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How blockchain can clean up the voluntary carbon market

Published 6 September 2023 in Technology • 6 min read

In the second in a series of articles looking at the carbon market, the authors explore how the use of blockchain technology could not only keep the voluntary carbon market honest and transparent, but it could also allow new products to evolve.

Carbon credits were bashed again in May. Late in the month, David Antonioli, the chief executive of Washington DC-based Verra, the world’s leading certifier of carbon credits, announced that he intended to step down. This followed an investigation by several international news organizations earlier this year that found that more than 90% of its rainforest carbon offsets were worthless. 

Elsewhere, Boston-based pressure group Corporate Accountability reported that more than 90% of the carbon offsets that US auto manufacturer Chevron has retired through the voluntary carbon market to cancel out its emissions appeared to be what it called “junk”.  

These scandals highlight the problems with the current mechanisms of the carbon credit market, predominantly a lack of standards and visibility.  

For the market to regain credibility it needs to change. A promising answer is to use blockchain, a record of transactions maintained across computers that are linked in a peer-to-peer network. This can help with transparency, standardize the market, avoid problems like double accounting – where the same emissions reductions are claimed by multiple organizations – and encourage the creation of liquidity in the market.  

It is an idea that is gaining traction. In a white paper published at the end of April, the World Economic Forum described digitizing the voluntary carbon market as “the leading use case for blockchain innovations in the climate space”. 

Stop cheating 

First and foremost, blockchain technology can help carbon credits maintain their credibility by keeping the process clean and stopping cheating. This is crucial to avoid the problems that have plagued the sector.  

Although the application of blockchain does not automatically increase project quality, blockchain can help to provide transparency on the methodology applied and the calculations made by the project. This means that if a certain number of mangroves in one area is planted, then there is visibility about the maximum level of removal of greenhouse gas (GHG) emissions that can be claimed.  

If it is possible to see that a specific project is supposed to generate 5,000 carbon credits by 2025 with a further 5,000 credits to be issued by 2027, the owner of the project is limited with the number of carbon credits that can be issued.

A promising answer is to use blockchain, a record of transactions maintained across computers that are linked in a peer-to-peer network.

The international standard – backed by non-profits and many governments – is that one carbon credit is equivalent to one ton of carbon dioxide emissions.  

Much in the same way that companies that sell green or sustainable bonds or loans in the capital markets have third-party verifiers, blockchain can also help monitor that projects are happening the way that they claim.  

Satellite imaging can help track the progress of projects to give investors a good sense of GHG removal. Together with the help of third-party checkers who can then measure the emissions removals either once or twice a year, a detailed picture can be built up and stored for anyone to look at. 

All of this is both an advantage for and a weight off the minds of the buyers of carbon credits.  

Look to the future 

The oversight of the carbon credit market that is given by blockchain could not just clean up the market, it could help it evolve too. Its transparency means that future credits can be created for assets that do not yet exist, but which give the right to carbon credit in the future. 

Let’s say that I buy a forward in the carbon market – 50,000 credits that I will get in 2025.  

I have no idea how that project will evolve between now and then. 

First of all, by tokenizing the carbon credit and then using digital data it is possible to track the progress of the project within the token itself. This is crucial because the project remains transparent to the carbon credit owner at any point in time.  

But if the project remains not only on track, but is likely to be completed ahead of time, the value of those carbon credits goes up. Obviously, it doesn’t make sense to foster short-term trading just so traders make gains from carbon credits, but it might make sense to cash in those credits and sell them to someone who is desperate for them.  

With a constant market, it would be possible to trade carbon credits at any time.  

At the moment, the tokenization of carbon credits still has a foot in the old world. To all intents and purposes, it is a legacy paper certificate that is tokenized.  

What is needed is for that process to become virtual from the beginning.  

In doing so, everything could be stored on the blockchain with native blockchain registry and native carbon credit tokens. Only when you get to that point can you assure the market that there is full control over issues like double selling and double accounting.  

There are of course downsides to blockchain.

satelliteSatellite imaging can help track the progress of projects to give investors a good sense of GHG removal

Blockchain should, in the end, be more cost-efficient than traditional databases. It cuts expensive market intermediaries with their opaque margins out of the market. It might appear a disadvantage that the technology does not make it easy to modify data once it has been recorded, and it is comparatively slow too, but this can also be seen as an advantage, The point of blockchain technology is to have an immutable leger of carbon credits.  

But the most significant issue is blockchain’s energy consumption. In August last year, the White House estimated that global electricity usage for blockchain stood at 120 and 240 billion kilowatt-hours per year. To put that into perspective, that is equivalent to between 0.4% and 0.9% of annual global energy usage and exceeds the annual electricity use of Argentina or Australia.  

But this is only true for proof-of-work blockchains.  

Almost all tokenized carbon credits like Ethereum and Polygon are built on proof-of-stake blockchains. These use considerably less energy than proof-of-work blockchain. Some studies have found the energy usage of a proof-of-stake blockchain is on par with sending an email. 

Finally, there is the issue of regulation. Blockchain remains only selectively regulated, though that is beginning to change. Checks and balances such as a Know Your Client (KYC) check for token issuers and buyers, or secure token custody is needed to avoid the misuse of this technology. 

These issues need to be addressed to be sure, but the carbon credit market has had a cloud over it for much of the year. Blockchain technology can blow these clouds away. It can not only help with transparency for future carbon credits, but it can also help develop carbon assets that don’t yet exist.

Authors

Karl Schmedders - IMD Professor of Finance

Karl Schmedders

Professor of Finance at IMD

Karl Schmedders is Professor of Finance at IMD. In his research, he applies numerical solution techniques to complex economic and financial models, shedding light on relevant market issues and industry problems. He is also Director of IMD’s new online certification course for structured investment products in partnership with Swiss company Leonteq, teaches in the Advanced Management Concepts (AMC) and Executive MBA programs, and is an advisor on International Consulting Projects in the MBA program.

Jerome Cochet

Co-Founder & Managing Director at goodcarbon

With a strong business and marketing background, Jerome previously worked for the likes of McKinsey & Co, and Zalando, where he founded Zalando Marketing Services. As an avid nature and outdoors lover, Jerome always sought a way to combine this passion with his professional life and do his part to fight climate change, support biodiversity, and the local communities who are impacted.

Ricarda Röller

Director Business Development at goodcarbon

Previously a senior consultant at Kearney, Ricarda is now in charge of goodcarbon‘s sales approach, developing financial products, defining the platform requirements, and managing our team. Inspired by a trip through the Amazon, Ricarda firmly believes every single one of us has a responsibility for our planet and enjoys leading our team in having a real climate, biodiversity, and community impact.

Angelika Schmid

Data Scientist and head of data-driven sustainability at Accenture

Angelika Schmid is a Data Scientist and leads the data-driven sustainability group at Accenture consulting. She has dedicated her professional life to creating value and insights from data ever since she started her PhD in Applied Statistics in 2013. She leads strategic AI and ML projects in the Financial Sector and is currently supporting helping companies to set up ESG measurement and thereby making progress with regards to sustainability tangible and plannable.

Philipp Müller

Data science consultant at Accenture

Philipp Müller is data science consultant at Accenture. He completed a PhD studies at the Chair of Quantitative Business Administration, University of Zurich. His research interests include Computational Economics, Econometrics, and machine learning applications in economics and finance.

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