Financializing the Environment: The Emerging Web3 Carbon Credit Markets
Our unsustainable relationship with the planet is leading to climate change, biodiversity loss and environmental crises. More than 130 countries and regions around the world have proposed carbon neutrality goals, while green energy, low-carbon production facilities and sustainable development has become an international consensus. Carbon can be tracked and traded like any other commodity, building a market to decarbonize the global economy by putting a price on carbon and disincentivizing polluters. As environmental-friendly pressure increases, the carbon market is becoming an appealing financial marketplace for corporations to meet government environmental regulations in regards to carbon offsets. Examples include complex carbon emissions trading systems in the European Union, in Australia and in North America.
While traditional industries are racing to reduce carbon emissions, Web3 networks face their own energy consumption challenges: Proof-of-Work networks are known to consume large amounts of energy to operate. According to the Digiconomist, Bitcoin mining generates as much CO2 as New Zealand, and consumes as much electricity as Chile.
While these concerns are valid, many network operators are actively moving to more environmentally-friendly technologies and investing into projects to reduce pollution. For example, Ethereum is turning to a Proof-of-Stake mechanism, Ripple pledged to invest US$100 million in carbon neutral markets, and Polygon plans to achieve carbon negative emissions by 2022. Just as traditional industries become more economically friendly, Web3 projects are doing the same, while also aiming to optimize carbon credit markets to support the decarbonization of traditional industries.
A carbon credit represents the right to emit one metric ton of carbon dioxide and is a certified measurable and verifiable reduction in emissions. Carbon credits can be exchanged voluntarily in the carbon market or as part of a regulatory framework. This gave birth to traditional carbon markets, categorized as either voluntary carbon markets (VCMs) or compliance carbon markets (CCMs).
Only institutions approved by the regulatory agencies are allowed to participate in the compliance carbon credit market. Large-scale marketplaces are mainly distributed in Europe, the United Kingdom and North America. Thus, there is not much space for innovation in CCMs.
According to MSCI, the global market for compliant carbon credit trading in 2021 is estimated to be worth about $851 billion, with the voluntary carbon markets making up roughly $1 billion of that. Institutional investors are currently lacking due to the relatively small scale of VCM.
While VCMs operate at a fraction of the size of CCMs, it is a much more flexible and global market. Unlike CCMs, VCMs are not regulated by governments or governed by regulatory standards. Furthermore, there is no cap on the number of carbon credits that can be issued or traded. While this lack of standardization leads to challenges, this has not deterred large companies from sectors such as energy, technology and finance to active buyers of VCMs to drive their net zero carbon emission agendas. Individuals can also purchase credits to offset their carbon emissions. Despite its standardization challenges, VCMs can work as a marketplace reconciling supply and demand sides, and might play an important role in providing key funding for more transparent, robust climate-positive projects in practice.
In short, the idea behind voluntary carbon markets is that once the carbon emissions have been priced reasonably, regulators allow the market itself to decide the optimal usage of resources through allowing organizations to decide whether to buy credits or reduce pollution. This ultimately puts a cost on emissions, and companies or persons are thus incentivized to reduce this cost.
While carbon credits quantify carbon emissions, the methods used to quantify carbon emissions across jurisdictions varies heavily, leading to standardization challenges. While there are benefits in reducing carbon emissions in regards to environmental impacts, there are also no strictly uniform quantifiable standards to measure the impacts of VCM carbon credits from different jurisdictions. As a result of both credit unit standardization issues and environmental impact standardization issues, suppliers require more time to verify the quality of carbon credits before purchase. This drives inefficiencies in the voluntary carbon credit market, as inconsistent carbon credit standards lead to scarce financing, an opaque trading market, and ultimately poor market liquidity.
The empowerment of blockchain technology has the potential to solve the above problems. Many startups are trying to tokenize traditional carbon credits, using blockchain technology to convert carbon credits into divisible, easy-to-circulate, and transparent tokens to solve the standardization issues that exist in the voluntary carbon market. This is a solution that makes it easier for the public to participate in carbon-neutral climate governance, and blockchain-based tokens can be combined into DeFi projects for incentives.
