Climate change has become a mainstream topic, moving away from the spectre of NGOs and to an agenda among governments and in the corporate boardroom as well. The race to combat global warming has everyone interested, and the scaling of voluntary carbon markets is one of the key areas of interest in this regard.
Where the pledge was to keep global temperatures from rising beyond 2.5°C on average compared to pre-industrial levels, in reality, we need to find ways to prevent the earth’s temperatures from soaring by as much as 3–3.5°C within the 21st century alone. According to a report by the World Bank, the crisis could drive over 200 million people into forced migration within their respective nations by as soon as 2050.
Currently, less than one per cent of global greenhouse gas emissions are tracked and tackled through the use of carbon credits. There is an urgent need to increase this level significantly, but there are several barriers holding back scaling in this sector.
The problem at hand: Not unknown but little done till date
The issue of reducing carbon emissions is something nearly everyone agrees upon, but in terms of action, little has been done so far. Although there is consensus that there is an urgent need to reduce global emissions significantly, in reality, emissions continue to rise higher at an alarming rate to date.
It’s not just the scientists anymore, but even lawmakers, industries and consumers who know that the mean temperatures across the world are set to rise significantly, causing ice caps to melt faster and send sea levels higher. This, in turn, is set to wash away prominent coastlines globally by as soon as the end of the present century.
There is a pressing need for businesses to transform themselves into becoming climate-positive, but the real challenge is how to achieve this. Not only should organisations reduce carbon emissions and become more responsible about reporting them but also ensure that this trickles down their supply chain for effective change.
The challenge with present-day carbon markets’ infrastructure
Carbon markets are typically decentralised but too distributed to scale up commercially at present. Meanwhile, most projects related to carbon credits (including ones that use a Blockchain) are also too centralised in their design and lack the resources and flexibility to truly expand on a global scale.
Most of the traditional platforms for carbon markets and even the newer blockchain-based solutions work independent of each other, and there is a lack of standardisation that prevents interconnected operations.
There hasn’t been much focus on innovation and investment in developing decentralised carbon markets till date, despite rising awareness of what a pressing problem this is. The lack of interest in developing such solutions and supplying markets with robust and reliable technology for tracking and reporting carbon credits is one of the biggest hindrances that could prevent it from becoming a bigger concern.
Another major issue is a lack of understanding of how carbon markets function and how businesses can get started with carbon credits’ tracking. The market is highly opaque and very little is known beyond key sectors, although the concern is highly inclusive and all-encompassing.
Also Read: How blockchain is contributing for Scope 3 carbon emission tracking
To achieve true scalability, there must be a way to connect all existing solutions in the carbon market space together or create a whole new solution. The new solution should not function at scale without compromising on the key elements of trust, transparency and verifiability.
While centralised solutions may not be the answer, blockchain and Web3 technology can certainly render such a way out. A blockchain-based carbon markets platform can maintain decentralisation without being fragmented, complex and illiquid.
DeFi for carbon finance
One possible approach that can solve this challenge lies in the already existing worlds of DeFi and Web3. These technologies are designed with decentralisation from the ground up, while retaining security and transparency.
Decentralised finance has already taken the world by storm and caught the attention of the mainstream financial services industry in 2022. Democratising access to financial services to users, DeFi enables smarter, cost effective and faster peer-to-peer transactions without the need for expensive, opaque and sluggish intermediaries.
A DeFi based infrastructure for carbon markets powered by blockchain technology can significantly speed up efforts by industries across sectors to achieve net zero emissions in a responsible, inclusive and transparent manner. Here’s how such a system could work:
Base layer
The settlement layer would be based on a blockchain network, carrying with it all the benefits the technology has to offer, including decentralisation, immutability and encryption. This layer would have smart contract functionality and run DeFi protocols tailormade to handle carbon markets.
