Building a Climate Positive Reserve Currency System

Building a Climate Positive Reserve Currency System

Published Thu Apr 07 2022

Long Arc of the Emission Schedule

An asset primed for growth and an asset primed for stability sit on opposite sides of the spectrum of money. The best currency is not the best growth asset, as an ideal currency retains value, but does not dramatically fluctuate in value. With this in mind, KlimaDAO has taken a different approach to developing a currency than most protocols in DeFi today. Rather than a fixed supply or indefinite inflation, the lifecycle of the KlimaDAO protocol can be divided into two distinct phases: the treasury growth phase, where supply expansion is the priority of the protocol; and the maturity phase, where the priority shifts towards stability and market facilitation.

The primary driver of KLIMA emissions is the reward rate, since the growth in KLIMA supply from rebases is exponential. However, as outlined in KIP-3, the staking reward rate will only remain at the current hyperinflationary levels during the initial expansion phase of the protocol’s lifecycle. As the protocol matures, the reward rate will drop dramatically; at maturity the relative emissions from staking will be quite modest.

This rapid early supply growth prepares KLIMA to serve as a cryptocurrency- scaling along with demand and treasury assets - while rewarding the early stakers. The policy team must carefully balance staking emissions with bond capacities to ensure that KLIMA is not diluted (i.e. devalued) excessively by emissions. Once the reward rate is reduced significantly in later phases of KIP-3, KLIMA supply will stabilize.

Perils of Fixed Supply

KlimaDAO has no cap on supply, as it must expand to meet demand for the token as a currency forming the centerpiece of the on-chain carbon market. Our aggressive early emissions schedule will result in a large volume of KLIMA in circulation at maturity. A large total supply ensures we still have plenty of KLIMA in circulation to seed a wide array of liquidity pools, despite most of the total supply being staked. This empowers KLIMA to serve as the keystone liquidity pair for the on-chain carbon ecosystem (see KIP-8 for more).

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Network Effects

Often one of the strongest cases for the adoption of a reserve currency is the network effects that it possesses. Consider the US dollar, often called the “petrodollar” because it is the primary currency used to purchase oil on the global market. The very fact that the cost of oil is so essential to the production capabilities of many countries and organizations, means that when they have to compare their costs or determine the relative prices of their goods/services, they are forced to account this in terms of the petrodollar.

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As the on-chain carbon market matures and more tokenized carbon assets pair with KLIMA, it becomes harder and harder to justify pairing a new carbon asset with another asset other than KLIMA. As the de facto base pair between all carbon assets, the vast majority of offset transactions will eventually be denominated in terms of KLIMA, flowing through the liquidity pools owned by the KlimaDAO treasury.

In addition to the Lindy effect that occurs as more carbon tokens are paired against KLIMA, KlimaDAO continues to facilitate the carbon market through its open market operations. During the bootstrapping phase, this is seen through direct bonds for carbon assets and carbon-paired liquidity. As the protocol matures, more sophisticated financial instruments will be deployed to facilitate the continued growth of the KlimaDAO ecosystem (more to come on this in a future post).

With deep liquidity pairs and a large treasury, the protocol can assert its influence to grow the on-chain carbon markets to the scale necessary to address the climate crisis. Once the protocol has balanced KLIMA supply growth with demand, and reduced the reward rate to a sustainable level, the focus shifts from growth to maintenance. At this point, excess treasury reserves can be deployed to help new carbon offset projects directly.

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Targeting Value Convergence & Accounting for Unit Bias

By design, KLIMA’s mechanisms expand supply in tandem with treasury assets. To fulfill the protocol’s long-term goals, the two growths must be kept in careful balance. Consider the following extremities:

If KLIMA continues to take in carbon cryptocurrency while capping supply, in the long run each token will represent a constant proportion of an increasing backing. That is, token value as a function of backing diverges.

If KLIMA chooses to double its supply every so often (as in a stock split) without a proportional increase in value, then the value backing each token converges to 0. This is also undesirable for a reserve currency:

  • In the same way it is not sensible to exchange 1 BCT for 0.00001 KLIMA, it is equally unreasonable to exchange 1 BCT for 1000000 KLIMA.
  • The exponential nature of staking rewards would compound the hyperinflationary effects.
  • Without sufficient value behind each token and supply far outstripping demand, KLIMA would be unable to serve as a reliable store of value and medium of exchange for on-chain carbon assets.

With sufficient treasury diversity, the KLIMA token becomes an aggregate index of the on-chain carbon market, allowing carbon market participants to hold one token to access deep liquidity for all other carbon assets, as well as grow their carbon holdings by staking their KLIMA.

Larger Total Supply Facilitates a Robust On-Chain “Klimaconomy”

As we approach maturity, assuming the protocol is successful, we expect the supply of KLIMA to be magnitudes greater than what it is today. A larger supply naturally trends to a lower value, allowing people to better utilize KLIMA as a unit of account. It would be very cumbersome to work with a carbon tonne valued at 0.0000001 KLIMA, instead of 0.5 KLIMA. This also allows for expansionary growth with minimal disruption in supply.

Regardless of supply expansion, the treasury assures holders that KLIMA will retain at least its intrinsic value of 1 carbon tonne by serving as buyer of last resort (more here). As the protocol matures, additional mechanisms can be implemented as fallbacks to provide additional support at various values. As long as the treasury continues to absorb more carbon offsets via bonds than the KLIMA paid out to stakers as rewards, the number of carbon offsets held in reserves for each KLIMA token will grow. Therefore, the implied future value of each KLIMA token in terms of carbon credits custodied by the treasury will also grow.


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