How can Blockchain & DeFi help in reducing carbon footprints?
Bitcoin, Blockchain and Cryptocurrencies are well known words nowadays in any conversation circles.
We are already seeing blockchain use cases proliferating within the Financial industry. Other sectors like Supply Chain, Insurance, Healthcare, Government and Entertainment have seen promising applications of blockchain. However, there is a flourishing cohort within the cryptoverse who believe that blockchain has a solution for the climate crisis: crypto carbon credits. Its evangelists believe that carbon can be locked on a blockchain and kept out of the atmosphere.
This article explores how tokenised carbon credits could help in combating the climate crisis and if this can lead to Regenerative Finance or ReFi.
In 2021, 120 world leaders participated in the UN Climate Change Conference in Glasgow (COP26). Mitigating the effects of global warming, reducing the emission of Greenhouse Gas (GHG) were amongst the hot topics which were discussed. The below two points were emphasised:
- Reaffirming the Paris Agreement, where it was decided to limit the rise in global average temperature to 2℃ and making an effort to further limit it to 1.5℃.
- Need of a global carbon credit offset trading market
As reported by the IPCC in 2022 “the world is set to reach the 1.5ºC level within the next two decades”. The report highlights that only the most drastic cuts in carbon emissions from now would help prevent an environmental disaster.
The climate technology evangelists are questioning if apart from being an energy expensive technology, are there any opportunities that exist in blockchain that can be used to support and address the climate crisis.
What are Carbon Credits
Carbon credits are generated from projects that reduce emissions or remove carbon dioxide from the atmosphere. One carbon credit is created when the project verifies that it has reduced, avoided, or destroyed one metric tonne of GHG. According to the Environmental Defence Fund, that is the equivalent of a 3,800 Km drive in terms of carbon dioxide emissions.
Carbon credits were created to reduce the emission of GHG gases and effects of global warming. It is a tradable certificate that permits industries to emit one metric ton of carbon dioxide or an equivalent of GHG.
The polluting companies are awarded credits which allows them to continue to pollute up to a certain limit. This limit declines over time. The companies that exceed their limit need to buy additional credits, the ones which have surplus can sell theirs and earn profits. This creates an incentive for the companies to reduce their emissions and penalise the companies that exceed their limits. Current price of EU carbon is EUR 88.87 per tonne.
Market for Carbon Credits
In 1997, the United Nations’ Framework Convention on Climate Change (UNFCCC) came up with the Kyoto Protocol. It was a proposal to reduce worldwide carbon emissions.
Following this a global carbon market, known as Voluntary Carbon Market (VCM) emerged. It allowed organisations and individuals to buy carbon credits outside of any formal national or international regulatory requirements through over-the-counter (OTC) exchanges.
Although VCM has gained popularity owing to ESG factors, yet, in the last 20 years it has made little progress from the demand market perspective.
As reported by McKinsey in its 2021 report, today’s carbon credit market is fragmented and complex. The sale practices are dubious and there is limited pricing data. Their lack of transparency has resulted in constant criticism from the US Securities and Exchange Commission.
This is where Blockchain can help in the revival of VCM. A Taskforce on Scaling Voluntary Carbon Markets (TSVCM) was set up in 2020. TSVCM is leveraging Blockchain and Web3 technology to improve the current infrastructure.
Enter Blockchain & DeFi
Blockchain can provide the required disintermediation and transparency to the carbon credit market.
DeFi is reimagining finance for millions of people. Using DLT, smart-contract enabled marketplace and Automated Market Makers (AMMs), DeFi has invented new ways for transacting assets. The disruption of the borrowing and lending industries has given much needed momentum to Web3 organisations.
Web3 technology allows to revamp the organisational structures and create significant opportunities. P2P lending and tokenisation are aspects that can be maximised through DeFi, to target climate objectives.
Last year, the voluntary carbon market saw $1 billion in turnover, majorly due to the growing number of companies that are bringing voluntary credits onto blockchain. Experts believe that it is estimated to reach $100 billion by 2030.
DeFi and DAO communities are location agnostic, they create a network of individual contributors working towards common goals. Decentralisation penetrates their reach to the remotest areas.
How does it work in reality?
Theoretically, we can move the VCM onto a blockchain and the metadata for each credit, attested for its quality and origin, can be publicly available. Companies can have access to this transparent and liquid offset market unlike any that exists today.
Toucan Protocol was launched in October 2021. It aims to improve the infrastructure for environmental assets in Web3 and bring carbon markets to the DeFi marketplaces. KlimaDAO was the first platform to build on Toucan’s Web3 carbon market technology. It is working to revamp the economic incentives in the voluntary carbon market (VCM). So far, they have ‘bridged’ 21.9 M tons of carbon on Polygon.
Bridging refers to “retiring” that credit on its parent registry so it can’t be double-counted as an offset. Toucan issues a non-fungible token (NFT) for the retired credits, representing them virtually. This NFT contains data relating to the specific offset project it represents and can be fractionalized into Tokenised CO2 (TCO2) tokens. It can then be traded like any other cryptocurrency on a decentralised exchange (DEX).
Challenges on the way
Carbon credits are very specific to the project they were created from and this causes the carbon credits from different projects to be different. This in turn reflects in the credit’s price and hence they are not directly interchangeable.
Even with a DeFi marketplace, Toucan’s TCO2 suffers from a lack of liquidity as they need the same tokens to facilitate an exchange. Toucan is leveraging liquidity pools to solve this problem.
Toucan users can lend their TCO2 tokens to liquidity pools with TCO2 tokens representing similar projects. In lieu of lending their credits to one of Toucan’s pools, they receive a new token. This token represents a slice of the whole pool rather than one specific project. Since there is an ample quantity of this token, it is much easier to trade. Base Carbon Tonne (BCT) is the first pool introduced by Toucan and its token (BCT) is highly liquid.
To conclude, I would say, it is encouraging that there is a growing interest and awareness in exploring technology to reduce the carbon footprints. Blockchain can provide transparency, traceability and disintermediation. DeFi can enable liquidity and efficient trade of carbon credits. We require innovations and strategies to scale up the market and meaningfully move the dial on investment in our planet.