Multi-protocol interface
A multi-protocol interface would help aggregate on-Chain voluntary Carbon credits (bridged via various existing projects) and structure these into novel investable financial products while also providing a set of smart services (identity, liquidity, compliance, and more); all delivered via a host of DeFi protocols
The platform
With a decentralised exchange at its centre, the platform would host marketplace with automated market making for Carbon-based structured financial products. API based integration with enterprise apps, decentralised oracles for access to accurate, tamper-proof real-world data and other external systems via asset wrapper services, relayer networks, liquidity pools and custodial services can create a wholesome and vibrant decentralised ecosystem for Carbon Finance.
An optional DAO could further provide a decentralised reserve currency backed by on-chain Carbon credits to facilitate transactions on the platform and within the ecosystem.
In addition to being accessible to enterprise applications, this layer can also be tapped by other stakeholders, including auditors, investors, aggregators or brokers and corporates or institutions. Both auditors and enterprise apps can leverage data from the system for reporting carbon markets data to regulators with complete transparency and no chance of tampering it.
DeFi protocols for carbon markets
DeFi protocols integrated with verified third-party networks or services can be used to create secure, liquid and scalable decentralised carbon markets infrastructure. They can allow corporate firms and institutions as well as individuals perform transactions with tokenised carbon credits.
Be it trading, investing, yield farming, insurance, and more, all these can be supported by decentralised exchanges that can tap liquidity pools and farms made up of carbon tokens or stablecoins. External services can integrate additional features for security, including identity management, multi sig wallets and even their own liquidity pools and relayer networks into the system.
Also Read: Why the Carbon tax is just a step forward and not a solution
The governance of such a system can also be completely decentralised by forming a DAO. The DAO can be responsible for minting or burning of carbon credit-based tokens, support staking, and even offer tokenised bonds and credits to investors and stakers.
Carbon registries can tokenise their offerings and input their contributions to power such a decentralised system.
Powering accessibility
Ensuring that such a system employs a simple user interface can encourage more stakeholders to partake in such decentralised carbon market applications. Open standards-based APIs to develop the system can make it more scalable and accessible as well.
The benefits
Such a system has several key advantages that make it attractive and enticing for use by stakeholders, including:
On-chain credits
Carbon credits can be stored and managed in a tamperproof, time-stamped and secure manner on the distributed ledger
Carbon trading
A DeFi-based carbon trading platform has its own efficiencies, including speed, transparency and energy efficiencies (as long as it is built on top of a ‘green’ blockchain). Powered by smart contracts, trading and settlement can be automated for improved efficiencies in operations which cannot be implemented in a conventional, centralised model.
Institutional tools
Organisations can innovate on the system further, developing and offering structured products based on tokenising environmental projects that counter climate change. These products can offer higher levels of accountability and end-to-end visibility thanks to blockchain technology, something that traditional systems cannot offer.
Liquidity pools
Carbon markets can be infused with higher levels of liquidity as protocols incentivise providing liquidity to the system. This can not only boost participation but power capabilities for greater scalability.
Making carbon markets more inclusive and efficient
Together these can help overcome the various challenges faced by the current centralised systems and help create a more efficient, inclusive, and vibrant decentralised carbon market. Scalable solutions designed and deployed on the blockchain have the potential to make carbon finance more accessible and attractive for individuals and institutional investors.
Climate change needs scalable and easily deployable solutions
Climate change is a global coordination problem, and blockchain technology can play a pivotal role in boosting climate action by solving many of the underlying challenges of the voluntary carbon market – including democratising participation, increasing transparency and liquidity, and reducing costs while preventing risks of double-counting, hacking and frauds.
With the emergence of Web3 and decentralised finance, we have the opportunity to take this one step further, create truly next-gen smart carbon finance solutions, and effectively accelerate efforts towards addressing the most existential threat of our time.
The time is now!
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This article was first published on September 6, 2022
The post How to scale voluntary carbon markets with DeFi and Web3 appeared first on e27.