In September 2022, the American Carbon Registry launched its Digital Assets Consultation, in order to explore new opportunities in the carbon markets presented by Web3 technologies.
The questions and answers from KlimaDAO's submission are shared below.
Consultation Questions: First Questionnaire
Description of Proposed Service Offerings
1. Please share your mission and description of your client base.
KlimaDAO’s mission is to accelerate the delivery of climate finance to high-impact sustainability projects globally. Pursuant to this mission, we build infrastructure rails for both market access and analytics, including a carbon offset retirement aggregator and APIs for programmatic offsetting applications. Our clients thus range from individuals to businesses (in particular, traditional VCM participants as well as technology companies entering the VCM space).
2. Please describe your service offering as it relates to the digitization of carbon markets, including the type of blockchain consensus mechanism employed and type(s) of digital assets/instruments. Feel free to provide supplemental materials to complement your response.
KlimaDAO operates on the Polygon blockchain, a Proof of Stake (PoS) blockchain that is highly energy efficient and scalable (high throughput and very low transaction costs of fractions of a penny). Thus far we have only supported ICROA-endorsed carbon assets with our infrastructure.
Polygon blockchain emissions analyses:
KlimaDAO’s infrastructure enables access to the Web3 carbon market, including Web3 and Web2 integrations with carbon liquidity that we have facilitated and grown. Our tooling provides carbon asset retirement capability, marketplace functionality, user metrics tracking, and market analytics.
3. Please describe the value add of your proposed service to offset project developers/local communities, corporate and individual offset buyers, and independent standards/registries?
Offset Project Developers / Local Communities:
For project developers, KlimaDAO’s facilitated liquidity pools and carbon marketplace provide a disintermediated path for accessing capital from demand-side participants. Additionally, the transparent nature of the markets on the Polygon blockchain provide carbon project developers with clear price signals and historical market data which may be relevant to the economics of their projects.
KlimaDAO can engage with bridging partners to actively support carbon tokens that direct royalty payments back to offset developers/communities.
Corporate Buyers and Individual Offset Buyers:
Standardized access and API use through our technology for comparing cost between different credits on chain.
Accurate on demand spot prices for carbon held in our liquidity pools.
Adherence to carbon bridge, registry, and industry standards so credits sourced through our liquidity can be traced back to the initial issuance.
Independent Standards / Registries:
Liquidity support (market making) for various types of projects that may come from a standard like ACR. This includes KlimaDAO’s activities in project financing and forward carbon to support novel projects, such as blue carbon, to help them build liquidity.
Carbon dashboard provides information on the state of the web3 carbon market, including transactional information related to specific certification schemes.
4. What makes your service unique compared to other Web3 carbon market participants?
KlimaDAO helps facilitate the liquidity of carbon assets on the Polygon blockchain and provides the infrastructure to easily access this liquidity both on and off the chain. Liquidity facilitation is done through our tokenomics model and support for specific and innovative carbon projects through direct funding of carbon projects. In addition, we are the leading analytical platform for the on-chain carbon market, providing insights into the trading activity and availability of various tokenized carbon assets.
5. Have you had/will you have an initial coin offering?
We did not (and do not plan to) have an ICO.
6. Do/will you deal in a carbon backed cryptocurrency? The native governance token of the KlimaDAO protocol is backed by tokenized carbon assets. You can read more about the KLIMA token here: https://www.klimadao.finance/blog/what-is-KLIMA-tokens-role-in-onchain-carbon-market
Orientation Toward Climate Action
ACR has the goal of leveraging new technologies to drive real and meaningful climate action. We do not believe that technologies that just enable further trading of carbon offset credits necessarily serve this goal.
7. Please explain, in broad and specific terms, how your digital offering contributes to the goals and objectives of Article 6 of the Paris Agreement.
The tokenization and retirement of offsets on the blockchain provides a secure interface for sharing data to e.g. the Climate Warehouse to account for any corresponding adjustments which may be necessary (with, e.g., VCM credits that are utilized by CORSIA).
ACR is interested in mechanisms that enable the delivery of royalty payments back to offset project developers/communities and other ways to drive finance to projects.
8. Does/will your offering enable this type of capital flow? If so, how is/would this be actualized as part of your offering? KlimaDAO can engage with bridging partners to actively support carbon tokens that direct royalty payments back to offset developers/communities. We can also do this from our marketplace, wherein project developers themselves can sell non-fungible carbon tokens for fixed pricing, where a specified amount of capital is auto directed toward an address held by specific community groups.
Maintaining Environmental Integrity
ACR has policies in place to prevent double use (also referred to as double selling or double claiming) of offset credits, including the tracking of ownership of credits within the Registry by serial number and account.
