion(EU):AsapartoftheEUDigitalFinancePackagein2020,theEuropeanCommissionpublishedthedraftRegulationforMarketsinCryptoAssets(MiCA)tofosterinnovationandcompetitionindigitalfinancewhilecontrollingassociatedrisks.LargelyinspiredbytheFrenchPACTELawof2019,theregulationintendstoregulateplayersincryptomarketsratherthantheassetsthemselves.Theregulationwillapplytoanypersonissuingcryptoassets,orassociatedservices.However,willnotapplytosecuritytokensthatarealreadysubjecttoexistingEUregulatoryregimes.

Applicabilitytoemergingmarkets

Emergingmarketsanddevelopingeconomies(EMDEs)currentlylagbehindinboththeresourcesrequiredfordevelopingpilots,aswellasregulatoryframeworksforgoverningprojects.However,thetokenizationofinfrastructurehasthepotentialtopositivelyimpactEMDEsthemost.ThefinancingofinfrastructureinEMDEsisfacedwithgovernmentdeficits,issuesoftransparencyandinsufficientfinancialefficiency,aswellasthelackofperformancetracking,whichtokenizationcanaddress.

Tokenizationindevelopingcountriescanelevateprivatesectorconfidenceviaimprovinginfrastructureassetliquidity,whileopeningaccesstosmall-scaleprojectsandenlargingparticipationininfrastructuredevelopment.EMDEgovernmentscanbenefitfromprospectiveadministrativeandfinancialefficienciesbroughtaboutbyautomatedauditing,enhancedprojectmonitoring,andlowerfinancingcosts.Small-scaleprojectsoftendeliverthemosteconomicandsocialimpactperdollarspent.However,theseprojectsfacebarrierstofinancingduetohightransactioncostsduetotheirsmallsize.Bytokenizingsmallscaleinfrastructureprojects,due-diligenceandtransactioncostscanbedecreasedsignificantly.Takentogether,tokenizationhastheimpacttotransformboththeeconomiesandpeople’slivesinEMDEs.15However,tounlockthecompletebenefitsofblockchainthroughtokenization,itisimportanttocarefullyexamineandovercomethepotentialrisksandbarriersinEMDEsthrough:

a.Regulatoryharmonization:Formainstreamadoptionthroughaglobaluserbase,STOregulationofdifferentjurisdictionsneedstobeharmonized.IntheEMDEcontext,policymakersneedtoupdatethelegalandregulatoryframeworkstoaddresstheopportunitiesandrisksassociatedwithtokenization.Establishingthelegalstatusofasset-backedtokensandsmartcontractsmustbeprioritized.Taxationpoliciesshouldbemodernized,suchthatassettokensarealignedfortaxpurposes.Acarefulbalanceofregulationshouldbemaintainedtoensurethemarketisboth

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secureandfavorablefortheprivatesectortoparticipatein.Expertshaveproposedmultilateraldevelopmentbanks(MDBs)withothernongovernmentalorganizationsinitiateaworkinggrouptodevelopaprocesstotest”low-hangingfruit”applicationstowardsmorebroadlydefinedinfrastructureinvestmentdomains.16Ahybridglobalizedgovernanceandreportingsystemtointegratethespecifictokenizationrequirementsoftargetcountriescanbeestablishedtocreateglobalalignmentofsmartcontracts.17

b.Pilottestingandsandboxes:Thereisaneedfordevelopingpilotsandregulatorysandboxesforpromising-usecasestogainpracticalinsightsandtesttheadvantagesandconstraintsinareal-worldsetting.18Totestandlearnaboutthetechnology,somejurisdictionslikeSouthAfricaandthePhilippines19havealreadyestablishedregulatorysandboxestoallowforamoreflexibleapproachinconsultationwiththeregulator.Sandboxescreateasafespaceinwhichbusinessescantestinnovativeproducts,services,businessmodels,anddeliverymechanismsinaliveenvironmentwithoutimmediatelyincurringallthenormalregulatory