What is ReFi & why does it matter
Our monetary system fails to value the role that natural assets play in developing and sustaining human societies, and capital-driven industrial development has led to negative externalities, including greenhouse gas emissions, habitat destruction, and social inequality. Many projects aim to use Web3 tools to solve climate problems, and most of them belong to the emerging field of ReFi.
Regenerative Finance (ReFi) is a movement focused on the power of blockchain and Web3 to address climate change, support conservation and biodiversity, and create a more equitable and sustainable financial system.
ReFi uses various forms of capital to promote sustainable, systematic, and positive change for all stakeholders based on blockchain technology, bringing real natural assets on-chain. It is a cultural inclination towards funding community and public goods rather than projects meant to generate a return for the founders. Money and capital are seen as programmable tools to help solve climate and environmental problems through a community based on consensus on renewable natural resources. AsRegen Network’s Board Director, Kei Kreutler, pointed out that Regen focuses on anticipating both bioregional DAOs, organized around a geographic location such as the Amazon rainforest, and guild DAOs that integrate other communities.
Key ReFi Projects Analysis
We see a pattern emerging across the growing number of projects experimenting in the ReFi space in order to stabilize our climate and restore our ecosystems. By categorizing the various projects by their technology stacks, we can see projects emerging at the infrastructure, platform and DAO levels.
Infrastructure: Celo, Toucan Protocol
Unlike many Layer-1 public chains that target all markets, Celo tends to enable users without bank accounts to conveniently participate in DeFi products. Celo targets Africa and developing countries. The total value locked (TVL) of Celo was approximately $139 million by the end of 2021. DeFi, wallet and social impact projects account for a greater weight of the total TVL, making up about 26%, 24% and 10% respectively.
Ultimately, Celo can be considered as a supporting role, apart from providing a low-impact platform for other platforms, Celo itself does not deal with carbon credits directly.
Toucan Protocol, is a protocol based on Polygon that brings carbon as currency bricks of Web 3.0. It aims to turn carbon credits into programmable digital assets and improve price anchoring and liquidity issues in the carbon trading market. The protocol mainly realizes tokenization through the two functions: the Carbon Bridge and Carbon Pools.
The process of transferring legacy carbon credits on-chain via Toucan Protocol is as follows: First, buy a batch of carbon credits from a specific project and year from the traditional market (usually verified by Verra, a public certification agency). Then these credits are transferred on-chain via the Toucan carbon bridge and become a "BatchNFT", an NFT that contains details of the carbon type, year, location and carbon tonnage. To enhance liquidity, BatchNFT is subdivided into fungible TCO2 tokens. TCO2 is then deposited into different "Carbon Pools" according to specific criteria, depositors can use alternative "carbon reference tokens" such as BCT in exchange.
Currently most ReFi protocols are designed to create carbon standards and improve liquidity of carbon markets, then achieving market speculation and pricing, just as Toucan has done. Some people show concern that these new standards risk creating fragmentation that will affect liquidity, transparency and potentially accountability. Given Toucan has over 85% market share for on-chain carbon, we consider that there has been limited market share for other innovations in ReFi infrastructure.
Platform: Moss.earth, Nori, FlowCarbon
Moss Earth is a climate technology company focused on environmental services, using blockchain technology to support traceable and transparent carbon footprint offset processes. In 2020, it used the 150,000 carbon credits generated by the Amazon rainforest every year as asset reserves. By freezing the carbon credits verified by the carbon standard verification agency Verra, it mints the token MCO2 as on-chain assets for trading. Users can purchase, store and mortgage MCO2 to protect the environment.
Moss Earth has partnered with many large companies: Amazon has purchased more than $15 million in MCO2, helping protect approximately 800 million trees. Brazil's largest airline, Gol, offset its in-flight carbon emissions with relative MCO2. The Celo community also approved a proposal to allocate 0.5% of cUSD reserves to MCO2.
At present, there are many competing products at the platform level, and most have vertical solutions for different application scenarios of carbon credits. For instance, Nori, a platform whose goal is to address double-counting and fraud of carbon credits in existing markets, are building a trading market for carbon reduction primarily for farmers using regenerative farming methods involving soil carbon sequestration. FlowCarbon, an open-source protocol for carbon credits supported by known venture capital firm a16z, is a Celo-based open-source protocol for carbon credits that aims to be a transparent, threshold-free carbon trading market that continues to help companies reduce their carbon emissions to net zero or net negative. Flowcarbon’s token GNT is fully backed by the real-time value of off-chain credit and can be used as collateral, protocol vault assets, stablecoin reserves, or to offset on-chain carbon credits. We believe that there will be more innovative voices in the platform application layer in the future. They will probably create a vertically integrated carbon business including financing, corporate carbon emission services, carbon credits trading, and carbon pools with deep liquidity.
