KlimaDAO: An Introduction to Policy Making

KlimaDAO: An Introduction to Policy Making

Published Sat Feb 26 2022


KlimaDAO’s policy team is integral to the growth of the protocol, and the wider ReFi ecosystem. This entry introduces the KlimaDAO policy team’s role, defines the key mechanisms that they can use to guide growth, and takes a forward look at what the DAO’s policy development could look like as the protocol matures and moves through its Roadmap.

Establishing the on-chain ReFi economy is critical to make climate action accessible for all. As the reserve currency for ReFi, KLIMA aims to support sustained growth of the on-chain carbon market. Analogous to the Federal Reserve’s role in the US dollar economy, KlimaDAO plays the role of the “decentral” bank that governs the tokenized carbon economy for the benefit of ReFi, ensuring long-term liquidity and providing predictable demand via bonds. The Policy team is informed by economic models and data analysis, aiming to make objective decisions that optimize the long-term success of ReFi.

Ultimately, the goal of policy is to nurture a regenerative on-chain economy that incentivizes actions which protect our planet, with the KLIMA token at the center as the reserve currency. To this end, KlimaDAO’s policy team aims to facilitate growth within ReFi. The growth of ReFi will unlock adoption for KLIMA, and create a virtuous cycle of growth.

What does the policy team do?

The policy team works on behalf of the KlimaDAO community to understand and analyze the available data, evaluate the market, and advise the DAO and community on how the protocol can best position itself for long-term growth.

The policy team itself has only limited decision-making power, and instead primarily functions as an agent of the DAO to inform decision-making and propose optimal solutions. Proposals are posted on the KlimaDAO Forum for discussion with the community; Forum discussions that are received well are progressed to KlimaDAO’s Snapshot where Klima Improvement Proposals (KIPs) are voted on via on-chain token votes. The proportional KLIMA holdings of a voter determines their voting power.

The policy team has been granted the ability by the DAO to make small changes to Bond Control Variable (BCV) and APY via KIP-9 to align with pre-agreed objectives and enable the protocol to respond efficiently to changes in market conditions.

To date, one of the Policy team’s core objectives has been to bootstrap the treasury from zero, and establish an on-chain carbon economy through the growth and adoption of the protocol’s native token, KLIMA. The primary means of achieving this is via selling KLIMA tokens for a carbon asset or liquidity pair through bonding. The income is used to mint new KLIMA, some of which is distributed to network participants through staking, and some of which is retained by the DAO wallet to fund future development of the protocol.

Bonding is a trustless mechanism used by KlimaDAO which empowers the market to define the price of assets brought in. BCVs are used by the policy team to pace the market and incentivise predictable demand, but ultimately the market determines how much of a discount is required to compensate the cost to bonders of being illiquid for the bond’s maturity period of 5 days.

The primary role of staking is to expand the protocol’s supply. It provides benefits to both the protocol and the market participants. For the protocol it creates a supply sink that remains mostly illiquid to increase stability and premium of KLIMA. For participants, it allows them to align their incentives with the long-term success of the protocol, with long-term stakers receiving the most benefit. It also creates an opportunity cost for holders of unstaked KLIMA (e.g. KLIMA liquidity providers) as they are diluted by those who are staked.

While the key metric of staking is typically quoted as an annualized yield, staking rewards in our protocol are paid out of excess reserves, so it’s not technically appropriate to characterize rebases as “yield.” Rather, rebase rewards expand supply rapidly while incentivizing long-term staking of KLIMA due to the exponential curve of auto-compounding rewards.

Hence, bonding and staking incentives are the two primary levers the policy team can adjust to align KlimaDAO’s growth with its objectives, as well as prevailing market conditions. Capacity for each bondable asset can be modified by changing the Bond Control Variable, and staking rewards can be tweaked by changing the reward rate. Effective use of the bonding and staking mechanisms allows expansion of KLIMA supply to facilitate adoption in the early stages, with a gradual tapering of supply expansion as the on-chain carbon market matures.

