by Scott Clavenna
June 12, 2018

The concept of "tokenizing" renewable energy assets as a way to democratize financing has broad, intuitive appeal. 

Tokenization is often mentioned toward the rear of an energy-blockchain startup's white paper, or in the later phases of a product road map. It doesn't offer the same appeal as peer-to-peer trading, but it's an important concept in the blockchain world.

Traditional equity and debt for projects is never easy to come by, and developers are undoubtedly looking for ways to lower transaction costs and expand pools of investors. Blockchain — offering up a distributed ledger, smart contracts and tradable tokens on exchanges that have no technical limits on their geographic scope — does appear at first blush to offer a platform that improves on the crowdfunding trend.

Crypto expert David Allen Cohen explains tokenization in his description of WePower: "These tokens represent energy they commit to produce and deliver. [...] As a result, energy producers can trade directly with the green energy buyers (consumers and investors) and raise capital by selling energy upfront, at below-market rates. Energy tokenization ensures liquidity and extends much-needed access to capital."

Before getting too excited about yet another world-changing application of blockchain, it’s worth asking a number of hard, important questions. I’d group them into three categories:

  1. Technical: Does the blockchain platform have the necessary features, security, and robustness to support this type of financing? The ideas for blockchain are almost always well ahead of the technology, but that doesn’t mean it won’t catch up. It just means a lot of ICOs are crap — so caveat emptor. 
  1. Market need: Is project finance “broken” in some way today? The answer is surely "yes" for elements of this market. Capital is hard to come by or expensive in many countries today, or may be biased toward certain types of projects. Transaction costs can be prohibitively high for certain investors or projects, and development times can drag out as projects seek necessary capital or negotiate PPAs. 
  1. Regulatory: Does the blockchain platform, as designed, challenge any regulatory structures that would limit its ability to operate and provide value? Nearly all blockchain startups have tokens that could be regulated as securities or operate exchanges that are open to regulation. (More on that below.)

To get some perspective on tokenized renewable energy projects, I did what everyone should do when looking into blockchain: I reviewed a number of white papers, and then talked to an attorney. 

The white papers ranged from interesting to mildly heartbreaking.

Some seem very well intentioned, with enough industry and market knowledge to build a case that democratizing project finance via blockchain could help accelerate deployment of renewable energy and therefore contribute to the decarbonization of the electricity system.

Typically, the startup will have two different tokens: One that is more of a “utility” token, assuring access to a platform and accruing some type of value over time; and another that represents either a fractional share in the equity of a renewable energy asset or the produced energy at a given time in the future.

There is an exchange where these can be traded. Because of the blockchain, the features of smart contracts and distributed ledgers make it theoretically quite easy to execute transactions quickly and securely, with little overhead. So the story goes, at least, so far.

Fine print often reveals how little obligation the blockchain startups have to the token holders, how easily one’s tokens could end up holding no value, and how difficult it is to ensure a project even exists or gets financed at all.

And then there are the heartbreaking white papers. They are difficult to read, perhaps because of having been poorly translated into English, or perhaps because the writers have no idea what they’re talking about. Teams often have no background in anything relevant, and “projects” are little more than photographs of a rural school. 

That’s why you need to contact an attorney. There isn’t enough information in these white papers to truly understand this new area of blockchain. 

I spoke with Mark Higgins of Mintz Levin in Boston. He's just a few blocks away from the GTM office, and he works for one of the best firms in project finance, securities regulation and clean energy.

Mark has looked at this space with enthusiasm and the necessary skepticism of any good lawyer. We detail the conversation below. 

Scott Clavenna: We’ve had crowdfunded renewable energy projects in the past from companies like Mosaic. How would you explain the difference between those projects/companies and what’s being proposed today by blockchain startups?      

Mark Higgins: Crowdfunded endeavors like Mosaic share a lot of outward characteristics with the latest applications of blockchain technology in renewable energy. The design behind both was to unlock lots of small-dollar investments from parties who would not otherwise be able to participate in the renewable energy space. 

The essential difference with blockchain companies is that intrinsic in the technology is the ability to create a liquid market. Mosaic operated with microloans. Investors loaned money to projects with a certain rate of return that was fixed from the beginning. It allowed participants who wanted to support clean technology to do so on an individual level and receive some economic benefit for their efforts. The question of whether the investor was correctly assessing the opportunity cost of not placing the funds elsewhere was irrelevant to the appeal of the project. 

These renewable energy blockchain efforts are an attempt to inject greater return into the system. The fundamental gamble behind many of these concepts is that somewhere a market will value the return of these tokens at more than a nominal interest rate. If the company can create the right conditions for the market to develop — and thus allow for the possibility of a fundamentally greater return — the amount of capital will dwarf the amounts that were previously available from investors willing to support clean technology for the sake of supporting it (i.e., the low interest rates of Mosaic).

Scott Clavenna: If the blockchain company is in the U.S., and the project is in the U.S., is there any way this wouldn’t be regulated as a security?

