Inside a digitalized EAC exchange for renewable energy markets
Energy attribute certificates (EACs) each represent one megawatt-hour (MWh) of verified renewable energy generation that can be traded between interested parties—or held and retired by a party, such as a corporation meeting its annual climate and renewable energy targets. EACs are used to prove that electricity consumption is covered by an equivalent volume of renewable generation. Energy retailers, big corporations, and end-customers do their sustainability reporting by buying and claiming EACs to prove progress toward their voluntary sustainability goals. Voluntary EACs are largely sold in bilateral over-the-counter trades that are facilitated by brokers and their networks.
Sellers and buyers today rely completely on these brokers to navigate the often complicated and opaque EAC markets. It is brokers that buy EACs in bulk from renewable energy producers and offer them as more or less standardized products to buyer companies. The price is defined by a bargaining process between the seller and the broker on the one side and the buyer and broker on the other. This means that the broker always acts as a middleman that sits in between EAC sellers and buyers — reducing transparency around price discovery and available options. As a result, buyer companies can rarely express their needs directly to the producer or find EAC options on the market themselves, which undermines market access and the ability of buyers to achieve their proof-of-impact procurement needs.
That is why the integral part of the Energy Web Origin software development toolkit (SDK) is the Origin Exchange module that can be used to build an open and transparent marketplace for EACs. A few examples of primitive ‘spreadsheet’ exchanges do exist, such as the PJM-EIS GATS Bulletin Board, bring some much-needed transparency to the market. (Note: In October 2018 PJM-EIS and Energy Web announced an Origin-related project to explore blockchain-based enhancements to PJM’s REC market.) EW Origin and its Exchange module aim to help EAC markets make a transformative leap forward.
We at nonprofit EW are convinced that EAC markets could benefit greatly from sellers and buyers transacting more directly and from opening up the market for all buyers, including corporates that haven’t yet set or made progress toward renewable energy goals, small- and medium-sized enterprises (SMEs), households, and electric vehicles (EVs).
We hope to jumpstart renewable energy markets in many places around the world and simplify the EAC procurement process significantly. Creating a better trading experience for sellers and buyers will help scale demand for renewable energy that will increase volumes and ultimately benefit all market participants, including brokers. And even though there have been earlier attempts to achieve more open EAC trading through, for example, bulletin boards where sellers can openly post their buy offers, we believe that only a fully functional EAC exchange brings together sellers and buyers efficiently and creates a truly open market.
Why trade on an open exchange?
So how exactly is trading on an exchange different to trading over-the-counter?
The main difference is that trading on an exchange is multilateral. All interested traders can create buy and sell orders (usually called bids and asks, respectively) that are collected in an open order book. In the case of an EAC exchange specifically, those traders could be renewable energy generators (who probably want to sell), organizations like cities and corporations with climate and renewable energy targets (who probably want to buy), and brokers (who likely want to do both).
In contrast to trading over-the-counter, the volumes and prices are visible to all market participants. Through this open display of supply and demand, a universal market price for the traded product or commodity is established. In contrast to price discovery through private direct bargaining between seller and buyer, the price is defined by openly placing bids and asks on the order book.
The market price is found by sellers stating their expected price and the buyer accepting this price or bidding in their expected price. All orders are collected and ordered by price in the order book and a match is made if the seller and buyer agree on a price. Orders are created in an asynchronous way without the need for the seller and buyer to meet face to face. This way of trading is a big advantage for buyers because they can simply state their requirements without the need for an already existing offer on the market. They do not have to wait for an ask to arrive on the market and react to that but can proactively influence the price discovery by creating a bid.
Being able to buy and sell for the market price on an exchange opens up trade for many more (and maybe less-experienced) traders because they know that they can buy and sell to the established market price that is the same for all market participants. Access to an exchange also means that traders do not have to rely on their networks to trade but that they can buy and sell from anyone that puts down an order. It basically means that traders no longer have to know and trust each other because this function is taken over by the exchange. This also means that trading on an exchange reduces the transaction costs that go into creating a deal to nearly zero.
How does an EAC exchange differ from a regular commodity exchange?
