What is KlimaDAO? A Deep Dive.

Learn How a Digital Currency Can Help Fight Climate Change

By Matthew Carpenter-Arévalo

If you’re curious about the regenerative finance space, you’ve probably heard of KlimaDAO. If you’ve followed your curiosity to the KlimaDAO’s website and tried to understand what it is and what it does, you may have found yourself confused and you may have given up.

I’m here to tell you that you are not alone: KlimaDao is complex, but within that complexity, we may find an important tool for fighting climate change.

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In its simplest form, KlimaDAO is a digital reserve currency backed by natural assets like carbon credits.

KlimaDAO’s ultimate goal is to make carbon very expensive by becoming the world’s foremost purchaser of offsets.

When carbon offset credits are expensive two things happen: first, companies will find it cheaper to make their operations more energy-efficient instead of purchasing offsets to compensate for their emissions.

Second, those creating carbon sequestration capacity for the planet will profit from higher prices, thus enabling more and more incentives to pull carbon from the atmosphere.

So why create a digital currency backed by natural assets like carbon credits?

Writing about Celo, a carbon-negative blockchain, the techno-philosopher Packy McCormick wrote, “whatever backs money, people make more of. When money was backed by cattle, people bred more cattle. When it was backed by gold, people mined more gold. So why not back money with more of the things we want to see in the world: clean bodies of water, strong forests, biodiversity?”

Many people are aware that, until 1971, the US dollar was backed by gold, meaning that for every US dollar in existence, the US federal reserve held a corresponding amount of gold. The dollar was, in effect, an IOU, or dare I say a token, for a certain amount of gold. In theory, you could convert your dollars into gold at any point.

It’s common nowadays to say the US dollar is backed by oil, which isn’t exactly correct. The US Federal Reserve doesn’t hold oil reserves.

Rather, for a currency to be strong there needs to be constant demand, and in the case of US dollars, constant demand comes in the form of oil sales denominated in USD.

Most oil-producing nations agree to price and settle oil sales in USD in exchange for tacit support from the US government. Because the world has a constant and massive demand for oil, the world also creates constant and massive demand for USD.

KlimaDAO would like demand for their coin, $KLIMA, to help prevent the worst effects of climate change by using economic systems running in the background to create incentives for the development of a healthy planet. How we get there is complex, and the KlimaDAO plan is not without controversy and criticism. Allow me to delve into the details (note that I’ll refer to the currency as $KLIMA and the organization as KlimaDAO).

How do KlimaDAO and $KLIMA work?

First, KlimaDAO is a decentralized autonomous organization (for more on DAOs, see my note here). As a DAO, the organization operates somewhat like a cooperative, and $KLIMA token holders can vote on initiatives pertinent to the organization and the currency’s governance. In theory, the DAO is a non-profit; however, if employees are token holders, they benefit from the token’s appreciation.

Second, $KLIMA, the DAO’s token, is a fork of another cryptocurrency called OlympusDAO ($OHM).

In web3, software products are by default open-source, meaning anyone can look at the source code, make a copy, and launch a copy/competitor.

OlympusDAO is a project designed to make it easy to create stablecoins, meaning coins with a consistent value often pegged to FIAT or national currencies. Stablecoins are the highways of crypto, making it easy for money to move into, out of, and between projects.

It’s also worth pointing out that $KLIMA operates on Polygon, which is a Layer 2 rollup built on Ethereum.

Layer 2s are blockchains built on top of other blockchains (in this case, layer 1 is Ethereum) that inherit the layer 1 security mechanisms whilst creating efficiencies that allow people to transact at a much lower cost.

Think of it this way: when I was a kid and just getting into computers, I learned how to operate my parent’s 286 through the computer’s command prompt (remember C://?).

After a few years, operating systems like Windows came along and eliminated the need for regular people to learn how to interact with the command prompt.

Layer 2s, in my mind, perform a similar function in crypto: instead of sending people to interact with Ethereum, regular people will be able to perform most of what they want to do on Layer 2s, and only large institutions will interact directly with the Ethereum Blockchain.

