Tokenizing carbon
“Here’s the hard reality: What we’re doing to solve this [climate] crisis is not enough. We need greater urgency and ambition. We need far more speed and scale.”
- John Doerr
Setting the table
For those new to the conversation, 'Web3' (worldwide web version 3.0) is a growing movement building an internet governed by the masses rather than centralized entities. One of the most prominent innovations in this rapidly evolving landscape is decentralized finance (DeFi), an umbrella term for blockchain-based applications transforming the financial-services industry by making transactions faster, cheaper, and more secure.
Think of DeFi in layers:
The blockchain – Ethereum contains the transaction history and state of accounts.
The assets – ETH and the other tokens (currencies).
The protocols – smart contracts that provide the functionality, for example a service that allows for decentralized lending of assets.
The applications – the products we use to manage and access the protocols.
Instead of a financial institution sitting between your capital and the business you’d like to transact with, digital-native currencies cut those stakeholders out of the equation. By removing this point of friction, Ethereum has managed to process ~1.7x the payments volume of PayPal with ~0.2% of the headcount in ~26% of the time.
Most DeFi applications leverage the Ethereum platform instead of the Bitcoin platform because it’s better equipped for building decentralized applications (dApps) beyond peer-to-peer transactions. Due in part to Ethereum's smart contracts – programs stored on a blockchain that automatically execute transactions if certain conditions are met. This core feature removes the need for a central authority or intermediary. Users of the Ethereum network pay gas fees (transaction fees) in Ether (ETH).
In recent years, DeFi has given rise to regenerative finance (ReFi), a blossoming movement at the intersection of climate action and cryptocurrency. ReFi’s monetary system is built upon tokenizing (digitizing) carbon and natural capital assets and mobilizing individuals to protect them. When information from real-world systems is tokenized they become a fungible digital asset with full transparency, programmability, fractionalization, and composability (interoperability) with the emerging DeFi ecosystem.
The opportunity
One sector, in particular, where ReFi is emerging as a viable solution is voluntary carbon markets. As it stands, monitoring, reporting, and verifying (MRV) technology for nature-based carbon credits are expensive, high-touch, and time-consuming. In aggregate, these factors have limited the eligible pool of projects that have historically been financed and implemented.
For the subset of real-world (off-chain) offsets eventually packaged and sold, buyers typically have limited liquidity, data availability, and insight into the progress of the carbon avoidance or removal projects. In contrast, DeFi protocols make it easier to pool capital, increase liquidity, and incentivize participation in projects that would otherwise be too expensive or too logistically difficult for individuals and entities to participate in.
Using Ethereum for on blockchain (on-chain) carbon issuances provides verifiable proof when a tokenized credit is “burned” or “retired,” thereby solving the double-counting problem and fraud that plagues off-chain offsets. Thus, blockchain’s key benefits - transparency, immutability, frictionless collaboration, and collective governance - may be the right set of solutions for driving down the overhead costs and bureaucracy of carbon projects while increasing the supply of high-fidelity credits, market participation, and liquidity.
If all of this sounds a bit too theoretical, it’s worth taking a step back and unpacking the Web3-enabled toolkit that exists today.
In context
In theory, any ecosystem that can be verified can be tokenized and turned into an on-chain programmable asset. Today, OpenForest Protocol, Flow Carbon, and Single Earth are tokenizing forestation projects from start to finish. Meanwhile, Nori and Regen Network are scaling on-chain platforms, which coordinate between regenerative farmers and buyers (individuals & groups) to originate, verify, and sell tokenized carbon.
Toucan Protocol is a prominent project embracing the full potential of open-source, composable, and permissionless systems to pave the public infrastructure needed to create a “new money lego: programmable carbon.” To bring carbon on-chain, Toucan has built a Carbon Bridge - allowing anybody to tokenize carbon offsets (called TCO2 tokens) on the Verra registry and make them available to DeFi protocols.
The bridge provides an on-ramp for TCO2 tokens onto the Toucan Registry, a set of smart contracts built on Polygon - a blockchain running on an energy-efficient Proof of Stake (PoS) consensus mechanism. Users of the carbon bridge retire the off-chain carbon offsets before bringing them on-chain to ensure that a carbon token is unique.
