Louigi Verona

Blockchain is useful for adding transparency to charities. Or is it?

One of the alleged use cases for blockchain is charity transparency. A project that aims to do that is the AIDChain platform with their AidCoin token. In their whitepaper (v.04) they note a decline in the trust of big charities because of high profile cases of charity fraud. They further claim that current methodologies of assessing charities are limited to self-reporting or third party reporting, which itself is based on charities’ self-reporting.
The whitepaper then claims that AIDChain/AidCoin is a solution, because it offers a lower cost of transaction; more efficient tracking of funds; transparency based on smart contracts, which would return the money to the donors based on certain conditions; tax deduction, since currently blockchain tokens are not regarded as cash. They also add that adopting AIDChain/AidCoin would be very simple for charities and allow them to not have to invest in the IT sector.

Unfortunately, the picture painted by AIDChain’s authors is very misleading.

They are right about the decline of trust in charities, and they even provide links to relevant studies for UK and US. But this seems to be the only non-controversial statement they make.
There are three fundamental problems with their narrative:
  • they limit the assessment of charities to tracking of funds
  • they are incorrect about the range of currently used methodologies to assess charities
  • their AIDChain solution as it is described in the whitepaper does nothing to make the situation any better
Since the answer to this question focuses on someone’s startup, which is trying to raise money, I decided to add a disclaimer.
Disclaimer: Please note that this analysis focuses on the AIDChain project simply because it was brought to my attention as a viable use case for blockchain. Since AIDChain is the first project of its kind, I am thus analyzing their approach to this problem. In other words, I have no stake in this, I have no connections to either AIDChain or their possible competitors, if those even exist, and all I am doing is analyzing their publicly available whitepaper.
Having said that, it is clear that the AIDChain approach is nothing original as far as it goes, and matches the general approach blockchain solutions tend to adopt.

i. Assessment of charities is more than tracking of funds

Charity assessment today has significantly evolved, and tracking funds is only part of it. The modern way to assess charity effectiveness is impact based (see Effective altruism) and involves a complicated analysis not only of the charity finances, but the scientific research behind the chosen method of helping, interviews with both charity employees and the people they are trying to help, on-site visits, follow up, the degree of transparency of a charity in question and evidence-based analysis of whether there is room for more funding (the impact of marginal dollars).
The interest of such charity assessment organizations is not limited to where the money goes or overhead. They are focused on assessing what a charity is doing and how effective and evidence-based its activities are, every step of the way. The set of discussion topics is different for every type of charity.
For instance, GiveWell, a notable charity assessment organization, provides an incredibly in-depth description of their process of charity evaluation, as well as documents, conversations, on-site visit reports for charities they have reviewed, including those they decided to not recommend.
GiveWell has focused primarily on the cost-effectiveness of the organizations that it evaluates, rather than traditional metrics such as the percentage of the organization’s budget that is spent on overhead. In the first year, Karnofsky and Hassenfeld (GiveWell founders) advocated that charities should generally spend more money on overhead, so that they could pay for staff and record keeping to track how effective their efforts were. This ran counter to standard ways of evaluating charities based on the ratio of overhead to funds deployed for the charity work itself.
Source: Impact-based_evaluation
That this is more than just an opinion of one organization is attested by the fact that it is basically going mainstream, with such notable organizations as GuideStar, BBB Wise Giving Alliance, and Charity Navigator writing open letters urging nonprofits and donors to end the use of the overhead ratio as the sole or main indicator of a nonprofit’s performance.
A study from the Stanford Social Innovation Review has further criticized some of these organizations themselves for relying heavily on financial data that is not adequate for evaluating a nonprofit organization, and that a more comprehensive approach similar to one of GiveWell and Giving What We Can should be used.
So, the AidCoin whitepaper’s implicit premise that it all comes down to tracking funds is a demonstrably outdated approach. Which means that their understanding of charity assessment is extremely narrow and superificial, and falls short of the approach that evolved out of years of experience in organizations that are actually doing it.
And, most importantly, the whitepaper authors seems to be really focused on preventing fraud, whereas a charity can be completely honest and very transparent, but poorly run and a bad choice to invest your money into. AIDChain does not offer a lot in this regard.

