The KLIMA token's role in the on-chain carbon market

The KLIMA token's role in the on-chain carbon market

Published Mon Aug 08 2022


KLIMA is useful in different ways for different ecosystem participants.

For users of on-chain carbon, KLIMA is valuable because it lets them quickly source and retire tokenized carbon credits as KLIMA is the primary trading pair in tokenized carbon pools. Others see it as a way to have influence over the DAO’s token-based governance – an important mechanism for developing the on-chain carbon market in line with the needs of the ecosystem. For those who align with the project’s long-term vision and utility, holding the staked version of KLIMA is seen as the primary way to mitigate the impacts of participating in an inflationary ecosystem. Meanwhile, for KlimaDAO itself, the native KLIMA token offers a set of benefits that enables the development of its Protocol Owned Liquidity model.

There are also other uses for KLIMA as a composable building block for DeFi-native platforms – for those who wish to build on top of it, KlimaDAO will soon release technical documents.

In this article, we break down some of the key elements of the KLIMA token’s utility, role, and importance in the on-chain carbon market.

Tokenized carbon credit retirement

Unlocking transparency, efficiency, and accessibility to the Voluntary Carbon Market (VCM) is one of the core objectives of KlimaDAO and our partners who are developing the on-chain carbon ecosystem. To date, over 400,000 tonnes of tokenized carbon has been retired (or offset) on the blockchain (view statistics here).

With the launch of KlimaDAO’s retirement aggregator, on-chain assets can now be retired with just a few clicks and by initiating a single transaction.

To enable these retirements, KlimaDAO has developed liquidity pools that pair the KLIMA token with a range of tokenized carbon credits that have been bridged on-chain from partners C3, Moss, and Toucan Protocol. The development of these pools allows groups of similar tokenized carbon credits (such as groups that have similar vintages and technology types) to be bundled together, thereby reducing fragmentation across the market and increasing efficiency for participants.

As KLIMA itself is the token paired with tokenized carbon in liquidity pools, when the retirement aggregator is used the trades are routed directly through the KLIMA liquidity pools by KlimaDAO on behalf of the user. Because of the way that liquidity pools function, any cryptocurrency available on SushiSwap can be used to execute the retirement, but it will ultimately be routed through the liquidity pool that contains KLIMA itself. This means that tokens such as ETH, USDC, and MATIC can be used to make an immediate retirement. As can the KLIMA token itself, or other carbon assets!

Note that if a user already holds the tokenized carbon tonne they wish to retire, then no trades need to be routed through the liquidity pool itself to execute the retirement.

On-chain governance

One of the revolutionary aspects of Web3 ecosystems and more recently the emergence of ‘DeFi 2.0’ is the development of communities that are truly involved with the development and growth of a protocol. As stated in Morgan Stanley’s recent report, Crypto and Carbon – Global Interoperable Voluntary Offset Marketplace on Chain, "DAOs create an incentive for community participation and ownership." This is what has been fostered via the distribution of the KLIMA token, as well as the communication and voting frameworks that have been implemented for its governance.

Engaging with DAO governance processes includes participating in discussion within Discord, sharing views on the Forum, and, critically, voting directly on key protocol decisions on Snapshot. When a decision is voted on in Snapshot and passes, the results are implemented by the DAO.

This approach gives holders of the KLIMA token the opportunity to guide the development of the protocol in line with what the on-chain carbon ecosystem requires to thrive.

Holders of the KLIMA token (or the staked and wrapped-staked version) are proportionally allocated one vote per KLIMA token for KlimaDAO’s voting decisions.

Below, we illustrate the flow of the DAO’s governance process.

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KlimaDAO has passed all of its key decisions since launch through its token voting process. This includes votes on issues such as allowing the MCO2 token within our treasury via bonds, modifications to our operating model within the contributor DAO, and the formalization of key strategic partnerships, such as that with C3. There have been 25 governance decisions since the launch of the DAO in October 2021.

Liquidity provision

KLIMA plays a key role in scaling growth and participation within the VCM. In 2021, the legacy VCM surpassed $1billion in traded value. It is expected to more than double by 2027. Meanwhile, the on-chain carbon market has already surpassed $3 billion in the nine months since it launched. With innovative solutions that directly address some of the market’s existing failures, continued growth is predicted over the next decade.

One of the oft-cited issues inhibiting the scaling up of the VCM is poor and fragmented liquidity. Indeed, liquidity is one of the most important aspects of every market – primarily because it enables a market to function efficiently. With poor liquidity, even small trades can disrupt the market value of a given commodity (or token) disproportionately. However, when there is deeper liquidity, the market can function efficiently for users, enabling them to take market positions without incurring slippage.

The carbon pools that KlimaDAO has developed that enable one-transaction retirements are built on top of deep liquidity that facilitates market operations. The depth of liquidity means that large transactions can be made at any given time, without disrupting the market.

The graphic below indicates the type of tokenized carbon credit pools that KlimaDAO helps facilitate within its ecosystem, with metrics included.

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Liquidity pools enable the market activity between two tokens to happen; they are hosted on decentralized exchanges (also known as DEXs) such as SushiSwap and QuickSwap. These liquidity pools often pair tokens with lower supply with other tokens such as a stablecoin, or a more established token such as ETH or wBTC. Because these tokens have significant supply they can be used to establish liquidity pairs across a variety of tokens.