All the advantages of trading on an open exchange instead of over-the-counter are also true for EAC trading. This is why we think that an EAC exchange is the best way to create a more-liquid and vibrant market.
There are, however, some differences between a commodity (like gold) and EACs. On a regular commodity exchange, the commodity that is traded is completely interchangeable; it is a uniform product. One unit that is bought and sold should be completely identical to any other unit. The same has historically been said for electricity. In the end, one electron is just the same as the next, at least as far as the physics of balancing a power grid are concerned.
But just as supermarket produce has been de-commoditized (you can now choose between conventional and organic, locally grown vs. imported, etc.), many customers care about the specifics of the renewable energy that they consume. These detailed needs can be expressed through EACs. Every EAC has specific characteristics that make it unique — like the generation device that it originated from, the grid region of that device, or the generation time frame — and ultimately fulfill the varying proof-of-impact needs of renewable energy buyers. Many EAC buyers have very specific requirements for renewables and associated EACs that they want to purchase and are willing to pay a premium for this. The Origin Exchange has to accommodate these differences and enable the efficient trading of very specific EACs.
On the seller side, this is realized by attaching important EAC information to the ask that is put on the exchange. Every ask has to be connected to an underlying verified EAC issued by a given market’s EAC “issuing body” and the device and generation information is taken from that EAC once the ask is created. The result is an ask that carries all the EAC information that could be important to a buyer. The buyer, on the other hand, can define specific impact criteria that are attached to a given bid. In contrast to the ask, these criteria are not connected to some underlying EAC but are purely defined by the needs of the buyer.
How are EAC criteria integrated into the matching engine?
The bids in the order book include the buyer’s requirements. Some companies, for example, only want to buy solar EACs or even only solar that was produced locally. The asks include the characteristics of the underlying EACs. With this order structure, the matching engine of the Origin Exchange can now not only match orders by price, but also include the EAC criteria in the matching, not unlike searching for a flight, hotel, or rental car online.
To better grasp how the matching works, it makes sense to imagine the market being sliced into many different segments with each combination of the EAC criteria defining its own market segment. Bids and asks participate in some market segments, but not in others, depending on their respective EAC criteria. Requiring the EAC criteria to match can be seen as adding a pre-check to the price matching. First, the market segments are created. Only if the EAC criteria match are the bids and asks actually “valid to match” — so the narrower a buyer’s bid criteria, the narrower the slice of asks matching this bid becomes. In a second step, there is a price matching within these segments that is like that of a regular commodity exchange.
To illustrate this, imagine a renewable energy procurement employee of Company ABC that wants to purchase EACs to cover the consumption of office buildings in locations all across the country for the month of January. Company ABC has the goal to support wind and solar and only buy EACs from these technologies. As the company buildings are all over the country, the company does not care about a specific region. The employee creates a bid on the Origin Exchange that reflect these requirements. On the other side, there is an energy producer that owns an onshore wind park in Region X. The wind park owner has used the Origin Issuer module and its registry integration to provide generation evidence and get certificates issued for the first 20 days of January. By depositing the EACs to the Origin Exchange the wind park owner was able to create a sell offer. The EAC criteria of the bid and ask would look like this:
The asks always include the most-specific definition of the EAC criteria because they relate to the existing EAC that was generated by a specific generation device in a specific region at a specific time. The criteria on the bid side can be more general as they are based on the buyer’s needs. This is also why Company ABC’s bid participates in multiple market segments. It can be matched with all solar and wind (on- and off-shore) asks from all regions that were generated in the month of January. This means that the ask of the wind park owner is a possible match, but “competes” with all asks in these segments. If there is a cheaper ask in any of those market segments this ask would match with the bid instead of the example ask. For example, if there would be a cheaper solar ask, it would “beat” the wind park owner’s ask. It becomes clear that the more specific the requirements of the buyer, the narrower the possible field of market segments and the smaller the number of asks it can be matched with. Because Company ABC is willing to buy either solar or wind, there is a larger range of possible asks it can be matched with than if it would, for example, only want solar from a very specific region.
