The Digital VCM will come to prominence in 2023. Here's why.

In 2023, a digital-first carbon market will take shape. It can improve credit integrity, transparency, accessibility and quality of supply and demand — provided that its actors are able to rise to existing challenges.

The Digital VCM will come to prominence in 2023. Here's why.

In 2022, the digital VCM started to form. Carbon credits were tokenized and traded on blockchain-based marketplaces. Web3 projects began leveraging tokenized carbon in a wide variety of applications — for example as collateral in decentralized finance (DeFi) debt markets. Novel use cases and demand sources started to appear, and voluntary carbon market (VCM) stakeholders began to recognize how blockchain technology and carbon credit tokenization could help scale up carbon markets with integrity. Numbers confirm this trend: In 2022, projects in the ReFi sector raised an approximate $120 to $160 million in funding. Many of them are now building with carbon credits tokenized via the Toucan Carbon Bridge.

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What is Web3?
Web3 is a loosely defined term for a user-centric internet that is open, accessible, fair and secure, and built on blockchain technology.
It also describes the third iteration of the internet, where Web1 enables "reading", Web2 unlocks "reading and creating" and Web3 makes it possible to "read, create and own".

In 2023, we expect these new trends and movements to really shape up. Here are some major industry trends we’re excited about this year.

  1. Web3’s value proposition for the VCM will solidify. Carbon credit integrity can be verified better, market and trading transparency will increase, there will be improved access to liquidity, and easier net-zero claims verification through the use of a variety of advanced products. Conventional and digital Web3 carbon markets will merge more and more.
  2. Blockchain technology will underpin the emerging digital VCM, but it will be talked about less. Instead, real problems that can be solved with this new technology will come into focus, and the technological foundation will fade into the background. Products built on blockchain-based carbon registries will come to the market, but they will be usable by everyone, not just Web3 participants.
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Tokenized carbon is the digital representation of real-world carbon credits on the blockchain. Learn more about the tokenization of carbon credits

3.  There will be significant progress in scaling carbon markets with high integrity. We predict that several IETA member registries will authorize carbon credit tokenization on public blockchains by the end of 2023. Some mistakes will without doubt be made along the way, but we trust industry stakeholders and builders to respond, repair, adapt, and continue to prove the value of the technology to the VCM. Early adopters on the demand side will hold tokenized carbon, and make 2023 net-zero claims based on retirements of on-chain carbon.

4.  More enterpreneurs will flock to the environmental and biodiversity asset class, and build out on-chain solutions in the process.

5.  Digital carbon markets will continue to grow in volume, and founders and builders will launch and improve innovative products addressing the climate emergency. We're really excited to see more projects facilitate sub-ton retirements, accelerate credit discovery and market analytics, and increase access to on-chain carbon credit liquidity. Carbon will also become a yield-bearing financial instrument, and it will become possible to earn interest on carbon credit deposits.

6.  The utility of tokenized carbon credits will expand as well, and new use cases will emerge. We can see more projects working on tools that bring liquidity to carbon markets, improved climate impact reporting, and digital measurement, reporting and verification (DMRV) tooling. New forms of crowdfunding for climate projects will emerge, and carbon will become embedded in fast-growing sectors like blockchain-based gaming and non-fungible tokens (NFTs).

7.  The Web3 industry will have to address issues of regulation and trust. To do so, they will work with regulators and policymakers to get strong consumer protection measures in place. Some policies will be well-informed, others will tamp down innovation — but we're confident that the market will continue to adapt in a future-proof way.

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What is ReFi?
ReFi stands for Regenerative Finance and refers to a large-scale financial system that operates in a non-extractive way. A portion of the value generated and transferred flows back to the planet, and climate-positive actions become financially rewarding.

Looking back on how digital carbon markets took shape in 2022

Throughout 2022, carbon credit registries and standards bodies developed frameworks to improve the VCM. Verra and Gold Standard launched public consultations to evaluate how they could safely leverage the benefits of tokenized carbon credits. Verra said it recognized the opportunities that crypto instruments presented to enhance financing to emission reduction and removal projects. Gold Standard acknowledged that tokenization could increase access to carbon markets, create a better record of transactions, and help increase trust. The International Emissions Trading Association (IETA) released guiding principles on credit tokenization, highlighting the potential that digital innovation provides for expanding market access, and to facilitate green investments. The World Economic Forum (WEF) initiated the Crypto Sustainability Coalition, which looks into the potential of blockchain-based technologies to address climate change.

