The premise of Crypto Carbon
If greenwashing is the outcome of traditional carbon offset markets - Can we use crypto to reprogram the incentives over-the-top to actually go green?
A young action, finally got people and companies to talk about their carbon footprint on the environment and reflect on what they can do to reduce it effectively, not just offset. A “budding movement within the crypto industry” with protocol organizations like Toucan, KlimaDAO, Moss, and Flow Carbon started to explore their way into carbon offset markets, and how to create new markets beyond offsetting.
Before we can go into what enables crypto carbon markets to be radically different from what traditional carbon markets arrived at after decades - I need to intro or refresh some basics: Decentralized Finance (DeFi), #ReFi, carbon credits, voluntary markets, offsetting vs. insetting and greenwashing vs. going green.
DeFi or “money legos”
Once value is tokenized, it needs liquidity to be easily exchangeable - else it will not flow, but be stuck in its value stock. Liquidity providers (LP) are market actors who provide a pair of tokens in an exchange pool, effectively making a token liquid, i.e. easily exchangeable for the other. Automated market making in decentralized exchanges (DEX) enables anyone to be an LP. Programmed incentive mechanisms into pools, assure that it pays off for someone to provide liquidity for a certain token: they get a share of the value created represented in the protocol token (if there was no value created this would be a ponzi scheme). Whereas most LP rewards are determined by governance, i.e. token vote. There is an emergent innovation that a protocol can own its liquidty.
In following articles we will understand all the DeFi components and compositions as well as NFTs as certificates or carbon credits to be able to imagine the promise of crypto carbon:
#ReFi - just to be complete:
#ReFi is a riff off DeFi - for now, only stumbled upon in niches of crypto twitter - signifying projects and people that are really into figuring out how to make DeFi work for Regenerative Finance. However, in #ReFi we don’t buy that either financial return or environmental return have to be a by-product of the other. Instead, we can represent in/tangible values as tokens and reprogram the valueflows such that it pays off participants to return on intangible values alike.
Carbon credits, voluntary markets, offsetting and greenwashing vs. insetting and going green in one wash:
A carbon credit is “any tradeable certificate representing the right to emit” a set amount of CO2e (carbon dioxide or equivalent amount of different green house gases). It goes without saying that if we just make use of this right, then any investment into renewables and regenerative ventures that effectively mint those credits just cancel out. As it stands today, all I can do with those minted credits by originating or supporting a regenerative venture is to sell the credits to a polluter. They then “offset their carbon emissions” in pure accounting, i.e. greenwash, making me a partner in crime.
Some carbon emissions you can’t just imagine getting rid off completely: e.g. flying, unless flying itself becomes carbon-free. For for-profit organizations it is even worse, they are on a set track to make profit, so any change is a cost unless it is an investment. Unless organizations turn for-purpose one day. Even in a profit-driven world though: Now many businesses realize that producing with on-site renewables (called “insetting”) is actually adding to their brand value.
“So insetting becomes an investment.” - Molly Webb, creator of YoYu
How did that happen? Thanks to you and me, the consumers - now that we look up.
Since per definition carbon credits are tokens, i.e. any tradeable certificate of the right to emit a set amount of carbon, we can add them into ReFi as a component - and start experimenting with incentives to actually go greener. Because it is financially more attractive then just offsetting dying ways of doing business. And this is exactly the tagline of Toucan:
“Tokenized carbon = building blocks for a regenerative economy”
“But wait!”, you say, “How do we know if these credits are valid without 3rd party validators?” This will be solved by what I would call the cryptoeconomics of carbon which is just about to start unfolding. Now that the traditional partners enabled these cryptocarbon protocols to take the training wheels off. It is not easy, since this is the first time that crypto meets real world beyond loans - but entirely possible.
Toucan Protocol
Toucan foremost provides a bridge between the real-world asset of carbond credits and DeFi. I only question the need that only credits from 3rd party verifyers can be bridged. Coming from decentralized energy systems research at Siemens, we have a long track record of demonstrating that technically minting these credits was entirely possible since 2008. However, we were lacking the mechanisms that cryptoeconomics brings to the table: A combination of reverse game theory and cryptographically secured public ledgers for transparency. We will get to the analysis of these mechanisms in later articles. But it is entirely possible the have data-driven distributed validation and plausibilisation of the data that signifies a carbon credit, and to use cryptoeconomics and distribtued ledger technology to prevent it’s double-spending.
Based on this assumption that cryptoeconomics is the missing piece of the puzzle, let’s analyze what components each protocol brings to the ecosystem and how they are currently composed:
Now the Bridging mechanism has been designed with requirements of a huge intermediary like Verra. It is bloated with process steps to keep compliant with an old standard that hasn’t proven effective, otherwise you wouldn’t be reading this.
What is worth noting is the TCO2 token though, and how it uses the non-fungible token standard ERC721 to encode and “decommoditize” the carbon credit. The token smart contract encodes the project specific data over a certain time period and the amount, and batches them into 1 tonne - hence “batchNFT”. Only compliance with this standard then will result in the ability to mint the fungible TCO2, which encodes the credit attributes in its label. Is it to closely married to Verra’s standard? Yes. Is that a blocker? No. Remember these are programmable.
Next comes the actual building block for playing regenerative money legos we are looking for: the Carbon Pool. Any amount of TCO2 tokens can be deposited in a pool, if they meet some specified pool criteria. That specified pool than mints a pool token. This way one can create liquidity and enables price finding for certain type of regenerative projects or across specific times, called vintage.
At any time you can return your pool tokens (also called carbon reference tokens) to the carbon pool and redeem the underlying TCO2, in order to “retire” (meaning to offset one’s carbon emissions).