For environmentally-minded readers (are there really any other kinds of readers here?), Polygon is much more environmentally friendly than Ethereum.

At the moment of writing, Ethereum, like Bitcoin, is still a proof-of-work-based network, meaning each transaction registered on the network must consume massive amounts of energy in order to be accepted as legitimate.

Ethereum plans to switch to a proof-of-stake (POS) security model in 2022, which will reduce its carbon footprint by 99.5%.

In the meantime, Polygon already operates on a proof-of-stake model and is, according to its founders, carbon neutral.

Because $KLIMA is a reserve currency, $KLIMA needs to be backed by something, meaning there has to be a valuable asset that the KlimaDAO is holding in order to give $KLIMA an intrinsic value, much like gold gave value to USD. As mentioned before, $KLIMA is backed by natural assets, which take the form of BCT and MCO2.

BCT stands for base carbon tonne and is a token created by Toucan, a protocol that takes off-chain carbon credits and brings them on-chain. So what does that even mean?

Let’s say, for example, a landowner develops a carbon offset program through regenerative agriculture, meaning she is able to demonstrate that changes in her land use are leading to more carbon being sequestered in the ground than before.

Once her project is measured and verified, she receives a piece of paper that represents the number of additional tonnes of carbon sequestered, and she can sell the paper representing that additional tonnage to a broker who in turn re-sells it to a company looking to achieve carbon neutrality by subtracting the farmer’s additional tonnage from its overall footprint.

In the pre-blockchain world (check out my article about why carbon markets need crypto), the project existed on a piece of paper and was probably kept in a desk somewhere. Its only digital footprint was to be registered in the database of an organization like Standard Verra, a carbon offset registry, but those registry databases aren’t open and accessible to the world.

In a world of blockchains, that piece of paper is converted into an NFT and registered on a public blockchain such that it can be scrutinized for quality. In addition, because it’s on the public blockchain, it can’t be re-sold or counted towards more than one company’s emission reduction goals.

Toucan is a protocol that essentially takes the pre-blockchain credits that have been approved by Standard Verra, a major player in the carbon offset space, and puts them on the blockchain in the form of BCT.

MCO2 is created by the Brazilian-based Moss.Earth and performs a similar function as BCT, only Moss.Earth is focused on offsets derived from projects in the Brazilian Amazon. A single BCT or a single MCO2 equates to a tonne of sequestered carbon.

One of the ways to get $KLIMA, therefore, is to buy BCT or MCO2 and deposit them into the KlimaDAO treasury.

In exchange, you receive $KLIMA at a discount, meaning you receive a greater value of KLIMA than the value of the tokenized carbon you deposited (there is a five-day vesting period, so you have to wait five days to retrieve your $KLIMA). This process of depositing carbon tokens and receiving KLIMA is called bonding and is what enables $KLIMA to have an intrinsic value.

So what if you don’t have any BCT or MCO2? How do you get $KLIMA?

You can just buy $KLIMA with a credit card and hold it.

If you want to bond $KlIMA, however, KlimaDAO makes it easy to purchase both BCT and MCO2 using $MATIC, which is the native token of Polygon, the level 2 protocol we mentioned above. Just like much of crypto, the process of bonding $KLIMA is not really user-friendly for non-native Cryptopians and will hopefully improve with the technological advances of the industry.

Before moving on, I should mention that in addition to bonding BCT and MCO2, you can also bond pairs of other cryptocurrencies.

To understand pairs, imagine you went to an old-fashioned money exchange in New York City and you wanted to swap Argentinian pesos for Mexican pesos.

You ask the person sitting behind the bulletproof glass if they can perform the necessary conversation, and they tell you that you’ll have to convert your Argentine Pesos into USD and then buy Mexican pesos, because the money exchange doesn’t accept transactions that are not USD based.

Something similar happens in crypto. In crypto, protocols need to have pools of pairs of currencies in order to ensure that people who want to sell a certain cryptocurrency and buy another can do so.

