- Nonprofit organizations (NPOs) rely heavily on public trust. In order to gain trust, they are committed to accountability and are required to maintain maximum transparency in every aspect of their activities – specifically with regards to their financial resources management. In this paper we suggest a new blockchain-based solution to tackle this challenge.
- We believe that our solution could be highly effective for the following organizations:
- Intergovernmental organizations (IGOs) that fund various projects, either their own or those of other NPOs (whether governmental or non-governmental)
- Non-governmental organizations (NGOs) operating under governmental mandates
- Charities looking to maximize their transparency
Are NPOs Losing Public Trust?
The past few years have shown a significant decline in public trust in NPOs . This trend is increasing in US and UK, two of the largest donor countries whose governments have decided to cut aid budgets . A recent report by Charity Commission for England and Wales states that the public level of trust in charities reached its lowest record ever in 2016 (since measuring started in 2005) and has stagnated since. According to this report, the top three factors that influence public trust in charities are: Financial transparency, adherence to values and efficient use of resources. Recent scandals, such as those at the American Red Cross, Personal Care Attendant and CCAP and Cancer Fund of America, have added fuel to the fire, causing collateral damage to NPOs all over the world. These cases show a rampant misuse of funds: Following the 2010 earthquake in Haiti, The American Red Cross raised $488m with the goal of providing homes to more than 130,000 people. In actuality, the number of permanent houses that were built was only six. The Red Cross did not disclose details on how the money was spent. Internal memos indicated that the group hired the wrong local people for this project. In the Personal Care Attendant scandal, the Minnesota Senate called to investigate whether $100m of the state’s welfare program (CCAP) were transferred, in suitcases, to fund a terrorist group in Somalia. And in the case of Cancer Fund of America, only 2.5% out of the total $75m that the organization raised went towards the actual charitable cause. The rest was used for telemarketing services, salaries and perks for its employees. In these cases alone, over $650m of American public money were either stolen or wrongly utilized. Though the examples above achingly call for a dedicated methodology to ensure proper use of funds, we do not claim that the only effective criteria by which to measure the success of an NPO is fund transparency. We believe that an NPO should be judged according to the extent of the actual impact and goals it has achieved. However in many cases, it is either difficult to set quantitative KPIs for success or it is difficult to measure the outcomes effectively. Furthermore, both donors and NPOs would like to get a bottom line, i.e. where did the money go and what has been achieved? We believe it is too simplistic to focus only on the plain measurable KPIs in the form of financial resources management, since the underlying assumption might be that effective financial management equals substantial impact. Proper financial management is necessary but not sufficient. It is only a means to an end, not the end. Therefore, it may serve, at best, as a good proxy for actual impact. Having said that, proper financial management should be the bedrock of any NPO that wishes to gain trust and gather support. The most effective way to exhibit proper financial management is to maintain maximal financial transparency. It is a difficult task, that requires time and resources. NPOs who fail to do so, will, at some point, run into difficulties in raising funds. In this paper we suggest a blockchain-based platform that will enable NPOs to create maximal financial transparency. The platform is designed to tackle the two main challenges of financial transparency: ensuring that all funds indeed reach the NPOs and assist in monitoring their use. Our aim is to show that with the use of blockchain, NPOs can regain public and donor trust. A classic example of an organization that is constantly under public scrutiny over use of funds is the United Nations. A country’s mandatory contributions to the UN is calculated by a complex formula that factors in gross national income and population. That amount is then used to help fund the UN regular budget which covers administrative costs, several programs and peacekeeping operations. In 2016, the United States paid more than $10B to UN entities. To quote US Ambassador to the UN Nikki Haley in March 2017 at a Council for Foreign Relation event “Everybody knows there’s fat in the peacekeeping missions”. The US currently contributes $2.4B to peacekeeping, more than to any other UN body. The current administration has signaled its desire to cut funding to the UN, due in a large part to the lack of transparency of use of funds. We argue that using a proper blockchain platform in an organization such as the UN will do much to cut out the ‘fat’ and impose best practices and proper use of funds. It could therefore be a tool to weed out wasteful projects and direct funds towards projects that are properly run, perhaps even securing a budget increase for those projects due to the transparency that donor countries will receive.
What is Blockchain?
Blockchain is a disruptive technology that combines the merits of modern cryptography and distributed ledgers. As the name suggests, a blockchain ledger consists of a chain of data blocks, sealed cryptographically and time-stamped. Each new block is a repository of the latest transactions and is linked to the previous block. The chain propagates at predefined time intervals as new blocks are added, thus forming a chronological chain that is a trail of the underlying transactions. There is no central entity that is responsible for validating transactions and updating the ledger. Therefore, each node on the network must maintain a copy of the ledger and validate new transactions independently. New transactions are executed, i.e. written into a new block, only if the nodes reach a consensus on their legitimacy. The criteria for reaching consensus vary across different blockchain protocols.
