Bringing Carbon Markets to the Blockchain

As crypto traders move into carbon markets, they are not only driving significant transaction volume, but are actually taking so many carbon credits out of the market, they are having a material impact on prices. Higher priced carbon offset credits make it more expensive for corporations to meet their voluntary carbon reduction goals. As a result, companies may find that it is more economically attractive to reduce, rather than offset, there carbon emissions. As the worlds of carbon markets and crypto converge, it is important that carbon market participants understand the basics of blockchain and some of the novel projects underway. Here, we look to provide readers an overview of how blockchain technology is being applied to carbon markets and the transparency of greenhouse gas management.

Blockchain Basics

The blockchain is the underlying technology for carbon-focused crypto organizations. According to the Ethereum organization, a blockchain is a public database that is updated and shared across many nodes in a network. An individual computer can serve as a node. There are two parts: the block and the chain. A “block" is the data and state. When stored in consecutive groups, it is known as "blocks". If you use bitcoin to make a purchase, the transaction needs to be added to a block to be successful. The "chain" refers to the way blocks get chained together so that each block cryptographically references its parent. In other words, the data in a block cannot change without changing all subsequent blocks. Any change requires the entire network to provide consensus.

There are two major types of consensus mechanisms. The first, proof-of-work, requires nodes to solve a difficult puzzle (requiring a lot of computing power) for new blocks to be added to the chain. Solving these computationally intensive puzzles is known has mining. The other type of consensus mechanism is known as proof-of-stake. This requires users to stake their crypto tokens. By doing so, they act as validators by ordering transactions and creating new blocks so that all nodes in the network can agree.

These crypto networks can be used to execute smart contracts. Beyond a store of value and as a mechanism for financial anonymity, this is to primary utility that crypto provides. Smart contracts essentially perform some action automatically based on pre-defined conditions being met. For example, if my crypto account receives a series of payments over the next 20-years equal to $1 million, I will transfer title of my property to you. If the series of payments is interrupted, the asset will be sold at market value, and you will receive 90% of the value of the payment made to date. More conditions could be added to this simple example. Each of these conditions would be embedded in the smart contract.

There are many different applications for smart contracts including borrowing, lending, trading, and gaming. Developers may also generate slick user interfaces so that non-coders can easily interact with applications and services that use smart contracts. The key point is that smart contracts are decentralized and therefore to not require a trusted intermediary. This allows things like borrowing, lending, and trading to occur in a more efficient and cost-effective way as there is no middle-man involved. The underlying value of crypto tokens lies in the belief that demand for smart contracts will grow. As this happens, crypto tokens will be needed to execute smart contracts and their demand (and price) will appreciate.

New Initiatives

Crypto builders are piling into initiatives focused on carbon markets. The Toucan Protocol is an organization that is looking to bring carbon offsets “on-chain” which will mean that any subsequent offset transactions will be recorded and verified on the blockchain. As of Q1 2022, Toucan had bridged nearly 20 million tonnes of carbon offset credits. Many of the voluntary carbon offsets that are being brought on-chain using the Toucan Protocol are being locked in the Klima DAO (Decentralized Autonomous Organization) treasury. About 80% of all Toucan bridged offset credits end up finding their way to Klima. When the offset credits become locked in the Klima DAO Treasury, they can no longer be traded. This reduces the available supply of credits in the market place and results in higher prices.

While Klima DOA has the stated purpose of driving up carbon offset prices, other initiatives are focused squarely on bringing an enhanced level of transparency to carbon markets. JustCarbon has plans to tokenize removal-based carbon offset projects and make them tradable on the blockchain. The organization will source offset credits from the Gold Standard or Verra, the two leading offset standard providers in the voluntary carbon market. The tokens will then be tradable on a blockchain-based trading platform. In addition to removal-based offset credit, JustCarbon will also offset credit from carbon projects that reduce emission from deforestation and degradation (REDD). By putting credits on-chain, JustCarbon hopes to allow project developers to retain a bigger share of the project value by eliminating the need for intermediaries. Eventually, JustCarbon plans to govern its activities through a DAO and create Just Carbon Governance Units (JCGs) – whose holders will vote on major business decisions of the organization. The JCGs will be issued to (via donation) individuals, companies, governments, and civil society groups that are users of the platform.