9. Please explain the capabilities of your technology to track individual digitized credits so that they can be traced from their owner back to their origin.
Distributed Ledger Technology (DLT) has a number of advantages for tracking digital carbon assets. In general, DLT has already demonstrated its ability to bring benefits to users in many cases, including the following:
increased visibility into and transparency of data contributed to the ledger;
lower operational costs thanks to the elimination of a central authority;
faster transaction speeds because there's no lag in updates to ledgers;
greatly reduced risks of fraudulent activity, tampering and manipulation;
increased reliability and resiliency because there's no longer a central system that creates the potential for a single point of failure; and
significantly higher levels of security.
Entity retirements through our platform are currently tracked via their climate pledge pages. An example can be found here.
The Carbon Dashboard is available to view every carbon offset that has been bridged: https://carbon.klimadao.finance/
10. Please describe the process envisioned when an owner of a digitized credit makes an environmental claim related to compensating for their emissions with a digitized credit. The following transaction showcases 3500 offsets being burned for a retirement claim used in the aforementioned pledge dashboard: click here
Our smart contracts are open source and all documentation related to their use is public, accessible here.
Summary of actions taken to achieve offsetting on-chain:
1) A user connects their wallet to KlimaDAO’s decentralized application interface.
2) The payment asset (e.g. KLIMA, USDC, or a carbon token) is selected.
3) The asset to be retired is selected (e.g. BCT, NCT, NBO, etc).
4) The user selects a specific offsetting project from within one of the aforementioned carbon pools if they wish to support a specific project.
5) The user inputs information related to the beneficiary and the retirement message.
6) The user retires the offset(s). When this occurs KlimaDAO’s retirement aggregator routes their payment to the relevant liquidity pools, purchases the carbon tokens, and retires the carbon tokens in accordance to the token issuer/bridge specifications to ensure a single claim of benefit for the tokens retired. This results in burning* the carbon tokens equal to the number of offsets they wish to utilize for their environmental claim.
7) The user receives a receipt of the transaction with a unique transaction hash, and the details of the retirement including references to the official bridge retirement certification.
*Burning tokens is analogous to withdrawing them from the chain, whereby tokens are permanently removed from the market and can no longer be traded. New tokens can only be created through direct issuance by a ledger or through bridging by a partner.
11. What other mechanisms does your system have in place to prevent double use?
(Retirement is the permanent removal of an ACR credit from circulation as a transactable unit and the only stage of a credit’s life where a claim of an emission reduction or removal may be made.)
Burning a token permanently removes it from circulation, making double use impossible. From a technical perspective here is what happens to burned tokens:
Tokens are sent to the zero address. It is 0x0000000000000000000000000000000000000000.
On a blockchain, one needs the private key of the address to transfer/initiate any transaction.
There is no private key for the zero address. Due to this, tokens are irretrievably lost and will remain at the zero address since nobody can initiate transactions from this address.
As a result, the total original token supply is reduced.
12. Please describe your proposal for when an ACR credit will be retired on the Registry in relation to its related digital asset.
ACR should publish clear guidelines for appropriate tokenization of ACR credits, ideally in line with the tokenization framework being developed by IETA. Under the IETA framework, guidelines for both “Direct” (a.k.a. one-way) and “Secured” (a.k.a. two-way) bridging should be published.
Direct tokenization is much simpler to implement and technically poses a much lower risk of failure than guaranteed tokenization. Direct Tokenization should permanently immobilize the credit and all structured credit attributes available in the ACR registry serial number (methodology, vintage, location, etc.) should be recorded on the blockchain and associated with the tokenized credit during the tokenization process. Direct tokenizers should either require a manual review of the data entered by clients during tokenization, or use an automated mechanism to retrieve this data from the ACR ledger.
Secured tokenization requires a special-purpose legal entity to maintain an inventory of immobilized credits on a dedicated ACR account, and to respond to tokenization and detokenization requests, as well as to spread withdrawals issued on the chain to the underlying ledger. This requires significantly more technical and legal infrastructure than direct tokenization, but it also offers the opportunity for credits to stream both inside and outside public blockchain ecosystems - avoiding lock-in of credits within a given tokenization system.
Secured tokenizers should be subject to stringent requirements of legal liability and auditability; ACR should provide a standard mechanism for Secured Tokenizers to publish their inventory of tokenized credits for auditing purposes.
Regardless of which tokenization scheme is utilized, on-chain retirements should only be possible for specific project/vintage tokens that correspond to an immobilized credit in the ACR registry, and such retirements must require that the underlying token is destroyed (preventing double-counting of the tokenized credit). For Secured Tokenization, when a retirement is issued on-chain, ACR should require that the underlying immobilized credit is retired in the ACR registry within a reasonable period of time.
