KlimaDAO: A catalyst for innovation within the Voluntary Carbon Market
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KlimaDAO: A catalyst for innovation within the Voluntary Carbon Market

Published Sun Jan 23 2022

Executive Summary

  • DeFi’s interoperable applications provide fertile ground for innovation in the carbon markets.
  • KlimaDAO is leveraging a stack of DeFi technologies to accelerate the delivery of climate finance to sustainability projects globally.
  • Blockchain enables data availability and transparency in a way that has simply not existed in traditional systems, let alone in the traditional carbon market.

Introduction

KlimaDAO leverages the infrastructure developed by our partners Toucan Protocol and Moss.Earth. This infrastructure enables carbon credits that have been issued through robust processes developed by Carbon Standards such as Verra and Gold Standard to maintain their integrity when they are bridged onto the blockchain.

Once carbon credits have been transferred on-chain they can begin to integrate with decentralized finance (DeFi) applications. This empowers the Voluntary Carbon Market (VCM) and gives it direct exposure to the transparency enabled by the blockchain, and the liquidity held in Automated Market Makers (AMMs) on Decentralised Exchanges (DEXs).

The KlimaDAO protocol has positioned itself as the liquidity engine for these markets. It utilises the novel incentive mechanisms pioneered by OlympusDAO to incentivize VCM participants to deposit their tokenised carbon credits into the KlimaDAO treasury through bonding rewards. The process of bonding allows the protocol to grow the carbon tokens in its treasury and maximise KlimaDAO’s impact on the carbon markets. Through KlimaDAO’s staking rewards it taps into the latent demand for carbon from the trillion dollar Web3 industry.

KlimaDAO has already emerged as one of the largest sources of demand for the VCM in 2021/22, and has helped drive up the cost of carbon on the market[1]. This demand and the impact on the market from KlimaDAO is key to ensure that the cost of carbon credits is above the cost of greenhouse gas abatement, and to unlock immediate growth across the market.

Leveraging the DeFi technology stack

One of the key innovations KlimaDAO has enabled is the usage of AMMs within the VCM.

The conventional process of purchasing credits in the legacy market is primarily through Over-the-Counter deals. Here, buyers and sellers offer up different values for an asset and execute a trade at a mutually agreed value. Once a trade is executed the sale price becomes the asset’s market value. Stocks, gold, real estate, and most other assets rely on this traditional market structure for trading.

However, AMMs have a different approach to trading assets. They are a financial tool unique to Ethereum and decentralized finance (DeFi). This new technology is decentralized, permissionless, always available for trading, and does not rely on traditional interactions between buyers and sellers. This new method of exchanging assets embodies the ideals of Ethereum, Web3, and blockchain technology in general: no one entity controls the system or the system’s flows, and anyone can build integrations to leverage this technology and innovate.

The foundation of this DeFi technology stack is the blockchain itself. KlimaDAO runs on the Polygon Blockchain, which utilizes the Proof of Stake (PoS) security model and is one of the most environmentally friendly blockchains in existence. In effect, Polygon can serve as a ‘meta registry’ of carbon trading, given that all transactions are recorded and immutable. The barrier for participation is low, with a Polygon wallet loaded with the appropriate asset (e.g. $BCT, $MCO2 or $USDC) all that is needed.

Evidence of how KlimaDAO has catalyzed innovations within the VCM, by leveraging DeFi tooling are discussed within different challenge areas below.

Fragmentation

The Taskforce on Scaling the Voluntary Carbon Markets (TSVCM) state that the VCM is highly complex and fragmented. Years of uncertainty prior to international climate change agreements being finalized have led standard setters, verifiers, project developers, and other market participants to develop and deploy best practices and market infrastructure in sometimes disjointed ways [2], which can lead to issues such as:

  • Fragmented Carbon Standards
  • Fragmented liquidity (causing challenges linking buyers with sellers)
  • Fragmented options for corporate demand and retail

A lack of clarity around offset quality and the existence of a myriad exchanges where trading actually occurs have naturally brought on criticism from NGOs and the press at large. The combination of real and perceived issues within the VCM creates difficulties when scaling them in line with the demands of the Paris Agreement and the fight against climate change.

Thankfully, key stakeholders in the market are beginning to coalesce around quality standards (such as those developed by Verra and Gold Standard) and are pushing for continually increasing the integrity of environmental claims made by individuals and companies.

The next step for the market to grow is to improve the trading infrastructure of the market while aggregating similar products to bring about increased efficiency for all stakeholders.

DeFi’s interoperable applications have provided fertile ground for innovation in carbon products. Most notably, carbon offset indices, such as Toucan Protocol’s BCT which is traded on SushiSwap, have consolidated much of the supply side and demand side of the on-chain VCM. Disparate interfaces and demand can now all access the same on-chain market within seconds.

Additional aggregated products under development include nature-based projects and pools which specify particular social or economic impacts in addition to their environmental benefit (most notably via the Sustainable Development Goals). DeFi enables these different carbon tokens to be integrated into new use-cases and a more efficient market.