Key Properties of Blockchain
- No intermediaries – the transactions are made peer-to-peer, using a system of cryptographic public wallet addresses, not through a third party, therefore transaction fees are minimal.
- Transparent and open – anyone can view and track all transactions as the ledger is public
- Immutable – all blocks are cryptographically signed which makes it impossible to edit or delete data after the it was added to the chain
- Secure and robust – the ledger is maintained by each node independently, eliminating the risk of a single point of failure
- Updated at near real time – new blocks are added to constant time intervals, usually every few minutes
A Suggested Blockchain-based Solution We suggest a blockchain based solution focused on two crucial aspects for NPOs: Monitoring flow of incoming funds and and monitoring use of proceeds. Underlying Assumptions In order to focus the discussion on the problem mentioned above, we propose a set of underlying assumptions. We believe that these assumptions have technical solutions which will be rather easily solved in the near future. Moreover, we can even estimate what those solutions will be and are able to suggest intermediate solutions, however they are beyond the scope of this paper and will be addressed in our future works. Our underlying assumptions are:
- There is no economic friction in exchanging cryptocurrencies to fiat money, and vice versa. As a result, NPOs (and all other related entities) are indifferent to the currency of the funds that are transferred to them. In addition, NPOs are able to seamlessly manage their financials over a blockchain platform
- All endpoints (NPOs, suppliers, etc.) undergo a periodic KYC procedure, run by KYC service providers. As funds are transferred to and from cryptographic wallets, it is imperative to track on a regular basis who are the beneficial owners of these wallets. This is a crucial anti-fraud measure and for preventing non-authorized entities from taking over legitimate wallet addresses and the funds they hold.
We believe that as an initial step in implementing this approach, the Ethereum blockchain can serve as the underlying infrastructure supporting this program. The Ethereum blockchain contains all of the technological features required to initiate the program and to provide the necessary functionality. In particular, Ethereum has the advantage of being a widely-adopted platform that has been proven to provide security, robustness and reliability. Moreover, the Ethereum virtual currency can serve as the currency for our program, and there would not be any need to create a new token or engage in a new ICO. By eliminating the complications that would accompany the creation and financing of a new token, use of Ethereum will allow for the most efficient, simple and immediate implementation. We have already begun to design the necessary architecture and believe the engineering could be completed within a matter of months. Monitoring Flow of Incoming Funds In our suggested platform, each endpoint operates only through approved public wallet addresses, that are periodically inspected and approved by the authorized KYC service providers. Donors can transfer funds directly to the NPO of their choice over the blockchain. Blockchain is perfectly suited for this use case:
- No intermediaries – the funds flow directly to the NPO, anywhere on the globe. The donor pays a minimal transaction fee (less than one $1), regardless of the amount they transfer
- Transparent and open – Donors can transfer funds to the NPO and make sure that these funds (in full) have reached their destination. In fact, anyone who wishes to do so, can. Instead of spending valuable resources on publishing fancy reports that are hard to validate, NPOs can simply share the link to their wallet addresses Moreover, it allows NPOs to raise funds for specific purposes under dedicated wallet addresses. Opening dedicated wallet addresses has two major advantages for NPOs versus opening dedicated bank accounts:
- Verification of wallet addresses and their prior usage is simple, public and instantaneous over blockchain and can be done by anyone, whereas bank accounts are private and managed by a third party making it virtually impossible for a donor to verify
- Blockchain is the ultimate record keeping platform. Therefore, tracking the use of proceeds via blockchain is much easier than over any other platform, as will be further discussed in this paper
- Immutable – Once the donation is made, i.e. written on the blockchain, it is there forever. Assuming the the donor wishes to prove making a donation (e.g. for tax deduction purposes), the transaction ID could be the only proof required for that purpose
- Secure and robust – data is properly managed and stored over the distributed network
- Updated at near real time – it only takes a few minutes to confirm the transaction and notify the donor
A fundraising event using blockchain infrastructure could go as follows:
- An NPO calls for donations to support a specific cause or project in a specific country
- The NPO publishes the validated wallet address instead of announcing the dedicated bank account details. Potential donors can verify that this address has been set up for the purpose of this new project and that the NPO is its beneficial owner
- Donors transfer the funds directly to the new wallet address. They know the net amount that will reach the destination since the transaction fees (less than one dollar) are clear
- Transactions are confirmed over the blockchain within a few minutes, and the donor is notified as soon as the confirmation is completed. This notification is the proof, for tax purposes or any other, that the donation has been made
- The donor, or anyone else, may follow the fundraising process in order to know how much money has been raised
Monitoring Use of Proceeds
