Infrastructure Project Finance, RippleNet, and On-Demand Liquidity
Infrastructure and the services it provides are the primary driver for economic development and wealth creation. From the roads we drive on to the water that flows to our faucets, infrastructure is integral to our daily lives. It sustains society’s competitiveness, economic growth, and most importantly, its members’ well-being. It also represents the world’s largest industry sector ripe for disruption by the blockchain, from contracting to financing, and operations based on information from digital twins.
The Finance Gap in Infrastructure
Currently, a vast infrastructure financing gap exists in the U.S. as well as the world. The gap is estimated at $3 trillion USD by 2030, domestically, and at $15 trillion USD by 2040, internationally (American Society of Civil Engineers, 2021; Global Infrastructure Hub, 2017). Per the American Society of Civil Engineers’ (ASCE) report, the US infrastructure received a C- rating. In other words, the infrastructure “…shows general signs of deterioration and requires attention. Some elements exhibit significant deficiencies in conditions and functionality, with increasing vulnerability to risk” (American Society of Civil Engineers, 2021). And this is already an upgrade from a D+ rating appraised in 2017. Yikes!
The finance gap is further exacerbated by factors such as climate risks and the global pandemic, requiring resilience. Cross-border direct investments, which include financing for infrastructure, have dipped by one-third to $1 trillion USD (United Nations Conference on Trade and Development, 2021). Such a drop off has had a detrimental effect, especially on greenfield infrastructure investments in emerging economies. The Biden administration has proposed the Build Back Better World (B3W) initiative that looks to invest in promising infrastructure projects around the world with the support of private-sector leaders. A wide range of financing approaches (e.g., corporate finance and project finance, including lending, private equity, and concessionary loans) are available. However, conventional avenues are often associated with high transaction fees, illiquidity, and high investment thresholds (Joffe, 2016).
Infrastructure investments are primarily made in the local currency of a project, hence, in addition to the illiquidity of nostros accounts, issues such as opaqueness, cross-border currency convertibility, exchange rate fluctuations, currency mismatches often arise in the legacy banking systems. The so-called “friction-cost” between parties, counterparties and intermediaries, can be as high as 6.5% of the transaction. International transactions can take convoluted steps which lead to extended settlement times, taking approximately three days to complete. It may be even longer in some cases. These frictions in cross-border financing lead to an increase in the cost of capital, and impact project bankability. Financial instruments such as derivates (futures, options, swaps, etc.) allow investors to hedge against some of these risks. Yet, the premiums and transaction fees for these contracts are high, the processes complex, and the instruments do not address the issue of opaqueness in legacy systems. Traditional transactions also take about 3 to 5 days to clear since the legacy payment-settlement systems are incoherent as countries have their own unique banking system, regulations, and currency.
Can RippleNet and On-Demand Liquidity Blockchain Technology Overcome Settlement Frictions?
Before the launch of RippleNet and On-Demand Liquidity (ODL), which were built leveraging the open-source XRP Ledger and its native currency, XRP, sending money globally traditionally involves using SWIFT, a service that allows banks to send messages with payment information. Once the payment is confirmed, manual input is required to transfer the funds. If the transacting banks do not have an existing relationship, the funds are routed through intermediary banks. Since each intermediary bank charges fees for its transaction services, the costs of an international settlement can have unexpected fees and delays.
Blockchain technologies are primed to facilitate and streamline cross-border financial transactions as it has the potential to remove high transfer fees, slow processing times, and opaqueness in the value transfer process by automated execution on contracts. Ripple sought to reduce friction costs by enabling participants to message, clear, and settle transactions at low cost and high speed. Transactions of value such as remittances should be instantaneous just like sending an email or sharing documents and videos online. Infrastructure, an asset class that is already known to be illiquid with a high barrier for entry, can benefit from blockchain technology and digital bridge currencies to become more bankable. The bankability of infrastructure is key to delivering projects that alignment with and attract investors. Removing frictions in cross-border investments will go a long way to addressing the time and cost issues.
RippleNet and ODL enables corporations and financial institutions to move value in real-time at a low cost, while knowing exactly how much and when the value reaches its intended destination. The users can look up account information to validate a destination’s wallet address before sending over a large sum of value. Utilizing the blockchain’s trust, transparent, and efficient characteristics can reduce the extra costs and other resources investors put towards mitigating cross-border investment risks. Being able to process payments and settlements in real-time, investors in infrastructure won’t need to worry about failures, establishing nostros, or pay premiums to “lock in” an exchange rate. This lowers the cost of capital and makes investments in infrastructure much more viable.
Positioning for Future Infrastructure and Tokenization
Infrastructure 4.0 is often referred to as ‘smart infrastructure’ enabled with sensors, edge processing of data, and delivery of insights not only for its owners and operators, but importantly for its investors. Providing real time updates on structural health, performance and use of roads, pipelines, water and energy systems improves how infrastructure assets can be valued, a key determinant for financing, risk underwriting and rating. The blockchain and digital assets solution is well-positioned to catalyze new investments in data-driven, tokenized infrastructure such as new toll roads, renewable energy projects, or even new cyber-physical ‘intelligent’ infrastructure systems that inform token characteristics. Full transparency of transactions, increasing trust among counterparties, and improving liquidity for institutional and retail investors in these networked infrastructures is a game changer for cost of financing and further democratization of infrastructure access and its financing. By linking performance data from infrastructure tokenization to tokenized loans and bonds through smart contracts and transacting these contracts across borders using blockchain technology, a global digital financing eco-system will be emergent to enable more resilient and equitable infrastructure services for society.
References
American Society of Civil Engineers. (2021). 2021 Report Card For America's Infrastructure.
https://infrastructurereportcard.org/wp-content/uploads/2020/12/National_IRC_2021-report.pdf
Global Infrastructure Hub. (2017). Global Infrastructure Outlook.
https://outlook.gihub.org/
Joffe, M. (2016). Doubly Bound: The Cost of Issuing Municipal Bonds. https://belonging.berkeley.edu/doubly-bound-costs-issuing-municipal-bonds
United Nations Conference on Trade and Development. (2021). World Investment Report 2021. https://unctad.org/webflyer/world-investment-report-2021