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Beyond the Buzz: What Can Blockchain Do for Carbon Markets?

With proper vetting, blockchain can shed light on the quality, quantity, and diversity of carbon credits and open new doors to climate financing.

The voluntary carbon market (VCM) has a trust problem: The quality and efficacy of the existing carbon credit supply is drawing widespread skepticism. Since its inception, the VCM — a decentralized market where private actors buy and sell carbon credits — has existed without a unifying standard for quality or mutually agreed upon accounting principles. Without these measures, multiple certifying options have crowded the market and buyers of carbon credits are often unable to differentiate signal from noise. A similar lack of transparency has implications for the credibility of climate benefit claims.

As the world looks to accelerate climate action – and to dramatically scale open markets for carbon products – trust and transparency will become even more vital to the VCM to fulfill its mission of helping avoid or remove atmospheric emissions to prevent a climate catastrophe. The question is: What’s blockchain got to do with it?

Apparently, a lot. Blockchain developers are making moves far beyond the cryptocurrency territory, with the recent flurry of activity in the blockchain-for-carbon space suggesting a new focus on disrupting the VCM status quo. Whether these aspirations can course correct a market plagued by low supply of credible high-quality carbon credits and lack of fully transparent monitoring, reporting, and measurement (MRV) around existing supply is an open question.

This article debunks some myths and highlights early lessons learned on blockchain-powered initiatives for carbon markets. Rather than a sweeping summary of the technology’s merits, the analysis is focused on its most promising applications in the supply and use chain of carbon credits.

Blockchain-for-Carbon 101 – The Building Blocks

Blockchain is essentially a database that can store information electronically: digitized blocks of data, linked by secure nodes, forming a chronological chain of information.

What differentiates a blockchain from a simple spreadsheet, or a conventional database is how the data is structured, stored, and linked to participants in a particular ecosystem. Every blockchain rests on a consensus mechanism that ensures that: 1) the network is distributed and not controlled by any single party; 2) the validator nodes are incentivized to behave honestly; and 3) blocks, once verified, can no longer be tampered with or changed.

Blockchain has a smart contracts feature that offers the potential for blockchain users to automate business processes to a high degree. Smart contracts are a sophisticated piece of code deployed on the blockchain — think of it as a vending machine, but online.

Smart contracts can store a wide range of metadata about a product — such as the carbon credits or other climate-positive activity — securely fused into tradable units. As such, they add another attractive tool to the blockchain toolbox, enabling fast, reliable, and transparent information exchange among participants in the network.

Blockchains can also interact with other systems and be programmed to facilitate interactions with far less reliance on intermediaries. Exposure and risk to fraud is limited through a digital signature that any blockchain user has, which puts their “fingerprint” on every interaction with the chain. This trust-building function can improve many aspects of carbon markets, where credits are designed to be traded. Blockchain can reduce transaction costs, minimize tedious paperwork, and streamline the carbon trading process.

While not a panacea, blockchain can ultimately enable the exchange of data in an entirely new way. Decentralization may bring a whole new definition of trust to a world where currently only a few gatekeepers control the flow of money, services, and data. If done right, trust can be largely designed into the system, facilitated by a technology that can enforce it, encrypt it, and maintain it through a network of computers that ensures its purpose.

From bored apes to carbon offsets: Why NFTs are making a climate play

In a short period of time, carbon markets have seen a rise in use cases for blockchain applications. One of the most prevalent ideas is asset tokenization, with a cluster of trade-finance, blockchain-backed ventures tackling poor liquidity, slow speed-to-market, and transactional friction in the carbon credit industry. In most cases, a token simply represents a claim on a carbon credit, in the same way the headline-grabbing Bored Ape NFTs represent a claim to a “unique” piece of artwork. Digital tokens, whether fungible, semi-fungible, or non-fungible, make it easy to access and trade carbon credits on the blockchain.

This trend is likely here to stay. It has attracted investors looking for financial technology solutions to carbon market problems. Blockchain-powered NFTs, in particular, are making waves in the offsets world. Smart contracts used to issue NFTs can play a helpful role in categorizing avoidance and removal credits, a clear benefit to investors and buyers confused by catch-all buckets for offset types. Credits benefit from being differentiated to effectively steer capital flows to high-quality credits.

NFTs are a blockchain-enabled receipt – but these tokens can be used for more than demonstrating ownership. They can be divided into smaller fractions or units for sale. Credits are typically not sold in volumes less than one metric ton of carbon—about the weight of a great white shark. That’s great for businesses buying in bulk, but it puts offsets for day-to-day transactions out of reach. Fractionalized carbon credits help ordinary consumers claim ownership of the same carbon credit and create more participation and democracy in the credit marketplace.

Beyond digital tokens: Blockchain’s ability to connect data dots

It’s not just token-first startups moving into this space. Large, incumbent banks made a big splash last year, with two high-profile groups announcing their intent to dive into carbon markets. These soon-to-be operationalized carbon credit settlement platforms will be underpinned by blockchain technology with a two-fold purpose: to give banking customers access to quality carbon credits and to bring efficiency to settlements, including retiring credits from originating registries.

The concept of a meta-registry, a fancy way of describing a blockchain-based platform aggregating metadata into a single public database, has also drawn attention. Blockchain could link up individual data systems that have thus far been siloed and create a publicly visible and trackable record of carbon credit information. These digital ledgers are likely to bring greater transparency to transactions in the credit marketplace by verifying buyer identity and removing the potential for “double counting,” an error in which credits are resold and claimed twice.