Mark Higgins: It seems like a bit of an Uber moment, doesn’t it? It took Uber forcing its way into markets and risking regulatory backlash to really open the door to ride-sharing.

That being said, the U.S. and China are generally acknowledged as the jurisdictions where the presumption is that blockchain tokens are going to be regulated as securities. A lot of the ICOs are coming out of other jurisdictions that are not regulating token sales as tightly. We are seeing discussion on how to distinguish utility tokens from securities, but for the time being the SEC has been clear — tokens are securities for purposes of U.S. securities laws. 

Scott Clavenna: If I’m a developer, should I look at this process of “tokenizing” an energy asset as a new source of capital that may have advantages to traditional sponsor equity or debt?

Mark Higgins: Of course. Tokenizing projects gives developers another tool in the toolbox. Properly done, it allows developers to tap into a previously unavailable pool of capital with less rigorous oversight and lower transaction costs — it’s a win the whole way through.

The real issue is the investor perspective. Much, but admittedly not all, of the difficulty (i.e., transaction costs) of traditional sponsor equity or debt transactions ensure that the developer does what they say they were going to do and give the investors rights in the event of a developer’s failure to follow through. People who invest large amounts of money want to make sure that they have a reasonable chance of getting it back.

It is harder to provide those same protections to individual buyers of tokens at small dollar amounts. The chance for something to go wrong is much higher (from an investor perspective) because, if there is no lead investor watching the shop, chances are that individual token buyers are much more willing to eat the loss. 

Scott Clavenna: If I’m a casual investor looking to support clean energy development, what should I think about before participating in a tokenized asset sale? 

Mark Higgins: Securities laws exist for many reasons, one of which is to protect casual individual investors. When they are cumbersome or too conservative, it’s usually a result of the fact that legislation and regulations would be far more convoluted if they were written to dovetail into every possible situation. The answer is that we have less precise laws that err on the side of caution when necessary.

If I’m a casual individual investor looking to support clean energy development and I’m looking at a blockchain opportunity, I would ask myself one question: can I explain to someone who knows nothing about blockchain how I am going to make money on my investment? Can I explain where my money is going, what it is doing and how it is coming back to me? 

There is a ton of hype right now in blockchain and there are moments where it feels like a cycle that feeds itself. It’s important to remember that buying a token is still an economic transaction and, if my dollar is going out into the world, I want to know how it’s coming back before I let it go.

Scott Clavenna: Assuming the process of tokenization works from a basic technical level, where would you think it has the most applicability in the renewable energy project finance market today?

Mark Higgins: There is a ton of enthusiasm at a grassroots level for renewable energy projects, but we have seen studies suggesting that top-level investment in this space has slowed down recently. It stands to reason that smaller projects with a smaller rate of return are going to be the ones that benefit the most.

With the big-money investments chasing the surest returns (and these are usually — but not always — the bigger projects), that leaves less air for down-market projects that are still viable. Creating an alternative financing source that is the result of lots of small investments instead of a small number of large investments gives those smaller renewable energy projects a much greater chance of getting off the ground.

Scott Clavenna: Is the market opportunity for asset tokenization limited to adding liquidity and increasing investor access, or does blockchain solve any other element of the project finance process?

Mark Higgins: At this stage, the goals of adding liquidity and increasing investor access are still really big deals. Conceptually, blockchain does seem to have the magic sauce to accomplish adding liquidity and increasing access, but we really have not seen anything come on to the market that shows those goals have practically been accomplished.

There are a ton of great ideas out there, but nothing has matured to the point that we can say a problem has been solved. Can the project financing process be streamlined? Of course. Can blockchain do it?  Probably. (I’d bet yes.) Are we there yet? No, we are not really there yet. 

Scott Clavenna: Does tokenizing energy assets introduce any risks/complexities/dangers to this market that aren’t currently present? 

Mark Higgins: Theoretically, when I lend someone a large amount of money or if I invest money in a venture, I know that I have the protection of securities laws and other legal protections before I even have to get to the specific protections that I will negotiate and contract for that are specific to this investment.

I am going to want the value of my money back and, because in this situation I am a large investor, I would like to watch my investment closely. If something happens that I do not like and that I believe threatens the value of my investment, I have the ability and opportunity to intervene and take steps to rescue the value of my dollars.  

When you democratize investment, suddenly there is no single person watching the dollars in their investment. If financial misconduct or other red flags start popping up, it is going to take a while for an investor base that is disconnected, at an arm’s length from each other (in addition to an arm’s length from the company) and lacking a lead voice to determine that their dollars are at risk. And it’s going to take longer for them to act. 

Time is money in these circumstances. Where a traditional investor may act quickly, a distributed group of individual investors that purchased handfuls of tokens may take a while to get organized. The circumstances are ripe for some people to lose money because of bad acts and not bad fortune. 

Still looking for more? You're in luck. Squares can watch the livestream of our Grid Edge Innovation Summit on June 20-21 in San Francisco, where we'll be talking about blockchain for energy. You can still register to attend in person here.