Toucan is a member of both IETA and the WEF Crypto Sustainability Coalition, where we co-chair the Web3 Climate Action Working Group.

Many new applications leveraging tokenized carbon popped up — and while they are exciting and novel, the technologies they use are sophisticated and will be designed and developed at their own pace. ReFi is an evolving space that still has to find its feet, but it has a lot of potential to address climate issues.

What we expect from the digital VCM in 2023

We believe that 2023 will be a breakthrough year — blockchain technology and the collaborative Web3 ethos will start to add real value to the VCM. Carbon markets will begin to scale with integrity, and public carbon ledgers will bring much-needed transparency to opaque markets. Open access attracts more builders to develop their own solutions to address climate change. And compliance measures like KYC, as well as risk and compliance oversight, will help keep corporations and individuals safe. Let’s dissect the big trends we predict for 2023:

Web3’s value proposition for the VCM solidifies

Web3 can be identified by its basic design principles:

  • Open access: Low barriers to entry for users, builders and researchers. Blockchain-based protocols use programmable smart contracts and open APIs (Application Programming Interface) that can be built on top of each other to extend functionality and reach.
  • Decentralization: Web3 systems are designed so that people can communicate and transact online without relying on trusted intermediaries. Users have the option to control their data and gain full custody of their assets.
  • Transparency: Every interaction — be it a transaction on a blockchain network or a file transfer on a peer-to-peer system — is verifiable and easy to analyze.
  • Open code: Open-sourced systems can be audited by everyone, are therefore more secure and have longer-term resilience.

Tying this in with environmental asset markets, blockchain technology will underpin much of the future carbon markets, but it will be talked about less.

Instead, successful ReFi products come into focus, and convince with real utility. Terms like “DAO” and “on-chain” will lose cultural currency — protocols will instead focus on solving the real problems that market actors face. Some areas where we expect to see improvements: more liquidity for carbon credit buyers and sellers, instant settlements for carbon credit trades, and open APIs. Web3 features like wallets and staking will be available for those that want them, but won’t be a barrier or point of friction for VCM stakeholders that are not comfortable using them. This will be a stark change from the second half of 2022, when much of the ReFi space was in a holding pattern as Web3 actors and VCM stakeholders worked together to develop a safe pathway to carbon credit tokenization.

Scaling carbon markets with integrity

Improving the integrity of carbon credits was a major theme in 2022, and innovative Web3 solutions will emerge to address the issue, tackling the following areas:

Accurate and transparent tracking of credits: Blockchain technology can provide a secure and transparent platform for tracking, verification, and trading of carbon credits.

Pricing challenges: A public ledger helps carbon markets with better price signals. In the conventional system, trades are often conducted through brokers and intermediaries, rather than on a public exchange. This means there is no publicly accessible pricing data, and it’s hard to establish reliable pricing signals.

Double counting: Blockchains can limit double counting issues, and ensure verifiable transactions. Double-counting refers to different claims that are simultaneously levied on the same carbon credit. Double-counting is a big issue in the VCM, as a former regulatory body reported.

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Integrity has been repeatedly identified as the largest barrier to scaling the VCM in line with meeting the aims of the Paris Agreement. Read our piece on scaling VCM integrity.

How did the conventional VCM address the integrity question in 2022?‌ ‌

A lot of integrity initiatives emerged in the VCM in 2022. A few examples:

  1. The Voluntary Carbon Markets Integrity Initiative (VCMI) developed a Claims Code of Practice for the VCM. This is essentially a guide on how carbon credits can be used by businesses and other stakeholders as part of a credible, net-zero decarbonization strategy.
  2. The Integrity Council for the Voluntary Carbon Market (ICVCM) released draft Core Carbon Principles (CCP) and Assessment Frameworks (AF) as standards to identify high-quality carbon credits. Note that the ICVCM and the Voluntary Carbon Markets Integrity VCMI have different areas of focus. The ICVCM concentrates on the supply integrity of carbon credits, while the Claims Code, which is overseen by VCMI, deals with demand-side claims made by individuals or organizations involved.
  3. Science Based Targets initiatives (SBTis) defined and promoted best practice in emissions reductions and net-zero targets. 

ReFi will continue to grow rapidly

We anticipate that the ReFi space will continue to grow and take shape throughout 2023, and that more real use cases for digital applications will materialize.

