The global climate summit COP26 marches on, but the presidents and the prime ministers have now left Glasgow. As the initial fanfare has faded, so has the media attention. Celebrities and world leaders called for more action, and pledged more to do more, but behind the scenes difficult negotiations are still taking place.
So why should the DeFi world care? Because it makes easy political target.
In his COP26 address, President Biden bluntly scolded China for not showing up and being a problem[1]. A sinister dictatorial state not willing to sacrifice economics to help fight climate change makes a facile appeal to voters, and catches on with mainstream media, except that it completely ignores how China has made impressive sustainability efforts such as reforestation.
The same facile generalization applies to crypto assets. Headlines such as “Bitcoin consumes a similar amount of power to the Netherlands”[2] grab attention and reinforce prejudices. Even though Bitcoin’s energy use is not actually comparable to the energy use of other crypto assets[3], and energy consumption does not equate to carbon emissions[4], subtle analysis is not necessarily what matters in politics, as Donald Trump has masterfully demonstrated. As the regulatory attention on crypto assets intensifies (see previous article Can DeFi Survive the Regulators?), it should come as no surprise that politicians will start applying the anti-climate argument to crypto assets.
Some basics of carbon trading
To shake off the “crypto is unsustainable” label, the DeFi world should seriously think about carbon trading.
Currently, two main forms of carbon trading exists — (1) the Emissions Trading Scheme (ETS), also known as “cap and trade”, which is highly regulated; and (2) Voluntary Emissions Reduction (VER), where buyers voluntarily buy carbon credits. In essence, under ETS, regulated companies buy and sell the “rights to pollute” under a scheme of caps, whereas VER enables buying carbon credits to offset emissions. Companies and financial institutions often buy carbon credits to meet their ESG goals.
Voluntary Emission Reduction (VER) credit is so called since buyers are not subject to regulatory constraints, unlike ETS. Voluntary markets have emerged over the recent years, as companies and financial institutions incorporate ESG into their agendas. A carbon offset corresponds to 1 ton of CO2 equivalent avoided (or compensated) through the successful implementation of a project, mainly in forestry, renewable energies and energy efficiency in developing countries. In other words, VER credits constitute a form of financing for these green projects. McKinsey estimates the voluntary carbon market to be worth at least $50 billion by 2030[5].
Projects go through extensive verification and auditing, as they must follow complex rules to be certified and thus eligible for carbon offsets. These rules comply to a recognized standard, the most common of which is VCS, which in turn is maintained by the Washington-based organization Verra. The organization maintains a registry, which records all projects and tracks all the carbon offsets registered. Hence VER credits pay for historical performance, i.e. after the carbon avoidance has been already achieved.
Given their cumbersome arrangements, voluntary carbon trading is now mostly mediated by traditional financial institutions, particularly European banks such as BNP Paribas and Standard Chartered with a strong commitment to sustainability. These financial institutions run voluntary carbon trading desks, which stock a number of selected carbon offsets from audited projects. Clients buy these credits (or offsets) with negotiated ad hoc legal documentation for every transaction.
Each VER comes with a unique serial number linked to the registry. When the client closes the transaction (i.e. buys the VER), the offset can be recognized in two ways:
· The financial institution can cancel the VERs from its own registry for its client where the transaction is recorded, the certification is issued by the Registry and transferred to the client.
· The financial institution can transfer the VERs to the client’s registry for its own record and maintenance.
Tokenization of carbon offsets
As obvious from the above, voluntary carbon trading in its current form is highly centralized and fraught with operational inefficiencies. Auditing and verification of emission reduction projects could take years, and the actual transaction involves much paperwork and internal bureaucracy. Hence it is no surprise that tokenization and blockchain technology at large will greatly benefit this market. Distributed ledger is the ideal technology for maintaining a registry as complex as carbon emissions reduction.
This idea is not lost on crypto startups, with varying approaches to tackle the inefficiencies in this market. Moss Co (https://mco2token.moss.earth/), with its MCO2 token, literally tokenizes existing voluntary carbon credits, where 1 MCO2 Token equals 1 carbon credit from a VCS certified environmental project. First Carbon (https://www.firstcarboncorp.com/) also sources verified carbon projects, presumably from current standards. Single.Earth (https://www.single.earth/), on other hand, approaches the problem differently. It bypasses existing standards and works with a much broader set of environmental data that mirrors biodiversity. Its MERIT token somewhat tracks carbon prices, and seeks to compensate landowners quickly to preserve biodiversity and offset carbon emissions. Singapore-based AirCarbon (https://www.aircarbon.co/carbon-assets) operates more like a traditional commodity exchange architecture but with distributed ledger technology. It securitizes carbon credits which are held by the exchange in a Trust. That in turn corresponds to a one ton Token on the Exchange.
All these efforts are laudable, but from the vantage point of managing the politics, a still broader effort is warranted. To stop detractors from applying the anti-climate argument to the sector, the DeFi world has to mobilize the community as a whole to make green tokens so prevalent that the sustainability crowd could feel the difference, especially from retail participation.
Popular wallets, for example, could make these token readily available to users as “donations” to support sustainability. NFT creators could mint green NFTs with their creativity brand for sustainability. Large exchanges could create indices for green tokens so that retail DeFi users could easily buy a sustainability basket. They could also source projects from traditional financial institutions directly, and tokenize them on-chain. It is an DeFi angle that senior executives of traditional financial institutions would probably be willing to explore, given their public commitment to sustainability goals.
Politics aside, in the long run, the DeFi world could help to resolve the most difficult challenge in carbon offsets: trust. Critics often point to the lack of transparency of projects, and their effectiveness in offsetting emissions, as well as the inconsistencies of various standards. With tokens tied to governance standards, and efficient monitoring with decentralized technology, perhaps DeFi could overcome these challenges. The world once trusted politicians to do right, to be a shining beacon in that late hour, and the world has been disappointed. Perhaps our inner light can guide us better, redeeming ourselves with technology that fosters community and a sense of hope.
[1] https://www.ft.com/content/4bf0f579-d44c-4e21-91bc-88058fa297fa
[2] https://www.bbc.com/news/science-environment-56215787
[3] http://datadrivenlab.org/climate/blockchain-energy-consumption-debunking-the-misperceptions-of-bitcoins-and-blockchains-climate-impact/
[4] https://hbr.org/2021/05/how-much-energy-does-bitcoin-actually-consume
[5] https://www.mckinsey.com/business-functions/sustainability/our-insights/a-blueprint-for-scaling-voluntary-carbon-markets-to-meet-the-climate-challenge