I may have Bitcoin and I want Dogecoin, but in order for that transaction to happen, the exchange I’m dealing with has to have those coins available as a pair. Otherwise, I’ll have to purchase a USD stablecoin and do two transactions, like the example I gave above.

So if I have, say, an equivalent value in cryptocurrency X and in cryptocurrency Y, I can sell both to the protocol in order to facilitate other people’s transactions between the two.

With $KLIMA, I can sell to the protocol an equivalent amount of $KLIMA and $USDC, a USD-denominated stablecoin, so that users who want to exchange those two currencies can be sure there is enough liquidity available to complete their transaction. If we return to the NYC-based money exchanger, we need to make sure there is enough cash in Argentine and Mexican pesos to make transactions possible.

In exchange for selling the pairs, I receive newly minted $KLIMA. $KLIMA allows you to bond pairs of $KLIMA and USDC, as I mentioned, or $KLIMA/BCT or $KLIMA/MCO2.

Now that we know how $KLIMA gets its value through bonding, we can ask how is the value of $KLIMA sustained?

Things are about to get complicated but bear with me.

When bonding happens, a tonne of carbon, represented as BCT, is exchanged for 1 $KLIMA with a 20% discount (we’ll come back to the discount in a minute). The 1:1 ratio is essentially the cost of making 1 KLIMA. However, when the market value of $KLIMA is higher than the market value of BCT, there’s money left over.

For example, a tonne of BCT might be trading at $2.50, and $KLIMA might be trading at $3.50. Because $KLIMA always pays 1 $KLIMA for $1BTC, there’s a dollar left over.

When the US government mints new coins, for example, it may cost $0.10 to make a $1 dollar bill, which means there is $0.90 left over for the US government. The technical term for this difference is seigniorage. $KLIMA makes a lot of money through this process, but it doesn’t keep all the money; it actually distributes it through a process called “staking”.

Now if you’re familiar with crypto, you’ve probably heard the term “staking”. Staking is a key component of proof-of-stake (POS) blockchains.

In POS blockchains, instead of using a vast amount of energy to prove a transaction is valid as in proof-of-work, validators compete to be able to register transactions on the blockchain and earn rewards.

When a validator believes a transaction is valid, it’ll “stake” or put up a certain amount of money as a sign of its confidence. The validator that stakes the most money gets to register the transaction on the blockchain and then receives a reward for doing so. Transactions that receive no staking are not submitted to the Blockchain, because they’re probably fraudulent. If a fraudulent transaction is staked and is then discovered, the validator loses the money they staked.

In order to win more often the chance to earn rewards for updating the blockchain, validators will borrow the blockchain’s native currency from others and then split the rewards with the lenders. Staking acts as a counter-balance to inflation since it essentially takes money out of circulation and temporarily reduces the money supply.

Because $KlimaDAO isn’t a blockchain but instead an application built on top of Polygon, a POS blockchain, $KLIMA doesn’t need staking to validate transactions, since validation is handled by Polygon.

$KLIMA does, however, offer its version of staking, which allows people to“lock-up” a certain amount of $KLIMA with the protocol, almost like a certificate of deposit from your bank: you promise not to take your money out, and the bank gives you a higher interest rate.

If it wasn’t for staking, bonders would swap their BCT for $KLIMA and then probably sell the $KLIMA to pocket the difference in value between the discounted $KLIMA (remember I mentioned bonders get a 20% discount?) they’ve received for bonding and the market value of $KLIMA. For example, because $KLIMA gives bonders discounted $KLIMA of say 20% if you bond BCT and immediately sell your $KLIMA, you’ve earned 20%.

Through staking, KlimaDAO gives users a more profitable activity than selling their $KLIMA right away. In addition, through staking, KlimaDAO reduces the amount of $KLIMA in circulation, thus creating reduced supply and driving up/sustaining the price.