We also see ReFi and the conventional VCM blending together more. Stakeholders like the WEF, Verra, Gold Standard and World Bank are already participating in developing frameworks to safely scale this nascent space. Governmental entities have also signalled interest in blockchain-based systems to help accelerate positive environmental and social outcomes. For example, the Biden White House in the US released a report on Climate and Energy Implications of Crypto-Assets in the United States, highlighting the potential uses of blockchain technologies for monitoring or mitigating climate impacts.  

Utility for carbon credits will expand

2022 saw a rise in applications that provide tokenized carbon with more utility, for example by integrating it into the DeFi space or into blockchain-typical uses, like staking.

A few examples of how new projects use tokenized carbon:

  1. Neutral will allow users to trade carbon futures and options. Read our interview with CEO Farouq Ghandour.
  2. Spirals empowers users to hold “green” versions of cryptocurrencies that fund climate impact projects across the world. Read our interview with CEO Helena Merk.
  3. Senken is a transparent and easy-to-use digital marketplace for tokenized carbon credits. Read our interview with founder Adrian Wons.
  4. Return Protocol is a climate action platform that automatically calculates and compensates fora user’s blockchain emissions.
  5. disCarbon is building transparent and verifiable carbon retirement tools, for example a Flight Emission Offsetter that allows anyone to compensate for their flight emissions.
  6. Atem is a platform that provides access to carbon credits through a simple API and web interface. It allows users to easily purchase and retire carbon credits.

Stronger regulations will improve trust in the VCM

Everyone can build with Web3 tooling and infrastructure. This open environment leads to unbridled innovation and close cooperation between founders and builders across the globe. But it also means that bad actors might be able to take advantage of novel systems. Throughout the year, the ReFi industry and its participants will address criticisms and rise to challenges, for example by collaborating with existing registries, standards bodies and other stakeholders. Together, we can build systems that help increase public trust in carbon credits as a tool to address the climate emergency, while also managing risks and protecting consumers.

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Read our detailed explainer on how KYC can be implemented in Web3 carbon markets

We expect regulations on Web3 to tighten throughout 2023, as mass-adoption speeds up. Toucan supports the implementation of reasonable regulative measures that keep users safe. Builders and founders in the digital carbon market space need to work with regulators to help them put smart, thoughtful policies in place — policies that protect consumers and manage risk, while supporting the innovation that’s being driven within Web3.

The DMRV space will grow rapidly with blockchain technology

DMRV (digital Measurement, Reporting and Verification) solutions will become more important throughout 2023. dMRV is a process that uses digital tools, like remote sensing, to track and verify the environmental impact of a particular activity or industry. In the past, it was a somewhat cumbersome process to monitor the climate impact of projects, requiring manual data entries and a high level of human oversight. We predict that dMRV infrastructure will evolve quickly, allowing for more accurate and comprehensive reporting, which in turn gives companies a clearer picture of their environmental impact.

The environmental asset market will expand

There will be a growing appetite to branch out from tokenized carbon credits. Biodiversity credits and environmental assets will start to appear. Biodiversity credits reward projects that focus on preserving and enhancing the diversity of plant and animal life within a particular ecosystem. (In comparison, carbon credits are a way to fund projects that reduce or capture carbon dioxide). Examples of biodiversity credit projects could be the restoration of wetlands or protection of critical habitats for endangered species. We expect on-chain solutions for biodiversity credits to emerge in 2023. This ties in with the above example: dMRV solutions like TreeSwift or Gaia could be leveraged to collect and log information about biodiversity. With small adjustments, digital carbon registries can work with other forms of impact certificates.

Conclusion

We’re excited for what 2023 will bring, and expect the digital carbon market space to drastically evolve throughout the coming months. Resourcefulness, conviction, deep knowledge and newfound connections will help form a level playing field where corporates, individuals, climate projects and builders can directly interact with each other, independent of short-term market movements. We’re looking forward to seeing which existing and new market participants have the endurance and insight to create real value.

We expect the lion’s share of growth and traction to go to early ReFi projects with a long-term vision and realistic plans for implementation. Additionally, many big players have been watching and waiting for the market to solidify and for the dust of market movements to settle, before dipping their toes into Web3-powered climate action.

To sum things up, the ReFi movement made significant progress in 2022, with numerous projects and initiatives demonstrating what is possible when carbon credits are tokenized. The rise in funding and recognition from industry stakeholders, including carbon registries and standards bodies, suggests that ReFi is poised to continue its growth and make a meaningful impact in addressing climate change.