How blockchain can improve carbon trading and the broader carbon market

Climate change is real. Natural disasters are happening around the world, and unless mitigation efforts are bolstered and improved, the earth will face dire consequences from climate change in the coming decades. Barring a few countries, every country in the world signed the Paris Agreement in 2015, which outlined global objectives to reduce carbon emissions and establish regulations to support the objectives. Have you considered which emerging disruptive technologies can contribute to global efforts in mitigating the negative impact of climate change? Blockchain is one of the key technologies that can significantly improve the efficacy, efficiency, and transparency of carbon trading and the overall carbon market. In turn, a more trustable and transparent carbon market can encourage governments and businesses to invest in decarbonization efforts.

Introduction to the carbon market, credits, and offsets

From the 2015 Paris agreement (and the 1997 Kyoto Protocol before that) arose the provisional solution to mitigate climate change–what we know today as the global carbon market. Essentially, it converts carbon emissions into a tradeable commodity that can be priced, bought, and sold within the carbon market–or simply put, carbon trading. When converted into a commodity, carbon emissions become carbon credits, or carbon offsets. Although the two terms are used interchangeably and represent a cutback/removal of carbon emissions that are rewarded for emissions created elsewhere, they are fundamentally different in how they work.

Carbon credits represent a cutback in carbon emissions or permission from regulators to create carbon emissions. The carbon revenue is usually traded vertically on the carbon compliance market (CCM) from businesses to regulators, but also sometimes from a business with excess carbon credits to other businesses.

On the other hand, carbon offsets represent the removal of carbon emissions. Offsets are created when business activities enable the business to remove a specific unit of carbon emissions from the atmosphere. The carbon revenue is then usually traded horizontally on the voluntary carbon market (VCM) from businesses to other businesses.

The next couple sections will discuss how businesses can generate and sell carbon credits.

How to generate carbon credits and offsets

Generally speaking, carbon credits are created based on governmental standards and regulations. For example, the state of California in the U.S. generates credits for a resident’s electricity and fuel consumption based on carbon emissions targets. Businesses in California are able to deal with carbon credits under a “cap-and-trade” program, which incentivizes businesses to reduce carbon emissions and stay under the cap. Ultimately, this creates the compliance carbon market (more on this later).

On the other hand, businesses can generate carbon offsets from the reduction, capture, and storage of carbon emissions through various activities and projects, such as renewable/alternative energy projects, improvements in energy efficiency, and reforestation. Because businesses are not forced to participate, this creates the voluntary carbon market, which will be explained more in detail later.

Businesses based in countries with ample natural resources, geographically rich landscapes, and other renewable energy sources can draw from these resources to create carbon offsets. Another way to generate carbon offsets is to save energy by converting to more environmentally friendly energy sources and infrastructure (e.g. LED light bulbs) to mitigate power consumption. Lastly, planting new trees and restoring forests are yet another way to generate carbon credits because they help reduce pollution.

Carbon market: how to sell carbon credits

Online carbon exchanges are a popular way of selling carbon credits and receive cash compensation for the generated offsets. Think of them as another commodity or stock exchange, but in this case, the asset is carbon. These exchanges have their unique standards and protocols that businesses must adhere to, in order to conduct carbon trading.

Compliance carbon market vs. voluntary carbon market

As mentioned earlier, there are two distinct carbon markets: the compliance carbon market and the voluntary carbon market.

The compliance carbon market is regulated by the government using cap-and-trade protocols with mandatory limitations on how much carbon can be produced, whereas the voluntary carbon market is created from businesses who want to purchase carbon credits and receive compensation for their carbon offsets. The voluntary carbon market is completely optional for businesses and individuals, who want to reduce their carbon footprint and participate in carbon trading, to opt-in. 

Who verifies carbon credits?

