📍 The pain point
The current VCM can be characterized as complex, fragmented, opaque and lacking in consistent regulation. This greatly reduces transparency between project developers and credit purchasers, leading to high levels of market risk and inefficiency. This leads to:
- Standards fragmentation and double counting
- Low price transparency and high mark-ups
- Risk of non-delivery
Standards fragmentation and double counting
Multiple carbon registries exist that certify and index carbon credits, such as Verra and the Gold Standard. Each registry however, has a different approach to assessing and characterising the type of carbon credit a project produces.
BeZero for example, recently found 94 different credit types across the five major registries, alongside multiple other standards relating to credit co-benefits. This lack of consistency exacerbates the differences between credits, making it difficult to pool similar types into standardised units, assess value and set a consistent price point.
The current VCM therefore lacks the liquidity necessary to establish market efficiency at scale. Presently, credit buyers must be individually matched to appropriate projects, which is time consuming, inefficient and involves intermediaries like brokers.
The presence of multiple registries can also contribute to the double counting of credits, as visibility is lacking across the lifecycle of a credit. For the integrity of the voluntary market, making sure that double counting cannot happen is pivotal. Clear, unified and interoperable records are therefore key.
Low price transparency and high mark-ups
Once a project developer has had their credits certified and issued on a registry, they often sell these 'over the counter' to wholesalers or brokers, due to the issues of liquidity identified above.
These transactions involve a bilateral contract between two specific partners, which is not visible to the wider market in terms of price or numbers negotiated. The wholesaler or broker is then responsible for selling the credits on to an end user.
The involvement of these middle-men means that the final purchase fee by an end user often represents a sizeable mark-up, with “shockingly little data” available on how money paid for final carbon offsets is actually spent. Indeed, these transactions have been criticised by the US Securities and Exchange Commission for their lack of transparency.
Recent research identified some 250 projects where brokers resold credits for at least three times the purchase price. EcoAct are discussed as placing a high mark-up on one particular project, purchasing credits for $2.75 a tonne and reselling them for around $15.
The project developer involved however, discussed that this mark-up merely reflected the way in which the market had changed since EcoAct initially purchased the credits. Indeed, many projects require early engagement by brokers to attract a reseller to make the project attractive, meaning that changes in price during implementation reflect the actions of the free market.
Conversely, others feel that intermediaries are benefitting from trading in conditions that eliminate price transparency around the amount of money reaching developers and on the ground beneficiaries, with no regulation currently controlling this. This can make carbon markets appear extractive and lacking in integrity, highlighting the need for greater efficiency and transparency.
Risk of non-delivery
Lack of market transparency poses many risks to credit purchasers, including those of non-delivery or trades not being executed immediately, if at all.
There is exacerbated by a lack of market reference data, which can lead to a disconnect between the end user and what a project is delivering on the ground. This creates limited visibility into a project’s lifecycle or ultimate impact, or whether it meets expected standards around effective carbon offset delivery, including aspects of additionality, permanence and risk of reversal.
✨ How web3 can help
Web3 has the potential to tackle these issues by cutting out inefficient systems and intermediaries, leveraging blockchain to:
- Create market liquidity for greater price visibility
- Coordinate a single registry
- Improve transparency between market actors
- Reliably record and attribute data to different credits
Achieving this can primarily be tackled via the tokenization of carbon credits...
🔗 Tokenizing carbon
Tokenizing a carbon credit refers to turning it into a digital asset that lives on the blockchain. Each credit is publicly coupled with accompanying data on its origin and characteristics.
This is super useful, as it enables:
- The ability to pool similar credits, making different projects more interchangeable
- The creation of a market without intermediaries, as projects can sell credits to end users directly without the need for wholesalers or brokers
- Greater data retention and transparency, with project impacts more visible and tracible over their lifetime
🔍 Liquidity to reduce fragmentation and increase transparency
Toucan Protocol has developed a carbon bridge that allows off-chain carbon credit holders to bring their credits onto the Polygon blockchain network. On-chain credits can be bought and sold like other assets or deposited into carbon pools.
These carbon pools are collections of tokenized carbon credits with similar attributes. A Base Carbon Tonne (BCT) consists of Verra credits issued in 2008 or later and currently trades at around $3 a credit. A Nature Carbon Tonne (NCT) represents a credit issued after 2012 for a nature-based project and currently trades at around $7 a credit.
There are two key advantages that pooling credits creates:
- Greater transparency: Many types of credits are able to move in and out of the pools, creating a huge choice for end users seeking to offset. Where else can you find 167 different projects that you can immediately buy on the market?
- Price signalling: These pools have now amassed $30-40 million in liquidity, creating a very fluid and deep market where buyers can acquire large amounts of credits without significant price spreads or slippage.
To date, Toucan has tokenized over 21 million tonnes of carbon via its on-chain bridge from 167 unique projects.
Similar projects include MOSS, which has tokenized 2 million carbon credits on the Ethereum blockchain, and Nori and Regen Network, both of which work with farmers to produce, verify and tokenize carbon credits within their own on-chain registries.
🤝🏼 Registry coordination to avoid double counting
Web3 can enable the creation of a single meta-registry, bringing together all tokenized credits in one place to reduce issues of fragmentation and double counting.
On-chain registries additionally provide verifiable proof when a tokenized credit is retired as an offset by the end user, thereby solving the double-counting problem and fraud that plagues off-chain offsets.
The World Bank’s Carbon Warehouse project seeks to integrate compliance, voluntary and centralised UN carbon registries into one platform. This would allow for high levels of visibility across markets, enabling greater coordination. Toucan are seeking to support such efforts, building a neutral open meta-registry of BCT and NCT carbon credits.
🧮 Publicly available, immutable records to reduce delivery risk
Tokenized credits include all data relating to the history of the credit, including that captured directly using local devices for ongoing monitoring.
This data can be updated and move with the credit across different transitions and market places. Purchasers and watchdogs are therefore much better able to track offset claims back to the project source and have an understanding of impacts on the ground.
Our next post will explore the pain point of lack of credit integrity 🔎