Given the nature of KlimaDAO’s role in the nascent ReFi market, the Policy team must also be forward-looking to unlock growth and demand across the whole space. For example, at the moment the majority of tokenized carbon tonnes on the blockchain are Toucan’s Base Carbon Tonne (BCT). KlimaDAO would stand to benefit from improving the diversity and quality of the tokenized carbon tonnes that are locked in its treasury.

However, with BCT being the most abundant and liquid tokenized carbon tonne available, KlimaDAO’s options for diversifying to new assets are limited. KlimaDAO can use its role as market facilitator to increase the volume and diversity of tokenized carbon tonnes available on-chain, without fragmenting liquidity, thereby encouraging innovation while maximizing market efficiency and thereby climate impact.

What is the current state of KlimaDAO policy?

Until recently, KlimaDAO’s reward rate was set to target 8,000% APY per KIP-9. This generous reward rate is possible because the runway for the protocol is high; the existing rate of rewards can be issued for over 4 months assuming no additional bond revenues come in.

KIP-14 which passed on February 21st 2022, aimed to move KlimaDAO into ‘resilience mode’, which focuses on KlimaDAO’s role in the nascent ReFi ecosystem and increasing stability of KLIMA as the wider markets adjust to macroeconomic conditions. Recently passed KIP-14 adjusts the reward rate to target an APY of 1,000%. This means that under current conditions, the protocol expects to grow its treasury by 10x over the next year. Under the previous reward rate framework, that expectation was 80x over the same period.

KIP-9 and KIP-14 focused on APY changes. However, staking and bonding are inextricably linked. To issue rewards, KlimaDAO must also incentivise bonds to mint new KLIMA. Hence, a high APY puts a lot of pressure on KlimaDAO to incentivise the movement of carbon credits onto the blockchain and into the treasury. This heavy incentivisation from bonding and staking can help rapidly build the market from the ground up, however they also increase sell pressure on the KLIMA token itself as supply is distributed to bonders and stakers who can liquidate their KLIMA position.

KIP-9 and KIP-14 help reduce the pressure on KlimaDAO to incentivise bonds, reduce volatility in KLIMA, and enable the transtion into a period of building resilience into the protocol.

Shifting the Narrative for Responsive Growth

Beyond the explicit changes in reward rate and bond capacities outlined in the most recent KIP proposals, the policy team is also attempting to shift the short-term narrative (as discussed in the recent Discord Policy Chats).

The goal of KlimaDAO’s launch strategy was to catalyze initial development of the on-chain carbon market. This initial goal has clearly been achieved: KlimaDAO receives regular coverage from carbon market media, there is booming interest in ReFi as evidenced by wide exposure at ETHDenver, and KlimaDAO has been in dialogue with members of IETA and ICROA to share our vision of the future of the voluntary carbon market.

However, where we expected rapid growth in the on-chain market and robust demand for on-chain offsets due to the improved liquidity and lower transaction fees, some issues have held back adoption of on-chain offsets:

  • KlimaDAO and our launch partner for carbon bridging (Toucan) launched without retirement functionalities, limiting adoption of on-chain offset consumption
  • legacy offset buyers have been slow to recognize the opportunity presented by on-chain offsets trading at or below equivalent off-chain offsets.

While DeFi markets move at lightning speed, ReFi’s tighter connection to the legacy markets has led to slower-than-anticipated growth. KlimaDAO’s partnerships team is working to establish demand through programs such as Klima Infinity, but ultimately we need a robust ecosystem driving adoption of on-chain offsets to keep the flywheel spinning. As such, the Policy team views the recent appearance of innovative bridges such as two-way bridging (Flow/GoddessDAO) and automated one-way bridging (C3) as healthy competition that breeds innovation and mitigates centralization - as well as spurring adoption by bringing more external demand into the on-chain market.

