December 5, 2023 A Distinct Absence: Why Crypto and Web3 Technologies Need Environmental, Social and Governance Frameworks Author(s): Minderoo Centre for Technology and Democracy Credit: Milad Faukurian for Unsplash This report demonstrates the importance of environmental, social, and governance principles (‘ESG’) specific to the crypto and Web3 space. Read the summary report and framework Read the full report Developed by VentureESG and the Minderoo Centre for Technology and Democracy, University of Cambridge, the report provides fundamental recommendations and a practical ESG framework to help VC (‘venture capital’) investors integrate ESG factors into their investment processes. The report is authored by Cessiah Lopez and Johannes Lenhard. Context: ESG is a set of principles guiding a firm’s or a fund’s management, processes, and practices. The term ‘ESG’ was introduced in a UN Report in 2004 and can be generally defined as ‘how corporations and investors integrate environmental, social, and governance concerns’ into their business models. Despite the recent ‘crypto winter’ (this period of decline in the crypto market generally characterised by low or falling prices and reduced investor interest), crypto and Web3 technologies may have profound and enduring impacts on our digital ecosystems. Integrating ESG principles into the VC process for investing in the crypto/Web3 space can play a pivotal role in building more resilient and socially responsible companies within the sector. By fostering responsible product design and practices, these principles can ultimately contribute to guiding the industry towards governance structures that work better for society. Process and methods: The researchers interviewed more than two dozen VCs, Web3 founders and operators, lawyers, and other policy makers and regulators (collectively referred to as ‘participants’) to understand the current landscape of crypto and Web3 and ESG’s place in it. We covered questions and topics regarding (ESG) challenges in the industry, such as those around NFTs, token governance, DeFi, and the pseudo-anonymous culture of the space. The researchers also explored VCs’ current investment processes and theses, looking at how ESG can be integrated with pragmatic, implementable guidance. We then worked on creating an explicitly crypto and Web3 focused ESG framework. Recommendations: Using the findings, the authors present five key recommendations for VCs to ensure responsible investing in the crypto and Web3 industries. They also present a fit-for-purpose ESG framework that VCs can use to enable the integration. -Question the need for blockchain. VCs should prioritise evaluating the necessity of blockchain technology in startup projects, indirectly scrutinising environmental impact, societal, and governance implications. -Conduct comprehensive due diligence. VCs should engage in active dialogue with Web3 founders, operators, and community members, moving beyond traditional due diligence methods in order to seek tangible evidence (e.g., that ESG principles are being followed by potential Web3 investments before making a decision to invest). -Standardise crypto-ESG terminology. While the authors strongly suggest sticking to the widespread concept of ESG, the application of its principles are more important than the nomenclature. An alternative could be ‘responsible investing’ which has become more popular, e.g., among LPs in VCs more generally. -Foster collaboration among key stakeholders. This includes policymakers and regulators, to create a comprehensive approach to ESG integration and involve the entire ecosystem for a holistic solution. -Use the tailored framework. VCs are encouraged to use the fit-for-purpose due diligence ESG framework, specifically designed for assessing crypto and Web3 ESG issues. The framework enables VCs to make responsible investments in the ecosystem. Framework: Building upon VentureESG’s comprehensive ‘Universe of ESG issues’ document, and informed by qualitative feedback from industry participants, the new fit-for-purpose ESG framework offers VCs a practical resource to enhance their due diligence processes for crypto and Web3 startups. It provides a concise and effective ‘list of questions’ that guides VCs to address unique industry-specific aspects, which are often overlooked. The framework touches on crypto/Web3 specific ESG issues, such as the environmental impact of crypto mining and proof-of-work (PoW) chains, the social impact of certain tokenomics, and governance issues around centralised exchanges or pseudo-anonymous communities. The framework’s aim is to make ESG fit-for-purpose for the ecosystem fostering responsible and sustainable investing practices.