ii. The range of currently used methodologies to assess charities

AIDChain whitepaper claims that the methods of assessing charities are limited to self-reporting. It does mention recipient reporting as well, but does not expand much on it, instead focusing on the assertion that the only option the public has is to just trust what the charities are volunteering about their operations.
As can be readily seen from the previous section, this is demonstrably incorrect. The methodologies used by modern charity assessment organizations go far beyond trusting self-reporting from charities. A big chunk of assessment is based on independent scientific data, as well as on on-site visits and financial audits.
The latter is important to note. Nobody just takes charities at their word, and their self-reported data is being critically evaluated and cross-checked. If a charity is not forthcoming with additional information, this lack of transparency is noted and a charity has a good chance of not being recommended.
Failing to accurately describe how charity assessment works today allows AIDChain authors to exaggerate deficiencies of the process, thus creating a false sense that assessment of modern non-profits is in complete turmoil. It also allows them to embolden the importance of their solution and downplay the success of currently existing solutions.

iii. AIDChain is a poor solution

AIDChain whitepaper lists the following as advantages of using AIDChain to assess charities:
  • Tracking the actual use of funds, from the time money is donated up until its conversion into local fiat currencies.
  • Verification of the identity of the recipients and reporting on the blockchain of their funds use.
  • Tracking of administrative costs of nonprofits.
  • Ensuring money earmarked for specific projects actually gets to those specific projects.
  • Comparison of the effectiveness of a euro spent in one charity versus a different charity.
  • Tracking of the investment policies of charities with the money they hold.
  • Reduction in transaction costs of money transfer through cryptocurrency rather than financial intermediaries. This becomes especially relevant when dealing with organization that operate in developing countries, where transfer fees for remittances can be as high as 20%
Since one of the selling points of the AIDChain solution is that it removes the need to trust an authority, what must be immediately noted is that quite a number of these advantages simply exchange trusting established charity assessment organizations for trusting the company behind the AIDChain platform.
For instance, the very first item claims the ability to track the actual use of funds. However, tracking money from donations to conversions into local fiat currencies does nothing to tell us how the funds are used once they are converted. So how will they do it?
The whitepaper explains this several pages later:
In the meanwhile, AIDChain will be able to track donations even after AidCoin is converted into fiat currencies thanks to the integration with the charity’s bank APIs. AidCoin will collaborate with companies such as TrueLayer in order to connect to the bank data, verify accounts, and access transactions in real-time, providing a clear picture of how charities are spending the funds received in AidCoin.
In other words, the tracking of actual use of funds is going to be done through the open APIs of European banks, which are required to provide them as the result of the EU Payment Services Directive (PSD2). That this curious fact is mentioned only several pages later is quite deceptive. And immediately raises a question: why is a cryptocurrency middleman required at all here, when it all comes down to tracking the actual use of funds through the normal banking system?
The AidCoin whitepaper does have an answer to that: “traceability of the entire donation flow will depend on the mainstream adoption of blockchain technology and cryptocurrencies”.
In other words, AIDChain’s model will work only in the case of a very hypothetical scenario of the world rejecting fiat currencies completely and switching to cryptocurrencies. And the current solution of using bank APIs is temporary.
But given the unlikelihood of cryptocurrencies ever becoming widely adopted, or at the very least becoming adopted enough in the observable future, this temporary solution is probably as permanent as it gets, and AidCoin’s services are not going to be any more transparent than any other assessment organization.
But this is where the authors’ poor understanding of modern charity assessment methods really shows. Tracking the use of funds, be it through blockchain or the banking system, might perhaps make it a little more difficult for the charities to cheat, but it does nothing to address the actual impact of a charity or whether one’s money are likely to be spent effectively.
And this is where fraud may actually be happening. Even authoritarian governments, routinely and almost openly misappropriating taxpayer funds, typically have their paperwork in order, with the fraud happening outside the context of purchase receipts.
A simple, but illustrative example would be to conspire with a local pharmacy and buy medicine for one price, while have the pharmacy log a different price — and pocket the remainder of the money. In this case blockchain records are going to be entirely clean, transparent and tamper-proof. The AIDChain platform will only create a false impression of security, while doing nothing to detect or prevent such fraud. This, however, is more likely to be discovered or prevented if a charity is regularly assessed from multiple angles, like it’s being done by many modern charity assessment organizations.
Verification of identities is presumably going to be done in the same fashion as any non-cryptocurrency service does it — through reliance on ID documents and other standard methods. The public will have to trust the AIDChain platform on this one too.
Tracking of administrative costs of nonprofits, as well as ensuring that money for specific projects actually gets to those specific projects, is also completely outside of the AIDChain platform. Authors of the whitepaper suggest that charities submit scans of receipts into the blockchain, implying this is more transparent. But, as already discussed above, fraud frequently happens outside of the paperwork. And simply adding receipts is no different than these same charities submitting documents to charity assessment organizations.
The whitepaper states:
Thanks to the AIDChain platform and AIDPay, the information automatically or manually recorded on the blockchain will be immutable, tamper-proof and publicly accessible through an open explorer, increasing the level of transparency and allowing public auditing besides AIDChain platform users.
Which looks like solving a problem that nobody has.
First, a lot of charity assessment organizations already publish financial documents that they review, and the public is able to independently audit them today, without having to use a blockchain.
But also, this strikes me as a thinly veiled implication that charity assessment organizations are likely to collude with the charities they assess. So likely, in fact, that we need AidCoin to solve that problem.
But we are presented with no evidence of such a fraudulent scheme ever emerging. Unless there is a proven record of charities submitting documents to charity assessment organizations and then someone tampering with them, blockchain’s immutability adds absolutely no value. And submitting documents in order to then tamper with them seems like a very unpractical way to cheat anyway. I was able to find no scandals involving a charity assessment organization being bribed by a charity so that they allow access to already submitted documents. And yet, this is a problem that AidCoin proudly announces to solve. Where is the value in solving a problem that nobody has?!
Again, as discussed earlier, if someone wants to cheat, all they have to do is add fraudulent or misleading receipts to the AIDChain platform, the same way they would do within a normal charity assessment process. AIDChain solution does nothing to address this and gleefully announces that it will basically rely on charities’ self-reporting, just like they claim everyone else does (and which we’ve already seen to be demonstrably false).
The whitepaper then claims that AIDChain would provide a comparison of the effectiveness of a euro spent in one charity versus a different charity, but the authors do not elaborate on how this will be done, by whom and using which criteria.
Finally, they claim the reduction in transaction costs of money transfers through cryptocurrency rather than financial intermediaries. This is a standard claim frequently made by blockchain enthusiasts as an advantage of blockchain in general. We have addressed it multiple times, specifically here. Suffice to say, the advantage is questionable and comes at a cost: if anything happens, no authority will be able to help and, say, return the funds.
Same goes for the advantages of smart contracts in general, discussed here.
Introduction of blockchain will also introduce a risk of funds being lost through hacking or phishing, as well as through accidental private keys loss. Once the funds become inaccessible for one of the listed reasons, there is no way to return them.
Blockchain also introduces an additional incentive for insider cheating, because unlike centralized payment systems, where the payments are tracked and mediated, and even unlike cash, which needs to be physically transported, a cryptocurrency is easier to manipulate. Someone managing charity funds may just send them from the charity wallet to their own anonymous address.
Such a crime would be very difficult to prosecute, and bitcoin mixers would guarantee the thief cashing out. See this question for more details on how this was done in case of high profile crimes like the WannaCry ransomware, where thousands of eyes were tracking the respective Bitcoin addresses. This security loophole is critical and very difficult to prevent.