This new narrative shifts the Policy team’s priorities from an ambition to rapidly expand supply of KLIMA, to more measured growth that aims to align with the growth of ReFi, prioritizing long-term resilience and tangible climate action.

What are the challenges of policy making?

KlimaDAO launched with attractive bonding and staking rewards to incentivize new market participants and rapid supply expansion. The KlimaDAO treasury started with nothing, and attractive incentives were fundamentally needed to bootstrap the treasury. KlimaDAO was the ignition for the development of the wider ReFi market which stands to be one most significant evolutions of DeFi this year.

The common challenge of policy makers, be it government officials, international associations, or blockchain protocols, is the balance of interests across parties. In the context of KlimaDAO, that could be between the DAO contributors, the community, those who have been a Klimate prior to launch and those who are new.

The strength of DAOs and distributed decision making is that all stakeholders are given a voice. KlimaDAO takes the DeFi approach of governance, whereby token holders are the arbiters and decision makers. This is embedded into the DAO and helps it deliver on the virtue of egalitarianism and the development of public goods. KlimaDAO is able to achieve this by leveraging the Ethereum blockchain and building on the processes of existing DAOs.

What is perhaps most challenging for KlimaDAO today, is that it is moving in uncharted territory. Moss' MCO2 token was the first major innovation for tokenized carbon credits launching in August 2020 and demonstrating to KlimaDAO and others the art of the possible. However, the on-chain carbon market did not exist on Polygon in early Autumn of 2021, and there remains relatively few examples of succesful carbon solutions on the blockchain.

For DAOs focused solely on DeFi, there is a significant amount of data that can be used to identify optimal strategies, and composable assets that can be used to deliver on specific objectives and generate revenues.

However, in the case of KlimaDAO, it is helping facilitate this market from the bottom-up. The off-chain data for the carbon market is hard to access and is fragmented. The data for the on-chain ReFi space is available, but it lacks depth and duration. Building up a picture of the possible future is difficult, without a rich history of data to leverage.

Hence, for the time being KlimaDAO’s Policy team develop their vision and proposals based on the best available data and forward-looking analysis. As this space matures, more data will become available to ensure robust and evidence-based decision making can be achieved.

As more ReFi solutions come online, KlimaDAO will be able to inform its policy development in line with new players in the space through symbiotic relationships. The data and value created by new partner protocols will be key to scaling KlimaDAO.

What additional tools can KlimaDAO use to foster growth?

OlympusDAO mechanics have been used by KlimaDAO to bootstrap the protocol to where it sits today. However, new mechanics may need to be developed to benefit the community, and strengthen the position of our collaborators within ReFi.

The below mechanisms detail policy approaches that could be developed by KlimaDAO through policy proposals and token votes. A cost-benefit analysis of these approaches would be required to ensure that they are the appropriate approach to help scale the adoption of KLIMA and ReFi. This analysis becomes more viable and accurate as more data for ReFi becomes available, although new mechanisms unavoidably add a layer of complexity and uncertainty to KlimaDAO’s trajectory, and do come with trade-offs that could create market inefficiencies that must be understood prior to taking action.

  • ReFi money legos: As new products come online carbon can be increasingly used as a collateral asset for borrowing. This would give the KlimaDAO treasury opportunities to tap into novel revenue streams and unlock new growth and expansion of the protocol.
  • Internal bonds: Regular staking provides a baseline rate of return within the KlimaDAO ecosystem, while users who want higher market-dictated yields are able to take up internal bonds that are tokenized in the form of composable ERC-20.
  • Locked staking: Currently, KlimaDAO is in a binary state. A user is either staked or not; the longer KLIMA is staked, the more rewards are compounded. By grouping players together to understand their commitment to the protocol and the benefits they bring, tiered rewards can be issued via locked staking.
  • T-bonds: Enabling the market to regulate itself by issuing bonuses to long-term stakers, and issuing penalties to those who leave early can maximize the efficiency of the protocol.

What is the policy team’s vision for KlimaDAO?