13. If you have an opinion, please describe your preferred offset credit status/registry functionality (e.g., custodial account, immobilized credits, etc.) prior to retirement and an environmental claim is made. Given the urgency of the climate crisis, ACR must not allow the innovation infused into the VCM by public blockchain technology to fizzle out due to slow implementation of changes required to enable tokenization. Instead, we recommend a phased approach to enabling tokenization that mitigates risks while allowing innovation to continue.
On-chain retirements should be incrementally batched onto the registry (ledger) so that the amount of live vs retired credits can be defined.
Phase 1 – immobilized state (boolean) that allows tokenization to continue using existing Direct bridges. In this initial phase, credits can be immobilized but cannot be “unimmobilized” (responsibility on Tokenizer).
Phase 2 – add mechanism for two way bridges to ‘detokenize’ that avoids risk of double-counting and/or fraud. (responsibility is on the Tokenizer to ensure integrity by e.g. batching retirements, providing a publicly auditable inventory of immobilized credits). Note that directly tokenized credits should NOT be allowed to be detokenized, so an additional flag may be required to indicate in the ACR registry that a credit was Directly tokenized and prevent detokenization.
Phase 3 – event-driven architecture where a listener process is established in the ACR Registry system that responds to blockchain events involving tokenized credits: batching retirements incrementally and handling tokenization/detokenization through a standard process. This phase shifts responsibility for integrity onto ACR rather than the Tokenizer.
A detailed guide for implementation of this final phase:
A ‘reverse bridge’ should take the form of an open-source Smart Contract that allows a user to destroy their unretired tokenized carbon credits and trigger the release of the corresponding off-chain ACR registry credits from the immobilization state, which are then transferred to a provided ACR registry account to allow the user to take custody.
Whenever a token is destroyed in this manner, the blockchain would record this event as an immutable and public record.
Tokenized credit retired on-chain are prevented from being reverse bridged as the tokens are “burned” (i.e. destroyed) during the on-chain retirement process.
These events would contain all relevant data such as the target registry, target registry account, offset vintage, project data, token origin, token quantity and more. Note, that events could also include the type of burn event: 'retirement' (with environmental benefit beneficiary and retirement reason details) or 'reactivation' (with delivery details, such as, for example, ACR Default Sub-Account ID).
These events would be emitted in real-time and would signal to the ACR system (or any other registry) that offsets can safely be ‘re-mobilized’ in the database, without risk of double-counting or tampering.
This solution would enable ACR’s registry to respond to these events at ACR’s own discretion, and ensure that ACR can apply its own respective Terms of Service to the process. For example, ACR would retain the power to implement restrictions on wallets and recipient accounts, offset credit criteria, quantities, fees, and more. This same smart contract could also serve as a trusted and transparent way to transfer qualified credits from other registries directly into the ACR system.
State and federal regulators are increasingly focusing on cryptocurrencies and tokens. ACR has concerns about entering into this space given the regulatory uncertainty. 14. Which jurisdiction(s) is your business registered in? Which jurisdictions do/will you offer services? KlimaDAO is not a business, therefore it does not detect where it is registered.
KlimaDAO is a decentralized autonomous organization, which operates through a trust.
The trust structure is the most suitable solution for the DAO, since the trust is a multifaceted complex system, but its multipurpose structure can be adapted precisely to the scope. It is also an instrument that can be tailored to fit the specific needs of the settlor in a versatile way due to its structural pliability: (i) it can be shaped by the settlor and the scope according to suit the needs; (ii) it allows for streamlined management; and, finally, (iii) the segregation of the property in trust allows to for avoidance of influence with personal or financial affairs of the trustee.
The trust is also generally accepted in almost all legal systems, and allows the applicable law to be chosen, thus leaving much freedom to the settlor as stated above.
Finally, there are many trusts which allow the settlor to choose the one that is closest and most suitable to the situation he wishes to protect.
Indeed, the trustee is bound by the proposals submitted by users on the forum and the votes taken, and receives irrevocable instructions that he must comply with.
The blockchain has no boundaries, and therefore KlimaDAO offers services everywhere not being bound to a specific jurisdiction.
For further information please see: https://www.klimadao.finance/blog/DAO-organization-theory
15. Would the digital assets/instruments that you offer representing ACR credits be non-securities under the federal securities laws? Would they be offered as securities in compliance with the federal securities laws?
