Making Sense of How Carbon Offsetting Can Drive Climate Action
We need a fair and equitable market that will assist the flow of finance toward climate action.
It is widely accepted that liquidity in the Voluntary Carbon Market (VCM) is highly fragmented and that the current over-the-counter nature of these markets is constraining their growth and limiting their chances of success at the scale the planet requires.
This limitation has severe consequences. The fundamental aim of the VCM is to channel meaningfully high levels of capital to pro-planet projects, and there is an obvious urgency to this task.
For the VCM to succeed and ultimately flourish, a diverse portfolio of offset types is required. There are four broad categories into which most offsets fall.
1. Avoided nature loss.
2. Nature-based sequestration.
3. Emissions avoidance and reduction.
4. Technology-based removal.
However, this diversity of offsets can bring its own complications and potential issues.
Understandably, when given an opportunity, buyers will seek specific types of carbon credit to best match their needs. For example, Microsoft's 2021 offset purchases focused primarily on forestry projects, followed by soil carbon sequestration, bioenergy, biochar and direct air capture projects (which are technology-based removals).
The sourcing of credits can involve research into a project's background, careful budgeting in an environment where prices are not widely publicized, and an ongoing relationship with a trusted intermediary.
Of course, individual entrepreneurs and SMEs lack both the resources and purchasing power of large corporates like Microsoft.
In terms of the qualities of different types of projects, nature-based offsets are relatively cheap and comparatively abundant, but their gains can be easily reversed while carbon-removal technology is in its nascent stage and prohibitively expensive for all but the largest multinationals.
Moreover, on top of the time that companies must spend on establishing what best meets their needs, over-the-counter transactions with carbon brokers are also time-consuming. It can take weeks to purchase and retire the correct credits. This is a trust-based process, much of which takes place behind closed doors.
The emerging crypto-carbon space is different. Although in its infancy, having only truly taken off in the fall of 2021, the burgeoning Regenerative Finance (ReFi) movement is starting to empower organizations and individuals alike to take more control over their climate-positive investments. Inclusive, transparent and sustainable solutions are emerging on the blockchain that will improve both transparency and price discovery.
Through technological innovation and a clear, decentralization-focused vision to move the internet beyond extractive capitalism, Web3 is putting to bed the false narrative that blockchain can only ever amount to being a destructive waste of computational energy.
Recently, the World Economic Forum recognized that "the crypto industry and Web3 innovations can become key players in propelling transparent, verifiable, and actionable change towards environmental sustainability in ways traditional institutions have been unable to." Accordingly, major blockchain players such as Polygon are going carbon positive and making large investments into green initiatives.
As my previous Entrepreneur article noted, building a better VCM on-chain is a key part of the ReFi vision. As publicly accessible, immutable ledgers, blockchains make market transactions permissionless and traceable, opening up all markets to greater levels of participation and scrutiny.
Several different types of carbon credit tokens are available in tokenized form on-chain, at this very moment. These include:
- BCT: The most prevalent on-chain carbon token, from Toucan protocol.
- NCT: A more recent development from Toucan, focusing on nature-based credits.
- MCO2: From MOSS, a pioneer in the crypto-carbon space, having been around since early 2020.
- UBO: The Universal Base Offset is a token from C3 that incorporates most Verra and Gold Standard methodologies. It is used for credits issued since 2014.
- NBO: C3's NatureBase Offset.
These different tokens reflect an innovation enabled by bringing these credits on-chain while delivering interoperability and composability. Each token itself consists of a transparent pool of underlying tokenized carbon assets, which can be exchanged readily, even in fractional amounts not practical or feasible with off-chain markets.
These tokens can then be used to form the building blocks of an entire on-chain ecosystem, where tracking, selecting, holding and retiring specific tokens can be incentivized using the mechanics of Decentralized Finance (DeFi).
The key to this growing ecosystem is Automated Market Makers (AMMs). These AMMs use highly liquid pools of tokenized carbon to enable the transparent and efficient exchange of tokens on well-established and secure Decentralized Exchanges (also known as DEXs) such as Uniswap and SushiSwap. This overcomes a key barrier within the VCM associated with over-the-counter trading and illiquid markets.
Unlike traditional markets that bring buyers and sellers together, AMMs are based on always-on algorithms that allow trades to be executed without permission, and they automatically use liquidity pools. Individual users simply swap one asset for another using the AMM rather than having to place a traditional buy or sell order, resulting in a wait for that order to get filled.
Just like humanity and Earth itself, the blockchain has no central authority. Solving the climate crisis requires cooperation and coordination on a global scale. As such, we need interoperability of complex forces working with minimal friction for everyone's mutual benefit.
While improving the VCM is just one part of the puzzle that we need to solve, the stratification of carbon assets through tokenization allows for a more fair and more equitable market where the flow of finance to pro-climate projects across the globe takes priority over intermediaries and market participants.
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