Open-source and public blockchains have also demonstrated their utility in global carbon markets, as researchers attempt to track a dizzying array of climate mitigation projects underway at local, regional, and global scales. An Ivy League school and a nonprofit are leading the charge to “put the Paris Agreement on the blockchain.” The ledger’s linkage function gives all participants the benefits of transparency, a useful tool to clarify the relationship between carbon markets globally. Technology certainly cannot resolve the intricacies of political relations; the advantage lies in its ability to weave multiple streams of data and digitize the climate accounting system across jurisdictional boundaries.

Blockchain is a rapidly evolving technology, and its implications for improving trust and transparency in the VCM are exciting. But it is important to separate its true functionality from technology hype at this early stage. With so much activity underway, hard lessons and cautionary tales are inevitable.

Unintended consequences: Elevating quality or unleashing zombie credits?

The risk of “zombie projects” on the blockchain was investigated in an analysis that found a substantial chunk of carbon credits sold as crypto tokens in 2021 would have been barred from trading in traditional markets due to quality issues. These zombie credits flooded the market and amplified skepticism about the VCM’s potential for meaningful emissions reductions. Lesson learned: tokenization does not solve underlying quality issues — in fact, it can give once buried junk credits new life when managed by traders motivated primarily by profit.

By itself, tokenization has little to do with quality. Carbon credits are tokenized and put on sale after they are issued, with token efforts largely relying on leading standards organizations to benchmark quality. Obfuscating quality in exchange for liquidity is a huge price to pay in an already low-quality market—and ultimately, a self-defeating choice. Just as the Nobel prize-winning economist Akerlof warned of lemons in a used car market that can drive out good cars, bad quality carbon credits drive out good carbon credits.

In the race to bottom for quality, labeling matters. Carbon credits are diverse in nature; think diamonds not gold. The value of diamonds is judged on a variety of metrics – cut, color, clarity, carat – while gold is judged on a single metric of quality – carats. Similarly, information on geography, origin, type, vintage, co-benefits, and status of mitigation activities are just a few attributes that make offsets a differentiated product. To treat it the same as a single carbon commodity is incompatible with the climate benefit we are trying to deliver at scale.

Token-forward efforts are not impervious to the criticisms by carbon market stalwarts. Leading climate tech companies are redesigning tokens to ensure environmental integrity. This shift to integrity from liquidity-first mentality is a step in the right direction. The next leap in innovation needs to be more ambitious still.

Pushing the envelope: Opportunities around scaling supply of carbon credits

If transparency is the currency of trust, any blockchain venture in carbon markets must consider the tradeoff between liquidity and differentiation. Liquidity is indispensable from a market growth point of view; differentiation supports environmental integrity. Promoting transparency over the quality and diversity of carbon credit supply in the VCM is as important to scale as liquidity.

The 400-million-ton sized voluntary carbon market pales in comparison to the climate need to reduce global emissions by 420 billion metric tons. One way to increase the quantity of credits available to the market is by differentiating the carbon credit supply. Blockchain can support this objective through its ability to differentiate across a spectrum of quality by making information transparent. This makes the technology uniquely suited to compare apples to oranges, a big benefit to address the supply scarcity problem.

So, where, and how can blockchain technology increase the integrity of supply to effectively scale up a high-quality voluntary carbon market? There are six promising areas of reform:

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Being clear about what blockchain can’t do for carbon credit supply is an important disclaimer to distill true utility. Blockchain has no discerning function of its own and is consequently susceptible to the classic “garbage in, garbage out” problem. Blockchains are typically meant to work as decentralized accounting ledgers and have no ability to differentiate between ‘good’ and ‘bad’ data linked to credits. It can, however, put the ability to monitor and verify data in the hands of individuals — empowering them to make informed purchasing and investment decisions.

Brevity of interactions and transactions is essential to a liquid voluntary carbon market. The next wave of movement should be around access and rights. A new focus on addressing hurdles on the supply side allows blockchain solutions to build credibility across the entire carbon credit value chain.

Trust, but verify: Blockchain’s growing role in carbon markets

The buzz surrounding blockchain’s potential to scale a trustworthy carbon market might seem inflated, but it is well-founded. Despite – and in some part, because of – the lessons learned from early missteps, blockchain initiatives now have a better solutions framework around core problems in carbon markets. While the technology is still in its relative infancy, startup proof-of-concept stories and prototype announcements by banks and multilateral institutions show that blockchain for carbon markets will stick around. There is promise in its ability to bring greater trust and transparency to a space clouded by a lack of clear standards and systems for defining quality credits.

The challenge now is to gain consensus on those standards and systems so that data entered as blocks strengthens the integrity of the entire chain. This is especially important as carbon credits expand from mostly low-quality tradable units into new and diverse formats, such as how they are created, what they represent, how they gain value, and other differentiated attributes.

In line with RMI’s “think, do, scale” approach, the Carbon Markets Initiative is working to enable collective action to generate trust in the quality of the data associated with on-chain carbon credits. We are interested in identifying blockchain use cases relevant to the needs of those who create, track, certify, sell, and buy carbon credits. We invite you to collaborate with us.