In the case of liquidity pools for tokenized carbon credits, however, the tokenized pools are paired with the KLIMA token; therefore KLIMA itself is the token that provides the liquidity for the on-chain carbon market.

There are two primary reasons why KLIMA is used, and why it is so instrumental in establishing the on-chain carbon market as a mature and stable solution over the long-term.

The importance of Protocol Owned Liquidity

First, the way that KlimaDAO uses KLIMA enables it to achieve a state of ‘Protocol Owned Liquidity’. In “DeFi 1.0” (i.e. the earlier iterations of DeFi), providing liquidity was mainly incentivised by rewards of the native tokens of the protocol so a user would get X extra tokens when they provided liquidity in the X/USDC Pool. Liquidity was therefore owned by individual users who were looking to “farm” the incentive rewards.

This brought a few problems with it:

  • Temporary liquidity: The liquidity is mercenary, meaning that once the rewards leave, so does the liquidity. Liquidity is only ever provided for the short term.
  • Constant selling pressure: Since rewards are paid to the liquidity provider, they sell these rewards either to provide more liquidity, causing more emissions, or for another token, causing constant selling pressure on the token.
  • Lack of security: The liquidity is owned by users and not by the protocol, which means users are free to exit at any time. This means that, during times of turmoil, liquidity providers will leave in order to reduce losses—just when the protocol needs it the most.

On the other hand, DeFi 2.0 protocols pioneered new techniques wherein the liquidity is owned by the protocol instead of individual users. This means that the protocol has a guaranteed amount of liquidity available at all times. In the view of the protocol, facilitating a market is more important than returns; the protocol therefore has the ability to act as a stable market facilitator over the long term, rather than being guided by shorter-term considerations that may impact individualized decision making (and perhaps lead to volatility).

Achieving protocol owned liquidity also reduces the cost for the protocol of securing the long-term availability of liquidity. In DeFi 1.0 protocols, rewards have to be constantly paid out to liquidity providers just to hold the liquidity. In DeFi 2.0, however, the protocol acquires the liquidity only once via bonding and is able to hold on to it forever from then on. KlimaDAO owns the vast majority of its liquidity and can guarantee a stable experience for users using KLIMA and tokenized carbon.

Reducing impermanent loss

Second, one of the risks of providing liquidity on DEXs is ‘impermanent loss’. Impermanent loss can happen when the two tokens held within a pool diverge in value. The greater the divergence, the greater the loss can be. Given that the overall price of carbon credits is expected to trend up over the long term toward 2050 (when we must achieve Net Zero carbon emissions to avoid the worst impacts of climate change), pairing carbon in a pool with a stable asset such as USDC all but guarantees impermanent loss when the long-term perspective is considered.

In the case of KlimaDAO (which has implemented Protocol Owned Liquidity and which itself takes a long-term view of the ecosystem), this impermanent loss would be felt by the DAO itself.

Given that KLIMA itself is backed by the carbon tokens held within the treasury, and its long-term value is expected to roughly correlate to the tokens that back it, the impacts of impermanent loss between the tokenized carbon credits and the KLIMA paired within it are likely to be less severe.

Growing the protocol

KLIMA is also the primary mechanism for the treasury to acquire tokenized carbon (referred to as “reserve assets”) and liquidity (referred to as “assets”) through bonding – these assets are used to back the KLIMA token and achieve Protocol Owned Liquidity, respectively.

1. Reserve assets:

  • BCT (Base Carbon Tonne; trades on SushiSwap)
  • MCO2 (Moss Carbon Credit Token; trades on Quickswap)
  • UBO (Universal Base Offset; trades on SushiSwap)
  • NBO (Nature Base Offset; trades on SushiSwap)

2. Assets:

  • KLIMA/BCT SushiSwap LP tokens
  • KLIMA/USDC SushiSwap LP tokens
  • KLIMA/MCO2 QuickSwap LP tokens

In addition, KLIMA is used to act as an inflation hedge to ecosystem participants through the distribution of staking rewards. We briefly outline the role of bonding and staking below.

Bonding allows ecosystem participants to obtain KLIMA at a lower cost basis because the protocol can distribute it at a discount to the market value (because it can mint KLIMA at the Intrinsic Value of the reserve assets). Bonding when there is a positive discount on KLIMA may be advantageous compared to simply acquiring KLIMA on a DEX. Bonding is therefore the primary means to acquire KLIMA for participants. The protocol will provide an amount of KLIMA, and a locking period for the duration of the bond – available on the app.

Staking is the primary anti-dilution measure mechanism of the protocol. During times where the protocol absorbs carbon tokens to mint new KLIMA (i.e. supply increases), existing holders are diluted against the growth in supply. By distributing KLIMA to those who ‘stake’, that dilution is minimized. The amount minted and distributed is controlled by a variable named the reward rate, which is the percentage of supply that is rebased on an eight-hour cadence.

KLIMA – the nucleus of ReFi

KLIMA is a central pillar of both the KlimaDAO protocol and the wider on-chain carbon market. Over the coming years, we anticipate the benefits of the on-chain carbon market will becoming better understood by organizations, corporations, and individuals alike. As this happens, the blockchain will take its place as the primary space for those who wish to access the VCM in a totally transparent manner, and take ownership over their unavoidable carbon emissions.

It is KLIMA that enables this.

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As a utility token that allows our community to exert influence over our development, while simultaneously embedding long-term stability and value creation into the ecosystem, KLIMA fulfills certain critical needs of ReFi and the broader carbon market.


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