DAO: KlimaDAO
KlimaDAO has attracted much attention because it had accumulated more than $110 million assets in less than a month since its inception. KLIMA tokens are backed by real-world carbon assets — Basis Carbon Tonnes (BCT). The token price is defined by supply and demand of the token and the underlying carbon assets.
It encourages emission reductions by driving up the price of carbon assets by buying as many credits as possible from the market and locking them in its treasury. The rising price of carbon is forcing polluters to either rely on increased paid costs to comply with voluntary emissions targets, or to take prompt action to reduce pollution. At the same time, more expensive carbon offsets might also lead to more climate-positive projects to emerge as selling credits to the market. Users can stake KLIMA through Klima DAO to earn profits, with APY having climbed as high as 37,000% at one point.
We can conclude that the token economics model of Klima DAO follows ponzi schemes, building on a strong consensus on climate governance. The more people are interested in supporting it, the higher the demand for KLIMA and BCT will be. Demand for BCT will help drive up KLIMA price and provide support for the Klima DAO treasury and incentives for carbon offsets for real-world companies. However, as the crypto market entered a bear market this year, Klima DAO's TVL and token prices have not performed well in the recent past.
DAOs like Klima DAO achieve long-term success, such as competing with BTC or ETH, which is not an easy task. Most ReFi DAOs token economic models are similar at present. For example, Kumo, the “green” version of MakerDAO, also uses ponzi-economics: the more KUSD in circulation, the more carbon emissions are removed from the market, and carbon projects can obtain more financing. While the market is still young and there is still ample room to develop new crypto-economic models to run DAO operations, placing heavier consideration on developing more sophisticated economic models can lead to greater stability and sustainability of DAO operations.
Controversy and Bottlenecks
ReFi is still quite immature and the number of projects is still relatively small. Therefore, the controversies and bottlenecks in the development of this market deserve our attention, as solving these can help to drive growth of this exciting sector. According to Curvelabs research, a balanced critique of ReFi requires familiarity with two simultaneous bodies of knowledge: ecological market-based conservation, and crypto economics.
Because the overall transaction process of carbon trading is quite complicated, and centralized verification agencies such as Verra and Gold Standard cannot be bypassed, the role of carbon credit tokenization is greatly reduced. In the end, the current decentralized systems are built on a centralized bottleneck.
Finally, the speculative nature of token trading also applies to tokenized carbon credits: some ReFi project tokens are only traded for short-term financial gains and do not truly fulfill their environmental protection duties. In this regard, clearer and more standardized regulatory processes are needed.
CONCLUSION
“There are powerful economic incentives to destroy and degrade critical natural landscapes around the world, but the voluntary carbon market is a brilliant financial mechanism that creates a counterbalancing incentive to reforest, revitalize and protect nature,” said Dana Gibber, CEO of FlowCarbon.
Our current economic system has been designed in such a way as to accumulate wealth and power for centralized elites without considering impacts on the climate or nature as a whole. Money tells a story of mining for profit - the exploitation of natural resources of people.
Compared with traditional carbon credit governance methods, the tokenization of carbon credits might build a more efficient carbon trading market and a more transparent regulatory environment, which can further promote carbon emission reduction for the earth.
Works Cited
https://je.mirror.xyz/S-dpms92hw6aiacUHoL3f_iAnLVDvbEUOXw7wpy7JaU
https://blog.curvelabs.eu/the-promises-and-pitfalls-of-regenerative-finance-4910f0f6f690
https://blog.curvelabs.eu/web3-natural-capital-assets-taxonomy-28285259f68c
https://www.msci.com/www/blog-posts/introducing-the-carbon-market/03227158119
https://medium.com/coinmonks/tokenomics-101-klima-dao-e8fac497454f
https://www.bitpush.news/articles/1957975
https://www.chaincatcher.com/article/2066836
https://coinmarketcap.com/alexandria/glossary/tokenized-carbon-credits