The digital assets offered by KlimaDAO cannot be considered securities because the legal definition of a security includes four types of instruments that are generally considered debt securities: notes, bonds, debentures, and instruments that constitute evidence of indebtedness. Regardless of any differences among these instruments, it is clear that our token has none of the characteristics of all four.
The statutory definition of a security also includes the following types of equity securities: shares, treasury stock, certificates of interest or participation in any profit-sharing arrangement, pre-organization certificates or subscriptions, transferable shares and undivided fractional interests in oil, gas or other mineral rights. These types of securities are characterized by two common features, both of which are absent in the case of our token.
Finally, the statutory definition includes the following derivative securities: security futures, security swaps, puts, calls, warrants, straddles, options or privileges on securities, and some foreign. The common feature of these securities is that they all involve contracts related to other securities. In the case of our token, assuming it entails a contract, it is clear that its underlying asset (whether the tokenized carbon credit or the carbon credit itself) is not a security. Consequently, the KLIMA token cannot be considered a derivative security.
We have already received an opinion from a top U.S. law firm that reiterates the above.
Therefore, the token is not currently identifiable as a security, but in the event that it qualifies as such in the future, the offering of the tokens still takes place in accordance with the US federal securities law.
16. Would the digital assets/instruments that you offer representing ACR credits not meet the definition of a futures contract and/or swap under federal commodity law? Would they be offered as futures contracts and/or swaps in compliance with federal commodity law? No, they cannot be defined as either futures contracts or swaps.
17. Will/are you registered as a money services business and in good standing with the U.S. Department of Treasury’s Financial Crimes Enforcement Network (“FinCEN”)? Are you eligible for an expressly identified exemption? No, KlimaDAO is not a money services company and therefore does not qualify for the exemption.
It is worth mentioning that KlimaDAO operates not only in the U.S. territory but all over the world and acts not only under the laws of the U.S. but also under the laws of other countries.
18. Do you have all state licenses required to conduct your business, including as it pertains to laws from state agencies that regard virtual currency as a regulated form of value within scope of the state’s money transmitter licensing statute or virtual currency business activity statute that may require you to obtain a state money transmitter license or virtual currency business license? None of the other instruments listed in the statutory definition of security captures the token. They are as follows: certificate of interest or participation in a security (KLIMA token does not entail any right to any other asset, whether a security or not), temporary or interim certificate for a security (KLIMA tokens are issued in definitive form and do not evidence securities), and guarantees of other securities (KLIMA tokens do not collateralize any obligation or any kind owed by any person).
In light of the foregoing, it appears reasonable to conclude that, with the exception of the category of securities referred to in the statute as “investment contracts”, the KLIMA token does not have any of the legal attributes or characteristics associated with the remaining examples of “securities” listed in the definition contained in Section 2(a)(1) of the Securities Act.
In other words, as mentioned above, KLIMA token does not qualify as a security and, therefore, it is not subject to all State licenses.
Consultation Questions: Second Questionnaire
Orientation Toward Climate Action
ACR has concerns about the energy use and resulting GHG emissions of some blockchain networks.
1. What technology design or approaches do you employ to minimize your energy demand? KlimaDAO operates on the Polygon blockchain, which is PoS and carbon neutral (they have offset all of their emissions).
2. Do you track your operation’s energy use or carbon footprint? Polygon is carbon neutral and has pledged to remain so each year.
a. If so, what is the boundary of the evaluation and what scopes are included? The network’s energy consumption was analyzed by CCRI and Offsetra.
b. If so, do you offset your emissions? KlimaDAO offset all of its Ethereum L1 associated emissions – the transaction can be viewed here and here (for activity that took place on Ethereum L1 prior to migrating to Polygon).
Maintaining Environmental Integrity
ACR has concerns about bridging across blockchain ecosystems (cross-chain bridging), based on our understanding that use of intermediary networks can impair traceability by breaking the link between a token and the underlying asset, thereby increasing the risk of double use.
3. Do you intend to enable cross-chain bridging as part of your offering?
We do not. a. If so, please explain the value proposition and specify which other platforms or exchanges would a token be bridged to.
b. If so, please describe how you have determined/will determine which intermediaries to use and the steps taken to evaluate/audit the algorithm.
ACR issues one offset credit for each metric ton of carbon dioxide equivalent (CO2e) emission reduction or removal. While we understand that fractionalization can allow for new use cases, ACR credits can only be transacted and retired on the ACR Registry as whole units.
4. Do you propose to enable the fractionalization of credits? KlimaDAO’s retirement aggregator tool allows for fractional retirements. We see credit fractionalization as key innovation enabled by Web3 as it allows carbon offsets to be integrated into other fintech services where ‘micro retirements’ take place transparently on the blockchain. a. If so, please describe how record keeping of transactions and retirements of tokens representing fractions of ACR credits will operate to be consistent with the Registry functionality.