Within the scope of the compliance carbon market, carbon credits are verified by the government because the government is the entity issuing credits. However, within the scope of the voluntary carbon market created from market demand, carbon credits do not have a government entity to regulate. Therefore, these credits are verified by the market itself. Essentially, the market automatically becomes a third-party verifier and entities within the market make sure market participants receive fair compensation. Ultimately, this causes a whole set of problems that will be explained in a later section.

Who can purchase carbon credits?

Currently, only businesses, representatives of major corporations, and third-party intermediaries can purchase carbon credits. However, moving forward, as the carbon credit market grows and retail exchanges become more popular, individuals will also be able to purchase carbon credits.

Benefits of selling carbon credits

The primary benefit of selling carbon credits is creating new revenue streams for your business. Who doesn’t like to diversify their revenue streams? For example, in Q1 of 2021, Tesla generated a whopping $518m dollars from selling carbon credits to legacy car companies. Furthermore, as long as the carbon credit market continues to grow, the prices of carbon credits will also continue to increase.

Another benefit of selling carbon credits is the 21st century adherence to corporate social responsibility (CSR) in the business world. Not only is it important to generate revenue, but it is now equally crucial to be environmentally conscious and aware of how much carbon emissions a business produces. A business can say they are “green,” but if they don’t back it up with concrete actions to reduce their carbon footprint, environmentally conscious consumers may not support the business.

Carbon credit: market overview

In 2020, the voluntary carbon market was valued at around $400m. According to a report from Ecosystem Marketplace (EM), the real market valuation of the voluntary carbon market has already reached roughly $2 billion, almost quadrupling its value from the previous year. If countries continue to meet the targets set by the Paris Agreement, the market value is forecasted to grow to $10-25 billion by the year 2030.

Problems with the current carbon market

Currently, the carbon credit market is still nascent; therefore, it has its share of problems. Among them, the three problems we want to emphasize are: “greenwashing,” implementation issues, and a lack of stakeholder inclusion and inequality.

Greenwashing

Greenwashing is a phenomenon that occurs when businesses give a false pretense of environmental consciousness, possibly falsify their CSR activities, and make significantly less of an environmental impact than they publicly report. Critics say that this is a result of the voluntary carbon market, which businesses may take advantage of by paying for the right to pollute. For example, German car manufacturer Volkswagen was famously called out for greenwashing when their vehicles were marketed to the public as environmentally friendly; however, the reality was that Volkswagen falsified their carbon emission tests by using a device on their vehicles to detect testing and change the vehicle’s performance to reduce carbon emission levels.

Implementation issues

Implementation of carbon credit projects requires VCM participants to go through a multi-step process of registration, evaluation, authentication, monitoring, reporting, and verification, which is not only cost-intensive, but also time-consuming. Additionally, the protocols and requirements for monitoring, reporting, and verification are not standardized, creating inconsistencies throughout the market and among projects.

Lack of stakeholder inclusion and inequality

As mentioned earlier, voluntary carbon markets are self-regulated markets, often creating economic inequalities that favor the wealthy. Furthermore, environmental projects that are participants of the VCM often have an unintended negative impact on the socio-economic and environmental stability of local communities, particularly those in less developed countries. There is a clear need for improved regulation on the rights and ownership of market participants. Moreover, the VCM is still predominantly controlled by businesses, excluding individuals and retail participants who wish to join the market.

How blockchain can be a solution for carbon market problems

As the carbon credit market continues to flourish, so does the development of blockchain technology. Blockchain technology is in a unique position to support the carbon market via its technological ability to improve decentralization, transparency, and efficiency. 

To address greenwashing in the carbon market, a blockchain-supported regulation could make all businesses required to report transactions and any legal documents on a public blockchain ledger to be viewed by anyone. That way, even if a company uses marketing strategies to falsify their reports, all carbon-related activities can be viewed on the blockchain for authentication.