So how does $KLIMA incentivize staking? Remember that $1 leftover from the bonding process? KlimaDAO distributes that to the stakers (70% goes to the stakers and 30% goes to the DAO to pay for operating expenses). As a result, $KLIMA stakers can earn upwards of 30–40,000% APY (annual percentage yield).

Normally, when I see a really high APY in crypto, I pause. Lots of crypto projects subsidize their APY in order to incentivize people to buy/stake their currency. I’ve heard someone say that, in web2, if you couldn’t identify the platform’s product, you were the product and in web3, if you can’t identify the yield, you are probably the yield, meaning others are earning interest on the money you deposit/stake.

Now I’m not an economist or a financier, but the $KLIMA APY makes sense to me since the $KLIMA protocol is making money based on the difference between the cost it pays people to bond $KLIMA and the market’s valuation of the $KLIMA coin. We should note that being able to distribute earnings to stakers depends entirely on there being demand for $KLIMA. If no one is bonding or buying $KLIMA, eventually there are no rewards to distribute.

It’s also worth pointing out that $KLIMA has already had one spectacular crash.

The price rose to $3,600 USD per $KLIMA in October 2021 before falling and stabilizing around $3.30 USD. While some people see the drop as proof that $KLIMA failed, I interpret it more as a sign of the vast amounts of speculative capital roaming the crypto halls looking for quick wins.

So what happens when the price of $KLIMA drops below the value of its assets in the treasury? Meaning, what happens if one $KLIMA is worth less than one $BCT?

When the price of $KLIMA is below the value of the assets in the treasury, the protocol will sell some of its assets (meaning the BCT or MCO2) and use the income to buy back $KLIMA and burn it, meaning take it out of circulation. That way, when there is less $KLIMA available on the market there should be a corresponding price adjustment.

So, does your brain hurt?

KlimaDAO actually does a lot more than what I’ve described here, and, for the sake of clarity, I’ve purposefully left out some of the more complicated details of how the currency operates. I may at some point in the future write a part II, but in the meantime, my hope is that you’ve gotten this far in understanding that $KLIMA represents a currency that is backed by offset carbon.

So what are the benefits of KlimaDAO?

In an interview with the Bankless Podcast, two of the core-team members of KlimaDAO spoke about the benefits of KlimaDAO and mentioned that the primary benefit of the currency is to democratize access to an often inaccessible asset class.

Sure, airlines will let you buy offsets for your flights, but do you really know where that money is going? In the case of $KLIMA, when you buy it you know that you’re holding a certain amount of carbon offsets, and so the transaction is much more transparent than it is with your shady airline program.

Being able to purchase $KLIMA easily is a big deal. Not only can individuals buy $KLIMA, but companies seeking to meet their voluntary emissions reductions pledges can buy and burn (take out of circulation) $KLIMA. Nowadays, some companies that have significant carbon reduction commitments will have people on staff to procure offsets. Most companies either cannot afford to hire that staff or would prefer not to.

What’s more, as we’ve discussed in past posts, when we move carbon offsets onto the Blockchain, we make the market work for everyone. First, we’re removing intermediaries, meaning more of the monies for caron offsets go to the people actually doing the work of making the planet healthier. Pricing is real-time, like a stock market, and all buyers meet and transact in the open, rather than sketchy buyers and sellers meeting in smokey rooms to hash out obscure deals.

So, if it works, what can the world do with $KLIMA?

I see a lot of ways in which $KLIMA can increase demand for carbon offsets.

For example, as crypto payments go more and more mainstream, you can imagine a world where virtue-signaling individuals insist on paying for goods and services in $KLIMA, showing the world that, instead of petrodollars, they use regenerative dollars. You can almost hear it: “I’d like the free-range chicken and, by the way, does your restaurant accept $KLIMA?!”.

We could also imagine a world where, with every purchase you make on say, Amazon, a small amount of $KLIMA is purchased and burned, thus making your transaction carbon neutral.

Given our desire for demand-side gratification in the effort to solve climate change, the ways in which we could utilize $KLIMA for good are limitless.

