Greening the Blockchain

How Decentralized Finance Can Change the Climate Equation

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Imagine waking up on a crisp, cool morning in early September 2038 and checking the news. You see a headline that world temperatures have fallen by half a degree Celsius in the past six months, meeting the final benchmark of the Paris Climate Accords. Then you check your online wallet. More good news. The balance is several zeroes bigger than it was the previous night — all because you made the choice to invest in the planet years before!

Image by QuoteInspector.com

The proposed financial instrument is a smart climate bond, whose payout would be determined by prevailing global temperatures. Yield and time of maturity could be tied to the goals of the Paris Climate Accords. This market-based capital infusion could fund anything from community block grants to getting more electric cars and trucks on the road sooner, at a lower sticker price.

The infrastructure already exists.

Climate-based smart contracts are used today for crop insurance. Rainfall datasets from NOAA and other sources allow insurers to automatically settle and pay claims to farmers, via Chainlink’s decentralized oracle technology.

Just what is a decentralized oracle? And what is a smart contract?

A smart contract is a self-executing financial agreement. In this instance, the smart climate bond would self-execute on the decentralized Ethereum blockchain. When all the required conditions are met, the contract is automatically paid. Hence the catch-phrase: “Code is law.”

To connect the blockchain to real-world data, such as price feeds or world temperature data, you need another layer. This is known as an oracle, sometimes referred to as the God Protocol.” The first oracles relied on a single data source and as such were vulnerable to attack. Next generation oracle systems rely on multiple data sources and reputational scoring, as well as hardware-based controls to ensure the integrity of data.

An important component of the DeFi sector, which automates traditional savings bonds, stablecoins, and other types of decentralized financial instruments, oracle technology has matured rapidly over the past three years. Additional security measures and careful study would need to go into planning data sourcing and payment schedules to protect against hacking, tampering, and fraud. Reconciling temperature data from different parts of the world and different sources, over a continuum of time, with the location of backup sensors secret and undisclosed, seems a worthwhile precaution.

In the past few weeks, we’ve heard a lot of talk about how Bitcoin and other forms of cryptocurrency aren’t actually that bad for the environment, mostly focused on miners’ use of renewable energy and surplus electricity from the grid. Certainly, other industries have their share of blame; Shell Oil was ordered by a Netherlands court to cut its CO2 emissions by 45%.

But what if instead of being one more in a long line of global warming offenders, the blockchain was actually the key to revolutionize the world economy in favor of carbon neutral goals?

What does a smart climate bond get us that other carbon reduction schemes do not? Simply put, it’s a broad-spectrum positive economic incentive to work to reduce global temperatures. Typically, environmental damage such as drought, flood, pollution, and loss of pollinators are a huge problem in economic theory because they are what are called externalities. There is no efficient way to get private parties to pay in advance for the damage they will cause. Because effects are spread unevenly among different populations, often the people feeling the brunt of the impact are not the same as those who profit from cutting corners.

This is why Shell has vowed to fight its recent carbon reduction order in court. This is why a climate change lawsuit on behalf of future generations was rejected by the U.S. Supreme Court. This is why politicians have trouble living up to their campaign promises for a greener economy. In the short term, switching to more sustainable technologies requires a greater capital outlay, and that money has to come from somewhere.

Blockchain technologies promise both accountability and freedom. Smart climate bonds create economic incentives tied directly to real-time scientific data, on a macro and a micro scale. Anyone, anywhere in the world, can set up a smart climate bond: private parties, the national government, or city and state governments. The idea of a variable-rate bond is nothing new. The U.S. Treasury and many municipalities already issue bonds where payments vary according to interest rates and market conditions. Corporate “junk” bonds are so known because their likelihood of maturity is deemed less than a sure thing.

Smart climate bonds could simply use the mechanism of the blockchain to verify contract conditions and execute payment. More ambitious coin-based and NFT-based solutions are possible as well. But who is going to pay for all of this? On the one hand, you can sell municipal climate bonds in exactly the same way as bonds to pay for a new public library or civic center.

On the other hand, there is an opportunity here for the largest crypto exchanges to do right by everybody. As of May 27, 2021, Coinbase and Gemini had a combined trading volume of $5.75B. They also both have hefty transaction fees, hovering just under 5 percent in many cases. What if the exchanges took one half of one percent away from those transaction fees and put it into a long-term climate “trust fund” instead? You would net about $3M each day. The exchanges could put some of those funds into charitable or “green industry” investments; the rest could go into a “kitty” backing a financial instrument available for sale or awarded to loyal customers. This would do a lot to rehabilitate the image of cryptocurrency. More importantly, because the yield and date of maturity depend on global carbon reduction, it creates a broad-spectrum, free-form incentive to innovate, invest, and live sustainably.

The more actors buy into climate-based smart contracts, the greater the likelihood that goals will be met. It’s a mass movement for survival that can only gain momentum, when finally given a rational economic expression. This result for some will be a pot of gold at the end of the climate rainbow. Yet for all of the earth’s inhabitants, the consequences will be far more profound.

Will you and your spouse renovate a farmhouse in Vermont? Or is it time to sail around the world? Thanks to your investment in our future, there is still a world left to appreciate and share.

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Product Architect at Lotus.fm, a startup dedicated to creating better user experiences for data driven applications.