To address issues with monitoring, reporting, and verification, blockchain-enabled platforms could be developed for market participants to access carbon data, verify real-time records and transactions, and improve the efficiency of calculations, tracking, and reporting of data. Ultimately, this will make the entire implementation process for carbon emission data more accurate, reliable, and standardized.

Lastly, to address the lack of stakeholder inclusion and inequality, decentralization of the voluntary carbon market removes gatekeepers for the carbon market and makes the market more accessible. Through a secure and decentralized network, blockchain can clearly identify and validate contributions from not only businesses, but also individuals who want to reduce their carbon footprint. Furthermore, more participants across the supply chain, such as consumers, distributors, suppliers, and manufacturers, can have access to the data on-chain and participate in blockchain-enabled tracing and reporting of carbon emissions.

End Note

Although the carbon market and carbon trading can be used to mitigate climate change, they could use improvements using the emerging disruptive technologies like blockchain. Blockchain technology can improve the transparency, verification, and efficiency, among many other areas, of the carbon market. For further reading on how blockchain can enable a more sustainable future, check out this article.

Glossary

Carbon credit	A carbon credit is a unit of measure generated from a specific project activity that destroys, sequesters or avoids greenhouse gas (GHG) emissions. One credit is equivalent to 1 Mt (metric tonne) of greenhouse gas emissions. A carbon credit and a carbon offset are effectively equivalent, i.e. different terms for the same thing.
Carbon	A euphemism to describe the amount of carbon dioxide (CO2) and all GHG, or greenhouse gas emissions, in the atmosphere. Often used as an umbrella term that includes not just carbon dioxide (CO2), but other greenhouse gasses such as methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), sulfur hexafluoride (SF6), and nitrogen trifluoride (NF3).
Cap and trade	Governments or companies are given emission targets (caps) and can purchase tradable emissions allowances to compensate for going over a cap. One cap is generally valued as one metric ton of CO2 emissions.
Carbon footprint	The total amount of greenhouse gases that are emitted into the atmosphere each year by a person, family, building, organization or company.
Carbon market	A carbon market refers to the buying and selling of GHG, or greenhouse gas emissions, worldwide. The overall carbon market consists of two submarkets: 1) a compliance market guided by government regulation and multinational agreements, and 2) a voluntary market typically utilized by businesses and individuals seeking to offset their carbon impact.
Carbon permit	A permit gives its holder the right to pollute up to a certain level.
Clean Development Mechanism (CDM)	The system was established under the Kyoto Protocol through which countries meet emissions targets by purchasing carbon credits that fund sustainable development projects.
Commodity broker	An entity that buys and sells carbon credits that are not yet retired. They collect a margin on the sale of this service.
Compliance market	The compliance market refers to the regulatory framework established by governments and multinational agreements to legally limit how many metric tons of greenhouse gasses businesses within their jurisdiction can emit. Within a compliance market, businesses that emit less than their allowance can often sell their unused allocation to businesses that emit more than their allowance, in what is often referred to as a “cap and trade” scheme. The compliance market is sometimes also referred to as the “regulatory market.”
Emissions obligation	Total amount of annual CO2 emissions from a company that are regulated under the California cap-and-trade system.
Gold standard	A certification standard for offset projects in countries that don’t have emission reduction targets under the Kyoto Protocol.
Greenhouse gas (GHG)	Stands for greenhouse gas. These gases include CO2 (carbon dioxide), CH4 (methane), N2O (nitrous oxide), HFCs (hydrofluorocarbons), PFCs (perfluorocarbons), and SF6 (sulfur hexafluoride). Some programs also include NF3 (nitrogen trifluoride).
Greenhouse gas effect	Is caused when GHG, or greenhouse gases, get trapped by the Earth’s atmosphere and retain heat.
Guarantees of origin (GO)	The European Union mandate that all member states must disclose to consumers the proportion of their electricity consumption that is generated from renewable energy.
