How tech can fix the voluntary carbon market

Almost every big corporation is making claims about “carbon neutrality.” Given a soapbox to stand on, they’ll gladly step up and announce that they’re “already net-zero” or “well on the way.”

So how can the same companies that pump thousands of tons of CO2 into our atmosphere every year claim to have a minimal impact on our planet? They off-set their emissions by paying to reduce the amount of CO2 (and equivalent pollutants) from our environment.

Unsurprisingly, there’s a whole industry built around supporting this. But it’s opaque, and many people (rightly) claim it’s currently full of bullshit. This has led to labels of “green-washing” being applied to a lot of corporate activity — and it’s not untrue. The voluntary carbon market is broken and it needs to be fixed.

What is the voluntary carbon market?

Two carbon markets exist: voluntary and compliance. The compliance market is regulated. Regional, national or international regimes set out to reduce the amount of carbon that businesses emit by applying limits and creating financial incentives. The main mechanisms they use are cap-and-trade or carbon tax.

Cap-and-trade sets a cap on the total amount of carbon an industry can emit, and issues permits that allow for certain amounts of emission. Businesses can buy and sell these permits among each other — thus generating an income when they don’t use their full allowance, and incurring costs when they have to buy more. Carbon tax is simpler: emit carbon; pay money.

Then there’s the voluntary market, which involves the trade of “carbon credits.”

Carbon credits are created by projects that benefit our environment (through ‘avoidance’ activities such as protecting rainforests and preventing carbon release from the destruction of trees, or ‘removal’ activities such as carbon capture). For every equivalent amount of carbon that these projects save, a company can purchase a credit to off-set the pollution they emit.

The most important distinction between the two markets, however, is that the voluntary market is unregulated, and voluntary carbon credits do not count against emission limits set by regulatory bodies.

So why do companies buy carbon credits? At its best, it allows them to reach ambitious net-zero goals by compensating for the remaining emissions that they cannot reduce. At its worst, it’s a vanity exercise and a quick way to demonstrate an environmental conscience.

The lack of regulation and dubious corporate motivations create significant transparency issues in a market that’s supposed to be doing good:

1. Projects that create credits are incentivized to create them as cheaply and easily as possible, knowing corporations will buy anything. The actual environmental benefit of the project comes second to the revenue it generates.
2. Carbon credit registries such as Verra and Gold Standard have no interest in acknowledging that the impact of projects varies significantly. For them, a ton of carbon reduced or removed gets labeled as credit, so long as it can meet the registry’s bare minimum criteria.
3. Many “middle-men” participate in the market, turning a profit by buying and selling credits (arbitrage). While it’s important to facilitate as many credit transactions as possible, the result is a total lack of transparency. It’s very difficult for companies to participate in the market with a clear understanding of what they’re buying.

Despite these issues, COP26 underlined the importance of the voluntary carbon market in fighting climate change, and has provided additional regulatory security to market participants. After all, the voluntary market is a critical part of the solution: it allows companies to act responsibly even when they are not required to do so by law.

The market is also expected to grow significantly due to pressure from consumers, financial markets and regulators. According to an Ecosystems Marketplace study, it surpassed $1bn in 2021, and numbers from the TSVCM report from January 2021 indicate massive growth over the coming decades.

So with this backing and anticipated market expansion, it’s essential that these issues get resolved ASAP. But how?

What’s the solution?

1. We need reliable, independent data — Third-party measurement is needed on both sides of the supply chain. On the demand side, companies need a better understanding of their carbon footprint — something that the latest wave of Carbon Accounting & Management solutions are aiming to address. Faced with the facts, they’ll be more likely to take their reduction and off-setting activity seriously. On the supply side, the true value of voluntary credits needs to be verified and projects need to be held to account. This will generate more trust in the market and reduce the stigma of “green-washing”. Companies such as our portfolio company Tanso or Watershed are helping corporates to measure and understand their footprint while ventures like Sylvera provide a tech-enabled and independent evaluation of the impact of projects.
2. We need transparent infrastructure — Incumbent market intermediaries such as resellers are currently incentivized to trade cheaper, lower-impact credits as they provide an opportunity to make a bigger profit. To address this behavior, we need to build infrastructure for transparent transactions, where buyers understand the impact of the credits they’re buying, as well as how much money actually reaches the projects themselves. Our portfolio company CEEZER is building the digital infrastructure allowing transparent and arbitrage-free transactions between credit-generating projects and corporates globally.
3. We need to disentangle the value chain — There’s currently too much conflict of interest in the market. The same parties that help reduce the emissions of corporations also sell them credits (if it’s not obvious where the conflict lies, let me state it clearly: the more these parties reduce emissions, the fewer credits they’re able to sell). This needs to change. We need different providers for different offerings: emission measurement, credit creation, impact measurement, emission reduction, credit trading, verification, etc.
4. We need corporations to diversify their choices in voluntary credits — The highest impact (best for the environment) credits originate from the removal and long-term storage of carbon — but their price (easily reaching $1000 per ton) makes them incredibly expensive. As a result, they’re purchased less frequently, and the projects that create them generate less income. However, if corporations moved away from supporting one or two random projects that fit the marketing agenda, combining smaller volumes of high-impact removal credits with other cheaper (but still impactful) credits from emission avoidance projects, we’d channel more money into tech that is actually making the biggest difference in the fight against climate change. The only caveat is that companies will need to actively monitor their portfolio over time, ensuring they increase their share of high-impact credits as projects and technology develops
5. We need more demand security to unlock future supply — Instead of merely competing for currently available high-quality projects long-term agreements, future contracts or funding projects in early stages would unlock additional supply. In a joint effort, McKinsey, Stripe, Alphabet, Shopify & Meta have just announced a $925 million carbon removal commitment

These five levers would ultimately provide better, more democratic access to the voluntary market for both supply and demand. They’ll reduce the need for arbitrage-hungry middlemen while encouraging greater support for higher-impact projects over cheaper, low-impact alternatives.

Done right, compensating through voluntary offsetting will be hugely significant in helping us meet the targets set out by the Paris agreement — and as we’ve shown, there is ample opportunity for new tech players to fix the system.

Ultimately, technology is the key to helping the voluntary market actually move the needle on climate change, and we are eager to see more tech players step up to the challenge of saving our planet ∎

This article was written by Stephan Fuechtenhans and Bastian Hasslinger, Investors at Picus Capital