KlimaDAO needs to be agile – it needs to marry the need for healthy expansion of the protocol itself with the needs and development of ReFi. The bottom line is that KlimaDAO is here to build accessible and impactful tools that can coordinate activities and generate high-integrity financial flows to carbon projects across the globe.

In addition to using specific policy mechanisms outlined above, KlimaDAO and its policy team have the objective of establishing KLIMA as a base carbon trading pair.

Again, a comparison between KlimaDAO and OlympusDAO is a useful exercise to demonstrate the difference in how these protocols need to operate, and how they must scale. Fundamentally, OlympusDAO has to hold liquidity in two pools to build out and achieve its objective of being the native currency of DeFi: OHM/DAI and OHM/ETH. DAI is one of most prominent stable coins, and Ether is the most transacted cryptocurrency. OlympusDAO can leverage established and liquid assets to realize its vision.

In ReFi (similarly to OHM in DeFi) KLIMA stands to be the native trading currency for carbon assets on the blockchain. The gateway to achieving this is the KLIMA/USDC pool; this pair is used to efficiently facilitate on-chain carbon market operations. By owning LP tokens, KlimaDAO is creating liquidity with KLIMA pairs. This liquidity will be the foundation of ReFi, and will unlock the growth of KlimaDAO.

However, for the KLIMA-carbon pairs, with a limited supply of KLIMA and tokenized carbon tonnes on the market, deep liquidity will take time to build. That said, excessively deep liquidity is not required, nor necessarily wanted. Excessively deep liquidity on certain KLIMA-carbon pairs can inhibit growth as it creates dependence between pairs.

Hence, KlimaDAO aims to adjust the model to have multiple dependencies and establish a resilient and diversified ecosystem. This can be achieved by bootstrapping each carbon pair, and utilizing BCVs to moderate the incentives against each pool to ensure harmonic growth of these pools for ReFi.

The first step in achieving this was KIP-8, which introduced KLIMA/USDC bonds. This established the role of KLIMA as a base carbon pair through a horizontal development model.

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Bonds can be used to incentivise pool development over time to match and perpetuate the growth of ReFi. For example by moving from the dominant KLIMA/BCT, to KLIMA/MCO2, to new KLIMA pairs as they come online, we empower the growth of new partners and maximize protocol resiliency.

This approach has an added benefit for KlimaDAO – rather than routing directly through the deep USDC pools, the pressure of bonding into single KLIMA pairs can be isolated and reduced. This will create a level of independence between the various ReFi carbon assets, enabling KlimaDAO to hold an index of independent carbon assets within its treasury.

Ultimately, this positions KLIMA as the foundational carbon currency, providing liquidity and facilitating efficient market operations across ReFi.

Looking ahead

The demand for ReFi and KLIMA surpassed all expectations at KlimaDAO’s launch.

Five months after launch there has been less supply within ReFi than KlimaDAO requires to achieve 80, 100, 200x growth in the next year. KlimaDAO requires new products to be developed ahead of the next market cycle to scale-up its impact. By developing symbiotic partnerships across ReFi, KlimaDAO can amplify the climate impact of partner projects, and maximize adoption of KLIMA.

Near-term policy change will reflect that the KlimaDAO community has voted to adjust to current market conditions and appropriately reduce bond capacity. The KIP-14 vote enables the DAO to move forward in this regard. This approach mitigates the impact associated with overly aggressive supply expansion during a slower market, and it aligns staking rewards with a lower risk environment compared to at launch.

In addition, it allows KlimaDAO to use this time to lengthen its runway and increase the resilience of the protocol with a longer-term horizon.

KlimaDAO needs to meet the ReFi market halfway, and the policy team need to work diligently to balance the interests of the KlimaDAO protocol and its community with the long-term growth of the ReFi ecosystem.

If you are interested in learning more about how KlimaDAO can enable coordination and financial activism to tackle climate change, join us on Discord and follow us on Twitter.


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