“Burning” an on-chain token is equivalent to retiring an off-chain offset. Once bridged, TCO2 tokens can be deposited in a Carbon Pool. In doing so, every TCO2 token in each standardized carbon reference pool shares a set of gating attributes (i.e., project type, country, carbon standard, and co-benefits), which provides a transparent price signal to the market.
Since launching on October 18th, 2021, Toucan and its first Carbon Pool designed with Klima, have brought over 13M carbon credits on-chain (~15.76M tons of CO2e). Members of the Klima decentralized autonomous organization (DAO) retire legacy Verra credits and receive a liquid reference token called the Base Carbon Tonne (BCT). Users can acquire $KLIMA tokens by depositing BCT to the KlimaDAO treasury, or directly from trading pools like SushiSwap.
Klima’s staking mechanism (a fork of $OHM) enables $Klima to be bought at a discount by bonding (locking up) carbon units for a set amount of time. Staking encourages demand for buying and long-term holding of KLIMA by offering participants roughly 7,872% annual percentage yield (APY), including compounding interest. For context, traditional high-yield savings accounts offer customers a meager 0.70%-1% APY.
In more recent news, MOSS recently announced that its MCO2 token, which is available on Gemini's crypto exchange, can now convert into Toucan’s new Carbon Pool for NCT. Since launching in March of 2020, the sale of MCO2 tokens has preserved ~301M trees and prevented 1,330 tons of CO2e while allocating more than $30M towards conservation projects in the Amazon. Bridging existing on-chain credits from one standard to another standard on a different blockchain is a monumental step towards unifying disparate carbon markets.
Looking to the future, EdenDAO, another group pooling capital to invest up to $10M in high-quality projects on Patch's carbon marketplace, will also be tokenizing and selling the future credits with the help of Toucan. To date, 20M+ carbon credits have now been brought on-chain via Toucan’s Carbon Bridge, equivalent to nearly 5% of all available credits in Verra’s Registry.
The influx of new carbon pools and partnerships put the Toucan meta-registry in a position to capture a +99% market share of on-chain carbon and solidify the TCO2 as the ubiquitous on-chain standard for credits. In reality, none of these demonstrations of collective action would be possible without contributions of a network of collaborative, not competitive, actors, including OlympusDAO, Syndicate, and more. The ReFi mentality is about fostering symbiotic relationships to achieve speed and scale at an unprecedented pace.
The barriers
Before Web3 can become the de-facto tools for scaling carbon markets, several factors need to be de-risked upstream:
Fidelity & Execution: In the eyes of many critics, tokenization adds an extra layer of skepticism to nascent carbon markets already entrenched in controversy. Ultimately, on-chain offsets are still only as good as the underlying data used to generate them. With this in mind, on-chain projects will have to overcome the MRV problems impacting legacy credits. Currently, there is little clarity about how blockchain technology can ensure the financial benefits of conversation reach the rural and/or Indigenous communities that are halting continued deforestation in areas of ecological importance.
Energy: There is also a generalized narrative that all cryptocurrencies and blockchain technologies are energy-intensive and therefore at odds with solving our climate crisis. In truth, Bitcoin and Proof of Work (PoW) consensus models (how each token is created through the system) are energy-intensive. A single Bitcoin transaction consumes as much energy as it takes to power the average American household for six weeks. However, Ethereum 2.0 and many other blockchains use Proof of Stake (PoS), which is 99.95% more energy-efficient and equally less carbon-intensive.
Where to from here
We are in the early days of Web3. Blockchain may not be a panacea for all of our ecological crises, but it is the type of creative solution we must not disregard if we have any chance of keeping global temperature increases under 1.5 °C.
As ReFi evolves, we must consider ways of going beyond carbon to protect and restore the natural capital - grasslands, forests, coral reefs, peatlands - that modern society has failed to value. We can achieve this through non-fungible tokens (NFTs), which we will cover in the 2nd part of this web3 x climate series.
As the trend towards tokenization continues, it isn’t unrealistic to imagine distinct “green currencies” backed by real-world carbon credits and natural resources. ReGen Ventures exists to partner with the pragmatists pushing the boundaries to protect and rebuild nature. We are here to support web3 builders as they work through the trial and error necessary to restore our planet. If this is the type of big hairy audacious problem you are solving or researching, drop us a line!
Hey! With a couple of other investors, we're writing a deep dive on ReFi for ClimatEU (platform for climate-tech investors and founders). Would love to include this resource/share some thoughts!