Notes on the present and future of blockchain-based carbon markets
A future of carbon markets one can imagine is, tokenized carbon credits traded on public blockchains working as a unified voluntary carbon market (VCM). In this blog post, I’ll present my current mental models of the present and future of blockchain-based VCM, and the potential path of it to becoming the world’s de-facto system to trade carbon credits.
Who is this blog post for
This blog post is composed for builders, researchers, and entrepreneurs in the ReFi community, but it’s also expected to serve to provide a map of the present and future of on-chain carbon markets for learners.
Premise
Why blockchain in the first place?
*Please feel free to skip this section if you are already familiar with the meme that blockchain is a reasonable solution for carbon markets.
To summarize,
- Carbon markets don’t require thousands of TPS.
- Carbon markets have been criticized for not being transparent enough and not having standards, so blockchain-based implementation is one of the obviously fit solutions.
- We can anticipate the emergence of innovative products and services because on-chain carbon markets inherit the hardness and composability of decentralized applications.
Scalability
One can imagine that carbon markets don’t require VISA-level scalability. On the contrary, we still don’t know what kind of applications are going to be built on top of on-chain carbon markets. But people have come up with ideas to solve the blockchain trilemma, and we are on the path to having >1000tx/s scalability.
Transparency and standards
There is a tremendous amount of literature mentioning the lack of transparency and standards in the voluntary carbon market. Blockchain-based carbon markets are quite obvious solutions to these issues.
Other benefits of blockchain-based carbon markets that I think are relatively underrated are hardness and composability
Composability
In the context of the decentralized application (dApp), high composability indicates things like “ease of assembly” or “ease of integration”. If systems are highly composable, it means that they can be combined like LEGO blocks. In the world of decentralized finance, the expression “Money Legos” is used to describe the highly composable nature of decentralized finance applications.
Hardness
Josh Stark (@ 0xjosh) has written a brilliant essay on the hardness of blockchain and decentralized applications.
In his essay, he explains hardness as follows.
- Human civilization depends in part on our ability to make the future more certain in specific ways.
- Fixed, hard points across time that let us make the world more predictable.
- We need these hard points because it is impossible to coordinate at scale without them.
- “Hardness” is defined as the capacity of a system to make something very likely to be true in the future. Hardness is most useful where it is customizable or programmable — where humans can choose something specific we want to be true in the future.
“Hard” carbon markets will have developers building applications/tools on top of the market. (more on this below) As seen in the DeFi space, innovative products and services are more likely to emerge on a solid foundation. (i.e. The Protocol Sink Thesis)
Josh also states that speaking about hardness is difficult because we don’t have a precise term for it. Therefore I recommend reading his essay to gain a more holistic understanding of “hardness”.
State of voluntary carbon markets
Firstly, there are carbon credit standards such as the Verified Carbon Standard (VCS) that offsetters can purchase. VCS is a carbon credit standard with the most adoption, and it has issued more than 900 million credits cumulatively.
Secondly, companies like Stripe and Shopify are investing in carbon removal early-stage startups. These companies’ purchase of carbon credits is different from buying credits like VCS; since the intent is to become the early adapter in purchasing potentially scalable solutions with permanent carbon removal. Unlike offsetting using VCS, these offset deals are often in the >$100/ton CO2e price range. The contract for these purchases could be designed to meet the financial need of the startup, meaning the contract might consist of prepayment, payment holdback, etc. (More details on flexible payment: P26) Also, investing in early-stage carbon removal solutions requires establishing a proprietary MRV (measurement, reporting, and verification) framework. In essence, an extremely high-touch approach is being pursued by some enterprises that are willing to pay a premium for high-quality offsets.
The state of on-chain carbon markets and the case for institutional ReFi
Toucan is the de-facto protocol of the voluntary on-chain carbon market; its market cap is currently around $60M. (accounting for all the major carbon pools) For comparison, — though carbon markets aren’t easily comparable due to the heterogeneous nature of carbon credits— the global Voluntary Carbon Offsets market size is around $300M~400M.
In terms of growing the on-chain carbon market, the advent of institutional investors would have the most influence on the market size. Currently, due to the lack of liquidity and infrastructure, institutional investors are unable to participate in carbon markets; despite the various opportunities such as neutralizing the net emissions of their portfolio or hedging against risks imposed by the effects of climate change. To put this into perspective,$19 trillion of total assets is under management by the world’s top 100 institutional investors, and VCM is around $300~400million in market size.
More details on the participation of institutional investors in VCM can be found in this report by McKinsey and Company.
The emergence of Institutional DeFi
A similar argument on institution participation had been made in the DeFi space, often being referred to as Institutional DeFi. MetaMask has a product called Metamask Institutional which is a crypto wallet/web3 gateway for institutions, and Aave has a liquidity pool that is permissioned and dedicated for institutions, called Aave Arc. These services’ value propositions are usually security and compliance that are optimized for institutions.
One can imagine that establishment of these enterprise-ready interfaces for DeFi led to the growth of volume in large transactions in the space; according to the report from Chainalysis, large institutional transactions, meaning those above $10 million in USD, accounted for over 60% of DeFi transactions in Q2 2021.
The case for institutional ReFi
I believe that the ReFi space could follow the path of DeFi to onboard institutions to its markets. On-chain market compatible MRV software that could generalize the processes pioneered by offsetters like Stripe and Shopify, or carbon liquidity pools akin to permissioned liquidity pools in Institutional DeFi, could be something worth exploring.
Concluding
One question about the role of the on-chain carbon market one can ask is: are carbon offsets buyers like Stripe and Shopify (presumptively along with deep-tech VCs) going to be the pioneers that grow the carbon market with high-touch purchases/investments? Then, what kind of role on-chain carbon markets might play?
- Thesis 1: On-chain carbon markets are just for the long-tail purchasers.
- Thesis 2: Enterprises pioneering carbon offset purchases/investments might integrate on-chain carbon markets into their processes. Pioneers like Shopify and Stripe might become, or work together with the ReFi community, to become the MetaMask Institutional of ReFi (i.e. Institutional DeFi of Refi)
The on-chain voluntary carbon market is something that is worth exploring. We don’t know what kind of innovations the hardness of on-chain carbon markets will catalyze, but with the right incentives, the outcome is something to look forward to.
Remarks
I mention Shopify and Stripe as the pioneers of high-quality carbon offset purchasing, but it’s important to note that there are other enterprises pursuing to offset their emissions in a similar manner. I emphasize the efforts made by those two companies in this blog post because I have done the most research about their work.