This would be dependent on whether the environmental benefit is internalized into the tokenized credit or if it is left on the registry. If left on the registry, we imagine bridging partners to bundle retirement data to synchronize with e.g. ACR. This could be done every 24 hours, for example.
b. If so, could you only enable fractionalization for immediate retirement
As KlimaDAO does not directly bridge credits onto the blockchain, we could certainly only enable fractionalization when retirements are completed immediately. However, current fractionalization efforts currently bundle offsets together for ‘batched retirements’. In either case, the technical implementation is not difficult to achieve.
Market Access, Democratization & Transparency
ACR membership is limited to duly organized legal entities. ACR performs KYC checks on all account applicants prior to approval according to a standardized, internal policy for performing appropriate due diligence, including but not limited to a review of the documents required to open an ACR account as stated in Step 6 of the Instructions for Opening a New ACR Account. While Account Holders may choose to remain private (i.e., not disclosed to the public), they are known to ACR.
5. Do you operate in a permissioned or permissionless blockchain? We operate on a public permissionless blockchain
a. If a permissioned blockchain, please describe any limitations on who can participate in your service offering. N/A
b. If a permissionless blockchain, do the smart contracts limit who can transact them? Please describe any such limitations. Yes, this can be implemented. View our press release here implementing a KYC’d solution for permissioned carbon pools.
6. Please describe the sign-up/application process. If participants need to go through KYC, please describe the timing of those checks and who conducts them (please identify any third-party providers used).
This information can be provided by IdentDeFi upon the launch of their product.
7. Can participants maintain anonymity while engaging with your service and would anonymous users be able to own and/or retire tokenized ACR credits? If only KYC’d users are required, this can be done. However, note that currently in the traditional market there are not strict KYC requirements for ACR account holders when they interface with clients (who may be individuals or businesses).
a. If so, please explain the value proposition.
For tokenized carbon retirements themselves, we would believe keeping this as open as possible would be beneficial. Again, note that there are not any KYC requirements for carbon retirements currently in place at any of the major carbon registries in the traditional market.
b. If so, what, if any, safeguards against illegal funds and transactions are in place? There is greater traceability of assets on the blockchain than in traditional markets. If KYC is required for users to trade tokenized ACR credits, that can be implemented.
8. Please discuss the availability of records pertaining to your role in creating, transacting, and burning of tokens. Please disclose any potential barriers to access the records by the public at large (e.g., need to have an account/wallet or Web3 literacy) and specify which are/would be available to the public, to registered users, and/or to standard/registry partners. All transactions occurring on the Polygon blockchain are available to the public. Information on e.g. KYC’d entities interacting with pools could theoretically be made available to the carbon registries themselves. A key question would be to what extent registries are currently collecting client data from market players like South Pole, 3Degrees, etc.
9. Which specific project and credit details and records would be available from the token itself and from an accompanying user interface and how is the information accessed?
All information provided for carbon credits on the ACR registry can in theory be included in a digital representation of those assets on the blockchain.
Disclaimer: The information provided in this blog post pertaining to KlimaDAO (“KlimaDAO”), its crypto-assets, business assets, strategy, and operations, is for general informational purposes only and is not a formal offer to sell or a solicitation of an offer to buy any securities, options, futures, or other derivatives related to securities in any jurisdiction and its content is not prescribed by securities laws. Information contained in this blog post should not be relied upon as advice to buy or sell or hold such securities or as an offer to sell such securities. This blog post does not take into account nor does it provide any tax, legal or investment advice or opinion regarding the specific investment objectives or financial situation of any person. KlimaDAO and its agents, advisors, directors, officers, employees and shareholders make no representation or warranties, expressed or implied, as to the accuracy of such information and KlimaDAO expressly disclaims any and all liability that may be based on such information or errors or omissions thereof. KlimaDAO reserves the right to amend or replace the information contained herein, in part or entirely, at any time, and undertakes no obligation to provide the recipient with access to the amended information or to notify the recipient thereof. The information contained in this blog post supersedes any prior blog post or conversation concerning the same, similar or related information. Any information, representations or statements not contained herein shall not be relied upon for any purpose. Neither KlimaDAO nor any of its representatives shall have any liability whatsoever, under contract, tort, trust or otherwise, to you or any person resulting from the use of the information in this blog post by you or any of your representatives or for omissions from the information in this blog post. Additionally, KlimaDAO undertakes no obligation to comment on the expectations of, or statements made by, third parties in respect of the matters discussed in this blog post.