The environmental concerns about blockchain and cryptocurrency are well-known. This is not surprising considering that Bitcoin mining uses more electricity per year than all of Finland. Even those who don’t know much about blockchain, seem to have a basic understanding of the technology’s energy consumption. To truly understand blockchain, it is important to reduce its power consumption. This article aims to decode the technology and examine the role that tokenized carbon credits might play in combating climate change.
Proof of Work, a cryptographic process used by Bitcoin and Ethereum to secure transactions, is very costly to attack cryptocurrency networks. However, Proof of Work (PoW), despite its environmental benefits, comes with a high cost because of the amount of energy required by expensive and dedicated hardware mining rigs to perform the complex calculations that underlie PoW. Proof of Stake (PoS), an alternative approach, maintains network security but requires far fewer calculations and can be done easily on a desktop computer. Polygon networks use this process to avoid the large energy consumption of Proof of Work. It has already been able to reduce greenhouse gas (GHG), emissions by more than 99%.
However, beyond energy consumption, some climate tech entrepreneurs are wondering if blockchain technology has greater potential to address climate change.
A New Approach
The most promising approach is to explore how blockchain technology could reinvigorate Voluntary Carbon markets (VCM). This market was initially touted as a game-changer in global warming mitigation by incentivizing GHG emissions reductions. However, it is only now that it is being widely adopted as governments, individuals, and corporations respond to the increasing evidence and urgency of our changing climate.
VCMs were first introduced in the 1990s when individuals and organizations could buy carbon credits without having to comply with any regulatory requirements. VCM trading volumes have steadily increased since then and they are widely expected to continue to gain in popularity due to investor interest in environmental and social governance (ESG) factors and increased pressure on countries to fulfill their Paris Agreement commitments.
The key factor behind the increase in carbon credit utilization has been the robustness and increased quality of carbon credits issued on the markets. There are several quality standards such as the Verified Carbon Standard, (VCS), and the Gold Standard.
Despite this, there has been little progress in the last 20 years on the demand side. VCMs are known to have many flaws, especially in the supply chain, where credit is traded between consumers, brokers, and organizations. This hinders the market’s ability to scale. A McKinsey report from 2021 states that VCMs are fragmented and complex, with questionable credit sales practices and limited pricing data, which makes it difficult for buyers to determine whether they are getting a fair price and for suppliers to manage their risk on Over counter exchanges. The SEC has criticized them for not being transparent. The market must scale by integrating the gains made on the supply side with a more efficient, transparent marketplace that can increase trust and allow for scaling.
This is where blockchain technology, specifically Ethereum and Ethereum compatible blockchains, can be used to address market failures. New ways to transact assets have been created by the use of Automated Market Makers, which are transparent and open-source distributed ledger systems. These solutions are already playing a pivotal role in the cryptocurrency ecosystem. New products require efficient and liquid markets to support growth. Without them, scale is impossible.
Traditional finance can have large banks and hedge funds serving as market makers. They provide billions of dollars of capital to help create and maintain markets and allow them to function efficiently. This includes allowing buyers and sellers to place orders. Instead, anyone can interact with the market or provide liquidity through AMMs’ blockchain solution. AMMs reward liquidity providers by allowing them to offer up a pair of frequently traded tokens to a “pool”, which traders can use to finish their orders at any given time at market equilibrium. All market activity, past and present, can be traced and transparently recorded because these liquid pools of assets are stored on the blockchain.
The VCM’s issues of poor transparency, fragmentation, and illiquidity on demand can be cited often. DeFi-enabled liquidity pool can provide much-needed clarity and access to carbon credits through the integration of carbon credits.
KlimaDAO, which works to align the economic incentives for participating in the voluntary market (VCM), by speeding the shift towards net-zero global carbon emissions, and the Toucan Protocol which brings carbon markets to DeFi marketplaces, have both facilitated individuals and organizations to make a difference. This is a significant moment in the history of the VCM. Together, these entities have created the infrastructure and incentives that will allow the supply of carbon credits to be embedded into DeFi. The blockchain will also benefit from the carbon credits.
The Toucan Protocol infrastructure has enabled almost 25 million carbon credits to be transferred onto the blockchain since the launch. Over 17.5 million carbon credits were later locked into the KlimaDAO Treasury. The incentive mechanisms in the KlimaDAO protocol that reward those who donate tokenized credits to KlimaDAO make this possible.
The most important thing for the VCM is the fact that KlimaDAO uses its Klima tokens to create stable liquidity pools for tokenized carbon credit tokens, such as the Toucan Protocol’s Base Carbon Tonne or Moss’ MCO2. These pools create a market that allows any individual or institution to directly access tokenized carbon credits and purchase them with low slippage. This is for people who want to purchase credits to offset carbon emissions, or for DeFi incentives. It is a remarkable feat to create this market from zero and has liquidity that consistently exceeds USD$10,000,000 per day.
A carbon credit broker was the only way to get carbon credits in the past. A buyer cannot control the extra fees charged to credit cards purchased from brokers. They rely on the broker to provide credit that they have, or that they can acquire, as well as retire any carbon credit they have. A buyer would need to contact several brokers by phone and email to get more information on the market price for carbon credit. This can be a tedious process for an organization that just wants to invest in the planet.
We are witnessing a new paradigm in the Voluntary Carbon Market. This is due to an increase in carbon credits being placed on the blockchain, and the availability of efficient and accessible markets that allow them to be traded. The AMMs and tokenized carbon credits are both new concepts. KlimaDAO provides liquidity in a transparent market, which allows anyone to invest and grow on the planet.
While significant effort has been made and positive results have been shown, much will be focused on how these new markets can grow their impact and stay relevant in the long term. A large portion of tokenized carbon credits currently focuses on carbon mitigation projects, which are still plentiful within the system. However, there is a growing interest in carbon removal technologies. Unfortunately, the legacy VCM has very limited liquidity. It will be interesting to see if and how the new blockchain-powered market can provide these highly sought-after removal carbon credits to its users. It will be interesting to see what the future holds.