Second, carbon offsets as an asset class are fairly stable and not tied to the performance of the stock market. Bitcoin tried to present itself to the world as an anti-inflation, anti-cyclical hedge, but in the most recent bear market (when prices drop), Bitcoin suffered just as much as the stock market.

We can imagine a world, therefore, where $KLIMA is positioned as a token used to balance a diversified portfolio, protecting against inflation, stock market crashes, and any number of events that can cause economic mayhem.

If $KLIMA proves itself stable during the current crypto winter, it may broaden its appeal beyond environmental Cryptopians and eventually get the attention of large money managers like hedge funds and pension funds.

Finally, given the recent collapse of the Terra/Luna stablecoin, the algorithmic stablecoin that was, for most of its existence, not backed by any asset class, it’s likely that the future stablecoins or digital reserve currencies will want to be backed by diversified assets, and here $KLIMA could find a major source of demand.

Right now stablecoins represent over 10% of the entire crypto market cap, meaning they have over $150 billion USD in value (yes, I said billions with a B). Backing stablecoins with $KLIMA seems like a natural progression for many, and also a means by which environmentally-sensitive networks can easily achieve a net-zero carbon footprint.

What Criticisms are there of KlimaDAO?

Oh sweet Jesus on a unicycle, there are a lot of criticisms of KlimaDAO coming from all sides, including fellow crypto-environmentalists.

The first thing I should point out is that no one really knows who is behind KlimaDAO.

Though the founders often appear on podcasts, go to events, and are active in the KlimaDAO Discord servers, they mostly go by aliases taken from Greek mythology. Though there’s no insinuation of foul play, it does make many people uncomfortable that we don’t know the non-crypto identity of the founders.

Second, KlimaDAO has a supply problem. The main source of KlimaDao’s carbon offsets is Toucan, the protocol that brings Standard Verra’s carbon credits onto the blockchain. Despite exercising a near-monopoly on the verification of climate offset projects, some of Verra’s carbon offsets are of dubious origin. Many are old and come from projects with questionable environmental impacts.

Recognizing this, KlimaDAO and its supporters argued that it was cleaning up the space by buying and removing poor-quality carbon credits from the market.

However, as a result of KlimaDAO’s demand, a lot of dormant projects have all of a sudden re-awakened, hoping to cash in on instant and unscrupulous demand. Ultimately the entire carbon offset industry needs to help ensure enforceable standards such that a token representing a tonne of carbon is actually a tonne of carbon.

KlimaDAO wants to buy high-quality projects, but is it inadvertently creating an incentive for crappy projects? The question ultimately leads to another criticism: KlimaDAO is fixing the demand side of carbon markets when what really needs fixing is the supply side.

What I mean is this: the voluntary carbon market is big and keeps getting bigger as more and more companies seek to meet their voluntary commitments to net-zero emissions. What’s holding back the carbon market from exploding is not demand, but supply, meaning high-quality projects that remove carbon from the atmosphere.

In order to scale carbon markets, we need more high-quality carbon offset projects to come onto the blockchain. In other words, we have more demand than we can handle; solving climate change requires more supply. KlimaDAO fixes some things, but not the biggest thing holding back carbon markets.

Along those same lines, some people who have been working diligently for a few years to build the underlying rails to enable carbon markets to move onto the Blockchain complain that the buzz around KlimaDAO would have some believe they’re the first movers in the regenerative finance space. These people complain that too much attention has made the regenerative finance dependent on the success of KlimaDAO.

Then there are questions about the mechanics of $KLIMA and how it will respond to volatility in the market.

As mentioned above, when the price of $KLIMA drops too low, KlimaDAO begins to sell the assets of its treasury, which means releasing BCT onto the market. Because KlimaDAO isn’t retiring carbon credits (meaning taking them out of circulation) there is a risk those credits could flood the market and drive down the price. Instead of helping carbon markets, in that scenario, KlimaDAO would be hurting them.