Greenhouse gas registry	A public listing platform for recognizing businesses that have reported third-party verified GHG, or greenhouse gas, inventories, as well as reduced emissions.
Kyoto Protocol	The United Nations protocol ratified in 1997 that established carbon emission reduction targets for participating nations (notably excluding the United States).
LCFS	Stands for Low Carbon Fuel Standard and is a measure that was enacted by former California Governor Schwarzenegger to develop alternative fuel markets as well as reduce the carbon intensity of transportation fuels by replacing 10% of gasoline or diesel with alternative fuels such as ethanol, biodiesel, renewable diesel, compressed natural gas, or biogas. LCFS credits are not the same as carbon credits.
LEED	Stands for Leadership in Energy and Environmental Design and is a globally-recognized rating system to measure the sustainability of all building types and all building phases. LEED is not related to GHG or the carbon market.
Permanent	Carbon credits only count as an emissions reduction once purchased and cannot be reversed.
Project design document (PDD)	An essential technical document that outlines a carbon credit project’s strategy and methods.
Project protocol	A document published by the Greenhouse Gas Registry. A carbon project developer will follow the methodology and meet all the criteria specified in the project protocol.
Quantification	In this regard, this addresses the number of tonnes of GHG, or greenhouse gas.
Real	The project exists and the credits represent measurable reductions in greenhouse gases.
REC	Stands for Renewable Energy Certificate and is a tool used to document the origins of one MWh (megawatt) of renewable energy between the electricity generator (wind, solar, hydro, etc.), the electricity purchaser, and its stakeholders.
REDD+	Stands for Reduce Emissions from Deforestation and Forest Degradation and is an international framework to both stop the destruction of forests and to implement forest management programs. It fosters environmental conservation and restoration, economic stimulus, training, and entrepreneurship based on data that GHGs (greenhouse gases) increase as forest stock decreases. REDD+ projects provide positive social benefits such as making bricks of charcoal with branches and twigs, rather than cutting down trees.
Registered	Carbon Credits can be used only once and must be registered with a unique serial number.
Registry	Is a third-party program to verify, account for, measure, and collect data for GHG, or greenhouse gas, emissions to be traded on the carbon market.
Regulatory offsets	Offsets purchased to fulfill a regulated emissions cap.
Renewable energy certificate	RECs are issued when one megawatt-hour (MWh) of electricity is generated and delivered to the electricity grid from a renewable energy resource.
Reseller	Is similar to a commodity broker, but on a smaller scale. A reseller sells to the end-user.
RNG Programs	Stands for Renewable Natural Gas and is a program giving gas customers a choice to purchase a percentage of their usage as natural gas, which is produced from biomass, and is interchangeable with liquified petroleum gas.
SDG	Stands for Sustainable Development Goals and is a list of 17 goals, as laid out by the United Nations, for a more sustainable future. Of the 17, four are climate-related, including climate action.
TIGR	Stands for Tradable Instrument for Global Renewables and is an online platform from which to track and trade RECs in Asia, Africa, and the Americas.
Validation	At the beginning stages, validation is a process of having a qualified accredited third-party audit of a carbon project. This assures that the project meets the GHG, or greenhouse gas, program criteria.
Verification	A process of having a qualified, accredited third-party audit of a carbon project after it has generated carbon credits. This assures that the carbon credits are genuine and bonafide.
Verified carbon standard (VCS)	A standard for certifying carbon emission reductions that is managed by the nonprofit Verra.
VOC	Stands for Volatile Organic Compound and are organic and man-made chemicals that impact indoor air quality and may pose health risks. A VOC is not a GHG. VOC’s are often found in building materials, home and personal products, and activities such as smoking cigarettes or burning wood.
Voluntary offsets	Offsets purchased for any other reason like a corporate sustainability program.
WRC	Stands for Water Restoration Certificate and is a certificate confirming the purchase of 1,000 gallons of water to offset water usage and restore critical rivers or streams, particularly at times when water is needed the most.