Blockchain in the Carbon Credit Markets

Blockchain Carbon Markets - Image via Shutterstock

Climate change and planet warming are the pressing issues of today that need immediate attention. The recently concluded United Nations climate change conference at Glasgow (COP26) emphasized the necessity to cut down greenhouse gases to keep the world habitable for future generations. Carbon trading, which has been around since 1997, is considered one of the vital solutions to curb carbon emissions. One of the notable outcomes of the conference was the closure of a deal to set rules to streamline the carbon markets. Blockchain technology could help build the digital infrastructure underpinning the carbon trade markets. The carbon credit ecosystem built on Blockchain adds transparency, liquidity, and standardization to carbon markets.

Carbon Credit Markets

Carbon trading was born in 1997 when 192 parties signed the Kyoto protocol, which came into force in 2005. This protocol mandated developed countries to reduce their GHG emissions between 2008 – 2012 to 5% below 1990 levels. The most significant climate accord to date, the Paris Agreement of 2015, extended the carbon emission reduction requirement to all countries. Article 6 of this Paris accord set rules to enhance the integrity of carbon markets and create a new global carbon offsetting mechanism.  

The climate change conferences provided one of the positive ways to motivate businesses and individuals to cut down on their carbon emissions is by enabling them to trade their emissions for credits, thereby creating a “carbon market.” Both clean energy producers and the fossil fuel industry found this solution appealing. Consequently, a new standard to offset carbon emissions called carbon credits emerged. 

“A carbon credit is a permit that allows the company that holds it to emit a certain amount of carbon dioxide or other greenhouse gases. One credit permits the emission of a mass equal to one ton of carbon dioxide.” – Investopedia.

There are two types of carbon credits

Certified Emissions Reduction (CER) – These credits are created through a regulatory framework and used by companies mandated to provide an account of their GHG emissions. CERs are regulated by third-party national, regional or international carbon certifying bodies.

Voluntary Emissions Reduction (VER) – They are the carbon credits traded voluntarily either over the counter or in voluntary markets. Anyone seeking to reduce their carbon footprint can offset their emissions with these credits.

According to the environmental analysis group, Ecosystem Marketplace, the voluntary credits market has crossed $1 billion and reached $1.006 billion in November 2021.

Where Blockchain Can Add Value to Carbon Markets?

Addressing Fragmentation

Today there are a wide array of GHG credits markets, both at global and regional levels. As a result, the offset trading system is often fragmented, limiting the market exposure for the credits. Cross-market trades are not lucrative as lack of visibility into the credits reduces their trustworthiness and hence their value.

Building carbon markets on public blockchains ensures that information about the credits is accessible by anyone, anywhere. It is easier to verify the provenance of the credit since it is possible to establish a verifiable trail from its genesis to when it is burned. Improved accessibility also reduces the barriers of entry for small and medium enterprises.

Improving Transparency

Stemming from fragmentation is a lack of transparency. Carbon offset programs are often criticized for allowing double-spending, for over-crediting, and for inept tracking of the issued credits. Since there are scores of stakeholders in this ecosystem, this opaqueness hinders the effectiveness of the programs. 

The immutable, secure, distributed nature of blockchain is a good enabler for transparency in the carbon markets ecosystem. Moreover, representing carbon credits as NFTs allows each credit to be uniquely tracked. It becomes easier to verify the ownership of the credit, thereby precluding multiple entities from claiming the same offset.

Reducing Costs 

Traditionally, the credits are bought and sold through brokers and agents. It frequently results in high transaction fees that are pocketed by these intermediaries. Furthermore, third-party auditors who are paid by the project owners to verify their carbon reduction claims are at times incentivized to approve any programs they investigate, thereby defeating the purpose of a credible carbon market.

Smart contract based tokenization of credits that includes clearly defined, self-executing conditions for minting and burning of tokens eliminates the need to rely on middlemen for carbon trading. Tracking the carbon reductions with IoT devices and recording them in real time on blockchain gives an auditable measure of an entity’s carbon reduction claims.

But, What About Carbon Emitted by the Blockchain Networks?

The next obvious concern among environmentalists is the carbon footprint created by the blockchain itself. In several countries, fossil fuel still remains a significant source of electricity. Some argue that the electricity used and resulting carbon emissions of a proof of work (PoW) based network defeats the purpose of using it to make carbon markets more effective and efficient. The concern, of course, can be addressed by choosing the right blockchain platform. Proof of stake (PoS) networks have a small energy footprint than their PoW counterparts. The number of transactions processed per unit of electricity consumed is also more efficient with these blockchains.  A report suggests that a transaction on the Solana network utilizes less energy than two Google searches and consumes 24 times less electricity than charging our phones. Similarly, a recent study by the researchers at the University College of London (UCL) comparing the environmental impact of six of the PoS based distributed ledger technologies (DLTs) gives an insight into what factors need to be considered while choosing energy- and carbon-efficient blockchain networks.

In conclusion, blockchain technology could prove to be an efficient means to handle the carbon credits markets. It is, however, paramount to select the right platform to drive the holistic effectiveness of creating carbon markets on distributed ledgers.

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