Similarly, one person I spoke to worried that, because KlimaDAO is the main purchaser of BCT, we don’t really know how BCT would be priced in a market without $KLIMA.

When I put this to one of the members of the core team, he rightly pointed out that BCT in its offline, non-blockchain form has a lot of buyers; many of those buyers simply haven’t come onto the blockchain yet. As such, we do have price discovery for BCT, but it takes place primarily in the non-blockchain markets.

Finally, KlimaDao faces a huge challenge. Standard Verra, the NGO that certifies carbon offset projects, recently announced that it would no longer be “bridging” its credits onto the blockchain through its preferred provider, Toucan.

Instead, Verra announced that it would initiate a “public consultation” within a week on how to proceed, and a month later that consultation has yet to materialize.

Already the bad guy throttling the growth of carbon markets, according to many, with one stroke of its pen Standard Verra has put into question the future supply of BCT.

KlimaDAO could of course opt to fill its treasury with non-Verra verified projects, but that opens an entirely new can of wormy problems.

What I would say though is that, despite receiving criticism from numerous actors in the regenerative finance space, everyone I spoke to wants KlimaDAO and $KLIMA to succeed. Few people debate the value of having a natural-asset-backed reserve currency. Most people debate the finer points of KlimaDAO’s execution and communications. Overall, KlimaDAO is in an envious position, since they receive the feedback (even though some of it can be nasty) but they also receive a lot of support.

Conclusion:

While it makes perfect sense to me that a currency backed by natural living assets will be part of the solution to climate change (assuming we can get there on time), it’s probably too early to say if KlimaDAO is the currency that will own that role. Having said that, no other competitors are even close to KlimaDAO’s size and scale.

What exactly is that size? As of today, $KLIMA has a market cap of $5 billion USD. Exactly because crypto operates mostly outside regulatory environments in an international market, and exactly because it is democratized, meaning anyone can invest in it, crypto failures are large and their scale can sometimes seem more definitive than need be.

A lot of people in the crypto space talk about how we’re trying to learn 100 years of lessons across governance, monetary policy, economic policy, computer science, and environmental science in the span of a few years. Journalists looking for clicks are quick to say, “See, X’s well-intentioned initiative was actually a scam!”.

Meanwhile, older environmentalists like Greenpeace continue to operate on the assumption that if we just protest and shame people enough, we’ll finally make progress in the fight against climate change, despite all the evidence that shows such a strategy hasn’t worked and won’t work to move the needle towards a sustainable planet.

All that being said, we’re still extremely early in the regenerative finance space, and I first and foremost applaud the KlimaDAO team for their effort. At the time of writing, KlimaDAO has offset 15 million tonnes of carbon, the equivalent of over 3 million cars, spending over $100 million dollars. They’ve built a model that can scale, and the next few months/years will show us whether or not there are major flaws in their model that can be exploited.

If KlimaDAO succeeds, it’s a major victory for the planet. Even if KlimaDAO fails, from its ashes will rise a more sophisticated and resilient player benefiting from all KlimaDAO’s learnings.

To conclude, for the time being, the world is better with KlimaDAO than without it.

Conclusion:

This article was hard for me to write, and I am indebted to a number of people. First and foremost, I want to thank Marcus Aurelius from the KlimaDAO core team for humoring me with my questions in Discord and then taking the time to walk me through the bonding process on a call. I also want to thank Florian Strauf who writes about Tokenomics and answered a few questions. If you want to learn more, This video was helpful to understand bonding, and This article was helpful to understand KlimaDAO Tokenomics. If you’ve made it this far and read the entire article, thank you!

If you’d like to receive my weekly newsletter about crypto, climate, and carbon, please sign up for my substack here.

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Matthew Carpenter-Arevalo

Matthew Carpenter-Arevalo

921 Followers

Ecuador/Canada. Working on Carbon Origination. Ex@Google, Ex@Twitter. Founder of @CentricoDigital. Contributor @TechCrunch @TheNextWeb.