Iliquidity & Scaling

The TSVCM also acknowledge barriers around poor liquidity in the VCM, which compounds fragmentation and limits scalability. Building up liquidity in the VCM and aggregating new sources of demand is critical for scaling up the market, raising the price of carbon above the cost of abatement, and overcoming key market failures.

“Currently, liquidity in voluntary carbon markets is fragmented. Projects have a range of attributes (project type or geography, for example) that can influence their value, and buyers have different attribute preferences. In today’s market, matching each individual buyer with a corresponding supplier is a time-consuming and inefficient process, transacted over-the-counter.” [1]

The typical OTC transactions from individual brokers have limited liquidity, with tranches of 10,000–250,000 tonne deals being common. Though there are some aggregated carbon credit products in existence, they are only present on specific exchanges and are not transferable outside of their host exchange.

This market structure is in contrast to what is being built in DeFi, which allows a considerable amount of interoperability between carbon products and the development of novel pools with unique characteristics. For example carbon removal nature-based projects from South America with a vintage of 2018+ can be integrated with similar credits into a pool representing nature-based projects globally with a vintage of 2016+.

This opens up far more efficient discovery opportunities between both suppliers and buyers in the VCM and has already seen the development of Core Carbon Reference Contracts on the blockchain. These reference contracts will serve as liquid reference contracts on the spot market that display a price signal to the wider market, enable the growth of supplier financing, and disrupt illiquid and fragmented OTC trades.

The Toucan Protocol’s Base Carbon Tonne pool allows for any tokenised carbon project from 2008 vintage onwards to be deposited into the pool. It enables suppliers who hold these credits to deposit them into the AMM and immediately find an off-taker for their BCTs. It also enables buyers to immediately access BCTs without needing to engage with a multitude of suppliers to find the best price and fulfil their demand. This solves a key failure at the interface between supply and demand.

The challenges of the Voluntary Carbon Market (VCM) are not unique. They are symptomatic of markets that trade in environmental commodities which represent public goods. The Taskforce on Scaling Voluntary Carbon Markets notes that “when a product follows a set of widely interrogated and codified standards, quality usually improves as producers are motivated to meet those standards” [2]. Significant work has been done on the supply-side for carbon credit origination to ensure that high standards for newly created carbon credits are in play.

At the demand side, harmonization is in progress as new pools are created, standards synced, and liquidity grows on-chain.

Opacity, Security, Data and transparency

Blockchain is oftentimes revered as a revolutionary technology, as its innate properties are hard to emulate by any other type of technology. When you combine its properties of decentralization, immutability, transparency, and security, a notion of “trustlessness” is created. In other words, the trust typically expected of vendors to sell their services is no longer required thanks to blockchain. No single entity is responsible for transactions to execute and the up-time for such a decentralized system is far better than what we can hope for with centralized registry databases from legacy market players.

As a ‘ledger’ of transactions, porting market activity over to the blockchain enables considerable data analysis opportunities. Consider that VCM transaction and market analysis is often retrospective, with market participants providing survey data on trades they have completed in previous months/years — obtaining this data is often not possible without paying for it. As an industry, the carbon market has relied on reports from the likes of Ecosystem Marketplace to have a high-level understanding of market trends.

The industry can do better.

Blockchain enables data availability and transparency in a way that has simply not existed in traditional financial systems, let alone in the traditional carbon market[3].

Market participants now have the ability to view holdings and transactions of public addresses using a block explorer (for example, Polygonscan), to search the blocks of a blockchain, their contents, and their relevant details. Within the context of the on-chain carbon ecosystem, users can now view total transaction volumes of specific carbon pools, their price history and spot prices, query the number and composition of offsets bridged over from different entities, and view how tokenized carbon offsets are being utilized on-chain.

Imagine visualizing the flows of finance to different offset project types in various geographies, live — blockchain enables this.

Delivering a next-generation carbon market

The TSVCM estimates that to deliver the 1.5-degree pathway needed to avert the worst effects of climate change, the VCM volume will need to grow by up to 15 times by 2030 — while simultaneously increasing the integrity of the underlying carbon credits. Such a development could drive billions of dollars from the net emitters of greenhouse gas emissions to the projects and organizations working to mitigate and remove them from the atmosphere. For finance to flow effectively and efficiently, a more robust and transparent VCM with high integrity quality standards and robust governance is required.

KlimaDAO is positioning itself as a nexus within the emerging on-chain climate market. Liquidity incentivized by our protocol mechanics is providing a trading space where transparency, value discovery, and interoperability between carbon products is flourishing. With our ecosystem partners we will continue to catalyze innovation in this space and accelerate the delivery of high-impact climate finance to sustainability projects globally.

Sources

[1] https://www.spglobal.com/platts/en/market-insights/podcasts/oil/012022-jet-fuel-values-buck-falling-passenger-trend-europe-aviation

[2] https://www.iif.com/Portals/1/Files/TSVCM_Report.pdf (pages 11, 19, 43, 44, 45, 46)

[3] https://www.ibm.com/blogs/blockchain/2019/04/how-transparency-through-blockchain-helps-the-cybersecurity-community/

Haftungsausschluss:

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