iv. Conclusion.

The AIDChain whitepaper does a poor job in explaining why blockchain is the future for charity assessment, but does a good job of demonstrating why it is not.
I was left with the impression that the team behind the project was more focused on trying to find a use case for blockchain, rather than trying to actually fix issues in the non-profit world.
The authors of the whitepaper demonstrate only cursory understanding of what actual difficulties charities and donors face, have either little interest to conduct basic research into modern charity assessment, or perhaps little interest to present it in their whitepaper, as doing so inevitably compromises the value of their solution.
Their description of charity assessment methods is critically incomplete and very misleading, creating a false impression that current charity assessment organizations are not effective.
They then proceed to claim that AIDChain is a solution, but fail to convincingly demonstrate why this is so. All they do is reiterate blockchain’s basic properties, such as immutability and relatively easy public access, without explaining how these properties translate into something useful. Neither did they care to address any of the possible objections, although a lot of them should have been easy to predict if one would think critically.
This makes their whitepaper impressive only to those who have a superficial understanding of how blockchain or smart contracts work. The public could be temporarily lured into a false sense of security, until the first scandal emerges and it becomes clear to everyone (if it hasn’t already) that blockchain is not a mechanism magically making everything honest and transparent.
Not only do the authors completely misunderstand the breadth and depth of charity assessment, but their proposals to increase purely financial transparency are sketchy, implausible and are not based on any data or real problems that are encountered in charity fraud. A lot of what they are offering is also contingent on an almost universal rejection of fiat currencies in favor of cryptocurrencies. Without this revolutionary and unlikely change in the world financial system their methods are conceptually no different to that of other organizations. In practice, AIDChain is likely to be less trustworthy due to their obvious lack of expertise.
AIDChain is a great example of a poorly thought out startup, based on popular misconceptions about blockchain, with a shallow whitepaper, dealing mostly in oversimplified versions of reality and buzz words. I don’t see how charity assessment is in any way a good use case for blockchain.

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