Regenerative Finance: Innovation for a sustainable future
Sustainability is more than a buzzword. The climate is in crisis and we need to act now.
Governments and consumers demand climate action, and organizations are ingraining sustainability into their operations and investment decisions in response. Unfortunately, our current financial system is not well aligned to meet the level of financing demand necessary.
Built around a narrow set of criteria of profit for the benefit of shareholders, traditional finance is not built to finance holistic investments that benefit all stakeholders with a variety of success criteria. Regenerative Finance, or ReFi for short, has emerged as a new type of financing structure that is rapidly gaining popularity.
ReFi takes a holistic approach to finance by focusing on a wider set of Environmental, Social, and Governance(ESG) investment criteria to determine investment worthiness. With ReFi kickstarting sustainable systems, we are on the precipice of a new type of economic boom.
What Is Regenerative Finance ?
Regenerative Finance is the process of using various forms of capital to drive systematic, sustainable, and positive change for all stakeholders. ReFi aims to direct investment toward regenerative businesses in order to accelerate their growth and help them scale up their impact. Regenerative Finance can help to address market failures by providing the capital that these businesses need to thrive. Regenerative Finance also helps to incentivize positive environmental and social outcomes, which is often lacking in traditional finance.
The key difference between ReFi and traditional finance is that Regenerative Finance prioritizes the long-term health of the system over short-term financial returns. ReFi investments often have lower rates of return in the short term as they are made with a longer time horizon in mind. However, as we have seen with the growth of sustainable investing, these investments can provide superior returns over the long term as they reduce risk and help to build a more sustainable future.
One of the major advantages of ReFi is that it can help to address market failures. Market failures happen when the free market does not allocate resources efficiently due to a lack of information or incentive structures. For example, ever since the industrial revolution humans have built industries without worrying about greenhouse gas emissions. While this appeared to produce sustainable growth, unchecked emissions now have us facing a climate crisis that could shave off up to 14% of GDP by 2050, representing $23T.
Current markets fail to account for the negative externalities of carbon emissions and inefficient allocation of resources now has humanity playing catch up in the face of impending environmental crisis. ReFi works to correct this by facilitating the intelligent allocation of resources.
Refi in Action: Carbon Offsets
The primary type of ReFi instrument that in use today are carbon offset credits. To create an offset, The process functions as a marketplace, with intermediaries connecting credit buyers and credit producers. Third-party organizations verify regenerative actions by the credit producer. Organizations utilize these credits to accelerate the offsetting of the scope 1, 2, and 3 emissions without rapidly altering their business operations.
The carbon market is currently divided into mandatory markets and voluntary markets. The mandatory markets are those in which credits are traded based on compliance with emissions caps, such as the European Union Emissions Trading Scheme (EU ETS) and the California Cap-and-Trade Program. The total size of the mandatory market was about $261B in 2020.
The Clean Development Mechanism (CDM) is one of the Kyoto Protocol’s flexible mechanisms, which allow major emitting countries to meet their emissions reduction targets by investing in emissions-reducing projects in other countries. The CDM is a project-based mechanism, meaning that individual projects generate Certified Emission Reduction (CER) credits which can be sold for profit to emission-reducing countries. The mandatory compliance has strict reporting and verification standards.
Voluntary markets are used by companies that aren’t legally obligated to lower their emissions but choose to due to ESG goals or stakeholder pressure. These markets are currently mainly dictated by a handful of entities such as Verra and The Gold Standard. The voluntary market is smaller but rapidly growing, reaching $1B in 2021 but could rise to as much $150B by 2030.
There are two main types of carbon credits: carbon avoidance and carbon removal. Carbon avoidance involves paying organizations to not do an action that would increase C02, such as paying a logging company not to cut down a particular section of trees. Avoidance has traditionally been the most common type of offset, representing 96% of issued credits in 2020. The second and more effective type of offset is carbon removal. This includes traditional activities such as planting a tree or utilizing more sustainable farming practices to keep carbon in the soil. Those that follow a specific methodology for their offsetting must have their actions verified by an independent third party. Every metric ton of net reduction of GHG’s creates one carbon credit. Buyers of carbon credits have business operations that make them net emitters of GHG’s. These businesses can purchase carbon credits on carbon marketplaces and apply them to their organization, therefore “offsetting” their operations so they are net carbon neutral.
Blockchain & Ecosystem Services
Distributed ledger technologies have evolved over the last several years to the point where real-world use cases are not only possible but represent an improvement over previous systems. The regenerative finance space is one of the strongest examples of innovation now being unlocked and is currently being played out in a few different ways. Organizations such as Toucan protocol are bridging carbon offsets directly from registries such as Verra.
By bridging the credits from a silo’ed database on-chain, the credit can be tracked to avoid double-spending. In addition, Toucan is able to repurpose existing DeFi infrastructure to facilitate the creation of new financial products around carbon credits. For example, KlimaDAO has utilized this infrastructure to build out a treasury backed up against carbon credit. This financial instrument reduces the supply of carbon credits and this increases the price. This makes it increasingly expensive for polluters to put off changing their operations.
Beyond Tunnel Vision: What Comes Next
The conversation about climate change and its effects on the environment has largely been focused on carbon emissions. This is understandable as the release of CO2 emissions is the most well-known driver of climate change. However, reducing CO2 emissions is just one part of a much greater mobilization necessary to ward off climate change. By focusing on carbon removal as the key metric to reach, we fail to recognize the effects climate change is causing on biodiversity, coral reef acidification, and water depletion.
Pricing these types of actions had traditionally been difficult. However, re-purposing existing DLT infrastructure allows the same mechanisms of pricing tokenized assets to be applied to regenerative actions. Organizations like Regen network, BasinDAO, and Avano are among the earliest creating assets around broader regenerative actions. As the financial opportunities around these businesses increase, this trend will only accelerate. With innovative new financing opportunities and assets being unlocked, it brings the pieces together for something powerful.
One exciting example is the idea of using natural capital to back up a currency. Inspired by Charles Eisenstein’s “Sacred Capital”, the Celo blockchain in partnership with the Climate Collective is pledging to back up 40% of their US dollar equivalent stablecoin with natural capital assets, such as rainforests and eventually broader assets like those backed against aquifer recharge and minerals This would incentive the protection of these natural assets since their stewards would effectively be creating fungible currency out of thin air. With the proliferation of natural capital assets being created, this future is possible.
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