The bids usually “compete” with even more other bids. Company ABC’s bid, for example, competes over the wind park owner’s ask with all other bids that have criteria that do not explicitly exclude the ask. An example of such an excluded bid is one that only specifies solar and would therefore not be a “valid match” for the wind ask. But every bid that allows wind as a possible “valid match” is not excluded and therefore competes with Company ABC’s bid.
In a functioning market, however, very specific bids should match with asks that have these criteria over more general bids. It can be expected that asks with more-highly-valued criteria from the perspective of buyers ask a higher price and that bids that include these specific criteria bid-in a higher price than bids for generic options where “any” is selected for all criteria. Another buyer company that in contrast to Company ABC does not care about buying only solar and wind and instead wants to optimize for the price would create a very general “any of available EACs” bid. This buyer company will likely be matched with a large hydro ask that is the cheapest option.
So even though very specific and very general bids theoretically compete over the same very specific ask and would be a “valid match” from the perspective of the EAC criteria, the specific bid should ultimately win when matched by price. The hope is that different price signals from the Origin Exchange drive investment in the technologies that are highly valued by buyers. The wind park owner, for example, might consider building another wind park if it becomes clear that high EAC prices can be achieved.
Where does the blockchain come in?
There are different ways to build exchanges on top of a blockchain and there are important trade-offs that drive design decisions.
The most-obvious design of having an order book entirely on-chain has some major drawbacks that have been illustrated by a number of early decentralized cryptocurrency exchanges. Most notable are the significant limitations to the matching algorithms that work on-chain that cannot create a seamless and efficient trading experience. It became clear that the power of blockchain lies in establishing trust and not running complex computations. We at EW are in favor of the targeted use of blockchain where it is needed and use of complementary technologies to effectively solve users’ problems. As a result, we chose a hybrid model where ownership changes are tracked on-chain while also having a seamless, low-latency matching that happens off-chain.
As illustrated in my prior blog post, it makes a lot of sense to track the entire lifecycle and ownership of the EAC on-chain. This is why we track all inputs and outputs of the exchange on-chain, as they represent the most relevant ownership changes — providing greater levels of easy-to-observe traceability that we know renewable energy buyers, sellers, regulators, and other stakeholders want. By recording only the most-relevant aspects of the trade, we could move the order book and matching algorithm off-chain to create a smooth trading experience that is comparable to that of regular exchanges that users are familiar with.
The default way of using the Origin Exchange module is to integrate it with the Origin Issuer module, which is designed for synchronizing exchanges with EAC issuing-body systems. This way, a modern and streamlined trading experience can be offered while still leveraging the full traceability and interoperability features of the Origin SDK. If both are integrated, the issued EAC token has to be deposited to the Origin Exchange in order to trade it. The deposit is recorded on-chain and the exchange operator is now in the custody of the EACs. This ensures that sellers (like the wind park owner from our example) can only trade the verified EACs that they actually own and that trades can be executed immediately. After the EAC has been traded, the buyer withdraws the EAC from the exchange to claim it for environmental impact reporting purposes. This is equally recorded on-chain and the EAC is removed from the custody of the exchange operator to the ownership of the buyer. This way, the ownership change from the seller to the buyer is clearly tracked on-chain. The entire audit trail is recorded in the background while buyers like Company ABC just create a bid, get matched, and immediately receive the EACs. Depending on the requirements of the operator of the Origin Exchange, all trades that happen within the exchange could be private or also be recorded on-chain. Using the privacy features of the Origin Issuer module, the deposit and withdrawal can also be kept private with only encrypted proofs of the transactions being recorded on-chain.
How can I use the Origin Exchange?
We are currently doing projects with a number of local partners in countries like the U.S., Thailand, Turkey, El Salvador, Brazil, and many others to launch EAC marketplaces that are built using the Origin Exchange module. Some of these marketplaces will go into production in the coming year. Nevertheless, because everything we do is open source, you do not have to wait until then to check out the Origin Exchange.
Visit https://energyweb.atlassian.net/wiki/spaces/OD/pages/1138884622/Exchange+Module to learn more.
Go to https://github.com/energywebfoundation/origin to take a look at our source code.
For more information about the Origin Issuer module, check out my other blog post: https://medium.com/energy-web-insights/issuing-certificates-with-the-ew-origin-sdk-part-i-7630c14e13b