ClimateTrade is another organization, like JustCarbon, that plans to use blockchain technology to develop a marketplace where companies can trade voluntary carbon credits. The underlying blockchain technology that is being used by ClimateTrade is known as Algorand, a scalable cryptocurrency protocol that supports smart contracts. ClimateTrade purchased and retired 2 million offsets in 2021 through its online platform and currently holds offset credits from 50 different project including those certified by Verra and the Clean Development Mechanism. The organization also plans to incorporate the digital carbon registries of Spain and Colombia, which will allow project developers to have their emissions reduction verified and issued in real-time. ClimateTrade is deploying blockchain technology primarily to avoid double counting of emissions reductions but has no plans to issue its own token.

Other carbon-crypto initiatives toiling in the space include Enerex, which is a platform that allows users to buy, sell and retire government mandated renewable energy certificates (RECs) and carbon offset credits on the Solana network. Enerex claims that it will serve as a bridge between real world assets and modern cryptocurrencies positioning it to be a full-service option for users that want information on an object’s history, origin, and transactions. Enerx will also have platforms to enable trading, tracking, and retirement of offset credits to support carbon neutral claims. Meanwhile, Carb0nFi is a new venture that is offering tokenized carbon offsets from Southeast Asia-based offset projects. Users will be able deposit crypto assets and will in turn have $ZRO tokens issued to them. The $ZRO tokens can then be staked to earn rewards or held to earn a discount on transaction fees for carbon offsets sold on the Carb0nFi exchange. Thallo is another recently launched crypto start-up focused on the creation of a decentralized marketplace for voluntary offsets. The exchange promises to offer low fees, high liquidity, rewards for early adopters, and unparalleled transparency and auditability.

Carbon Market Transparency

All of these disparate crypto-related initiatives have one underlying theme: increased transparency is coming to voluntary carbon offset markets. As climate change risk becomes an increasingly material risk to corporations, carbon risk management will become a core competency that every organization needs. Carbon markets are being used as a tool to mitigate the financial impact of reducing carbon exposure. The rationale for the creation of market-base carbon programs is that it may be more cost effective to pay others to reduce emissions than to reduce emissions within a company’s own operational footprint. As such, carbon markets are becoming an important tool for reducing climate-related risk and stakeholders are requesting more transparency as to how carbon offsetting actually occurs.

Questions regarding the quality of the underlying offset credits that are purchased is a primary concern for market participants. In fact, a new governance body known as the Integrity Council for the Voluntary Carbon Market (IC-VCM) is focused on addressing the question of offset quality through the development of Core Carbon Principles (CCP) with a taxonomy of attributes to ensure credits are high integrity. The IC-VCM will assess: 1) which standards may issue CCP credits; 2) which methodology types may issue CCP credits; and 3) the additional attributes that CCP credits must be tagged with (e.g., biodiversity benefits).

In addition to increased transparency around offset quality, offset market participants are also demanding the transaction and retirement history of credits. This is where the immutable blockchain ledger comes in. The blockchain can provide a record of an offset credit’s history, origin, and transactions. Blockchain technology can also be used to enable trading, tracking, and retirement of offset credits to prevent double counting. Carbon neutral claims by corporations are not sufficient unless they are supplemented with a full accounting of offset credit records. Blockchains can be a helpful tool in this regard. Driven by stakeholder expectations and regulatory standards, we expect carbon reporting will continue to trend toward higher transparency. Developing a data trail and transaction history using blockchain technology may become a necessary component of carbon reporting in the future.

Please Get in Touch

Frostbyte is helping our client source high integrity offset credits that allow for removal and permanent sequestration technologies to be scaled up commercially. We are also working with carbon offset purchasers to provide transparency around their carbon emission and offset reporting. Our sustainability services are cost effective and the broadest in the industry. We’ve worked with countless businesses around the world, including those in the energy, mining, chemical, and construction sectors. Our philosophy is that environmental management is the day-to-day work, while sustainability management is the message behind the work. Ultimately, our goal is to ensure that your organization meets the latest standards in Environmental, Social & Governance ratings while also balancing the needs of people, the planet and your profits.

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