There seems to be more work to be done wrt playing with multiple pools. Since to date only two pools were created: BCT (see below) and NCT. Pool parties, too, will need broader participation, especially directly from originators or carbon credits. Decentralization is progressive.
“Soon we will publish a post detailing our path to decentralization, where we will describe our plan to make the creation of these pools completely permissionless in the future.” - Toucan Protocol
KlimaDAO
KlimaDAO was the creator of the first pool, the Base Carbon Pool, with the carbon reference token BCT - the Base Carbon Tonne. The pool criteria are basic and entirely dependent on Verra, but obiously that will change. And the interesting part of the story is twofold and not what you expect if you are coming from traditional solar industry or carbon markets:
KlimaDAO is a fork of a cutting edge DeFi Protocol called Ohm (which we will elaborate on as promised in follow on articles). For now, this is a quick reference that explains the obvious problems with incentivizing LPs: they will always go where the incentives are higher, effectively drying up a protocol. So Ohm uses a combination of previously separately existing mechanisms in a simple game-theoretic model using its own protocol token OHM. Since these protocols are open source, and this protocol has merit to be a pain killer, there have been many forks, i.e. projects using the same code in their own repository to build upon. KlimaDAO was one of them.
KlimaDAO uses the same mechanisms to incentivize both to bond against KLIMA and staking KLIMA- effectively reducing the normal sell pressure. But nothing is normal in these times. We will go into how these two protocols faired and what are the current developments. But first let’s finish the round up, how KlimaDAO connects to Toucan.
Ohm protocol “only” created an algorithmic reserve currency. KlimaDAO’s added value was that 1 KLIMA would be backed by 1 BCT, the token of Toucan’s carbon pool that contains the fungible TCO2 tokens, that represent the carbon credits in Toucan’s on-chain registry. This sounds convoluted only if you try and unfold it. Effectively KlimaDAO locked BCT to mint its carbon-backed KLIMA, and Toucan created a bridge for carbon credits to become ReFi money legos in carbon pools. Each protocol found their niches.
Now both need more of the other, creating the mix of open collaboration and competition that is typical of crypto: Toucan supports more and versatile voluntary carbon markets (VCM), pushing KlimaDAO to innovate not only on financial engineering layer, but to improve the experience of VCM users, e.g. via Klima Infinity. Likewise KlimaDAO supports more and versatile carbon reference tokens to lock in their treasury like, MCO2, …then thanks to Toucan again: NCT,…then … Well, as opposed to OHM, which can bond against many other cryptotokens DAI, ETH, etc. there aren’t many bridged carbon tokens - yet. So, the protocol is adjusting its configuration through decentralized governance. Ecosystem funding strategy is likely to play out next.
What we see here is the bootstrapping of an ecosystem from a previously two-sided market using crypto token networks coordinated by distributed organizations, integrating with real-world assets - amidst the onset of yet another crypto winter:
Even though crypto cycles look chaotic, over the long term they’ve generated steady growth of new ideas, code, projects, and startups — the fundamental drivers of software innovation. - Chris Dixon and Eddy Lazzarin
The crazy high and low of KLIMA is likely also due to the meme^PR-driven culture forking a hot algorithmic token in an overheated market that was plowing too much money into yet too risky innovation too fast.
In Conclusion
KlimaDAO (backed by Mark Cuban) has programmatically created a “blackhole for carbon credits” - meaning, you don’t have to sell off to a polluter but can now mint KLIMA with your reference carbon tokens to see your climate positive action also pay off financially. It has done this with such a momentum that it attracted a lot of attention - even from the recovering reality-bending visionary of WeWork, Adam Neumann, backed by both a16z and a lot of red flags.
But this is not the conclusion I promised to leave you with until the follow up with a deep dive into DeFi components to be composed for ReFi.
I want to draw your attention that for now all of these protocol developers still cater to the same stakeholders of the centralized carbon markets: intermediary verifiers, large projects that can deliver tonnes of carbon (supply), and big corporations that need to offset their polluting ways (demand). In a way, for some of them it seems hard to let go of the web2.0 platform strategy (caution, that Doctorow critique in the link is hard to stomach even for me who is a very cuatious optimist. But it is important that we can discern reality-bending visions from the game changing programmable incentive mechanisms and technological innovation that needs use cases).
The open and permissionless infrastructures these new players are building and testing, however, are capable of much higher granular tokenization of carbon based on real-time location-based data, e.g. kilogramms of CO2e avoided from using clean energy of solar rooftops. A solar rooftop depending on its size, solar irradiation, and how much dirty grid energy it displaces at its specific location, could easily help me offset the round trip flight for an in-person workshop: which costs the earth 356 kgCO2.
A 30kWp solar rooftop, displaces anywhere between 60 to 200 kWh of grey electricity by green electricity per day, which roughly equates to 30kgCO2e avoided per day.
Imagine there was a crypto project that rewards its participants with carbon credits, for directly funding solar projects, say on a daily basis. I would definitely now claim around 12 of those tokens to offset this necessary flight. However, why should I burn these tokens?
Could I curate my own climate action collection? A collection that not only proves that I am taking action, but also makes clear my balance between offsetting and insetting. A collection that is beautiful to look at? Can I go greener - not only help other peers go green by funding solar directly?
What incentives and positive nudges do we need to thrive as members of the earth’s ecosystem? How can we make use of the developing crypto carbon infrastructure to truly bootstrap a multilayered network of balanced action and incentives? How do you want to participate in such a network? What are your needs? What valueflows would you be connecting to through your networks?
I am looking forward to the Crypto Carbon Ecosystem event, at which these and more questions will be raised and explored collectively.
Let’s reflect on this: the only effective change since the Paris Agreement that actually made companies move into insetting, is because we started caring about what and how we consume. Peer networks are powerful. Now we have powerful programmable incentives to play with.