This part of the challenge is more complicated than the former. We envision a new platform that tracks and analyzes the proceeds transferred to all “endpoints”. An endpoint may be any individual or entity, e.g. suppliers, subcontractors, legal authorities, etc., that is paid by the NPO. As mentioned above, we assume that NPOs are able to manage their entire financial activity over the blockchain and that all endpoints undergo a periodical KYC procedure. It is often (and mistakenly) presumed that blockchain technology provides a maximal level of privacy to users. This may be true for some blockchain protocols, but not for the majority of them. In particular, not for the currently most widely used protocols and for the protocol that our solution relies on. A cryptographic wallet’s public address is anonymous, and an expert can easily generate hundreds of them in a matter of seconds. Presumably, a user can generate multiple anonymous addresses and transfer funds between them in order to mask its fraudulent financial activity. However, if it is carried out over a blockchain that is accessible to all and that keeps records of all transactions, it would turn out to be useless. Existing tools can reverse engineer and analyze these scam attempts. We suggest a much simpler solution that does not require sophisticated software tools or anti-fraud experts. Our solution is a blockchain in which each wallet address is identified and associated with a specific endpoint. Each endpoint is registered on the distributed ledger along with all its KYC details. It is mandatory for an endpoint to register or go through the KYC procedure to be considered as a legitimate endpoint. The KYC procedure will be carried out by KYC service providers who will be in charge of collecting, validating and maintaining all necessary data about the endpoints. The data collected will resemble that of any standard ERP software, i.e. types of service, tax documentation, etc. As an added level of security, KYC service providers will also be required to undergo elaborate KYC procedures themselves to ensure their trustworthiness. Once the NPOs have an ERP system on the blockchain, with all of their transactions publicly available for monitoring, any simple software module could immediately generate all sorts of reports, e.g. how much money was spent per endpoint, per service, per country, per time period etc. These reports will not replace annual audits, but will definitely make it simpler, since all of the information is already on the blockchain. It is most likely that very few donors will dive into all these details to generate their own reports, but they will be able to if they wish. This solution provides the ultimate transparency donors can ask for. The platform will flag which NPOs are “transparent”, i.e. ensure compliance with KYC procedures, and which ones are not. As a result, NPOs will be required to be accountable for their endpoints and for making sure that they comply with KYC requirements. Otherwise, it might have to face the consequences. Earlier we indicated that blockchain is the perfect platform for tracking records and that it makes tracking financial resources management easier. Hopefully, we have made this point clear. Yet, there is more to it. One major advantage of blockchain over any other financial record keeping system is its immutability. Since all transactions are time-stamped and cannot be edited once confirmed, there is no way to “cook the books” without being traced. It simply cannot be done. Any attempt to transfer funds between projects, i.e. wallet addresses, will be immediately traced and flagged as fraud. There is no way around not reporting everything properly. Funds managed in bank accounts are at risk from these kinds of scams as banks accounts are inaccessible to donors and only to auditors, at best. Blockchain platforms are therefore superior for this purpose. Let us get back to the $10B contribution from the United States to the UN. It relies on UN reports to determine which entities received these funds. With blockchain the US could better analyze its actual contribution:
- Validate these transfers and their timings, thus ensuring whether specific entities have been properly funded
- Ensure that all funds were transferred to endpoints that are operating under the required KYC procedures
- Track projects’ progress and proceeds allocation, based on predefined budgeting criteria
- Compare year over year budgets
As further example, it should be noted that USAID shares data about its contributions worldwide. The data is analyzed by activity, sector and country. It even includes infographics and is available for download. There’s only one caveat, it is up to date as of FY2016… This paper is written at the end of July 2018. Had the USAid’s financial platform run over blockchain, it would have been possible to publish an identical analysis, updated as of ten minutes ago.
In this concise paper we tried to solve a key challenge that NPOs are facing. Transparency may not be their ultimate goal, but it is definitely a burden that stands in the way of achieving their goals. We realize that adopting new technologies is never easy and entails considerable efforts, especially for financial reporting software to be used by an entire ecosystem of conservative service providers, e.g. auditors, bookkeepers, etc. No doubt that it will take time to adopt, but we are certain that blockchain holds a solution for this challenge. Moreover, those who do make the effort of adopting, will reap the benefits and will set the standards for others to come. © All Rights Reserved to Hexa Foundation Ltd. (CC) Hexa Foundation Ltd. (CC) permits the free use of this document, subject to the conditions set forth below. The use of this document is permitted for private and personal use only. It is prohibited to copy and to use, or allow others to use, this document for any purpose, whether commercial or non-commercial, other than private and personal use. The contents of this document are permitted for use on an as-is basis. The reader or any third party shall not have any claim or demand against Hexa Foundation Ltd. (CC) with respect to any of the contents of this document. Hexa Foundation Ltd. (CC), including its employees and representatives, shall not have any liability for any damage to the reader or any third party that occurs, directly or indirectly, as a result from the use of this document or the information contained therein.