What happened when cryptocurrency businesses entered the carbon market?
Crypto companies claim that by putting carbon credits on the blockchain, they will be able to increase liquidity, reach a larger customer base, and drive more money to conservation efforts around the world.
Crypto companies were on a roll in 2021. Bitcoin, the world’s largest cryptocurrency, reached a record high of around $69 000 last November as investors piled into a bull run.
Meanwhile, blockchain, the distributed ledger technology that underpins cryptocurrencies, was being hailed as a panacea for many of the world’s problems, including climate change, by increasing transparency and facilitating the sale of carbon offsets.
A number of prominent cryptocurrency projects have begun developing digital carbon offsets and trading them online.
The underlying assets are credits that businesses can purchase from green projects on the voluntary carbon market that reduce planet-warming carbon dioxide (CO2) emissions through initiatives such as forest preservation or the construction of renewable energy facilities.
Buyers typically “retire” the credits, which means they are removed from the market and cannot be resold, in order to offset greenhouse gas emissions from their own activities.
However, rather than using them to offset emissions, some crypto players have placed them on the blockchain ledger and listed them on crypto exchanges where they can be bought, sold, and traded for other cryptocurrencies.
The Thomson Reuters Foundation discovered that one major pioneer in this new market, Brazilian “green” crypto firm Moss, purchased carbon credits it said were of “low quality” privately – a judgment it later reversed in response to the investigation – and mixed them with others to back its digital token, selling them for far more than it paid.
Here is how cryptocurrency players have influenced the voluntary carbon market:
How do crypto companies claim to aid in the fight against climate change?
Crypto firms say they want to help fill a significant funding gap for climate change projects, arguing that their participation will expand the market for carbon credits, which fund emissions reductions and nature conservation efforts.
According to a McKinsey report from 2021, approximately $4 trillion in new funding is required over the next 30 years to expand such projects on the scale required to combat climate change, such as producing clean energy, dealing with waste, or preserving forests and other ecosystems.
Crypto companies claim that by putting carbon credits on the blockchain, they will be able to increase liquidity and reach a larger customer base, resulting in more money going to conservation efforts around the world.
KlimaDAO, a crypto carbon project that issues tokens backed by carbon credit projects, reported over $3 billion in transactions in the last three months of 2021.
What is the process of tokenization?
To transfer credits to the blockchain, crypto firms must first “retire” them on the Verra system or other carbon credit registries such as the Gold Standard and the American Carbon Registry.
This is a way of demonstrating that the emissions reductions represented by each credit (one ton of CO2) have been applied to a corporate or individual goal – in other words, they have been used up.
Based on this, crypto companies create a digital token worth one carbon credit, which can be traded on cryptocurrency exchanges or “burned” by buyers to offset their emissions.
What is the problem?
Since 2019, crypto companies have been putting carbon credits on the blockchain, making them easy to buy and sell.
However, researchers discovered that some of these were so-called “zombie credits,” or offsets issued more than ten years after a project claimed to have reduced emissions.
According to Carbon Plan’s research, they went largely unsold on registries because their quality was questionable.
However, this did not prevent the digital tokens backed by them from commanding high prices on exchanges where the quality of the underlying credits is unknown.
The crypto-backed carbon tokens boomed at the peak of the crypto market, in late 2021 and early 2022.
KlimaDAO’s coins briefly traded for more than $1,000 each, despite the fact that the carbon credits backing them sold for less than $10 each. The tokens issued by KlimaDAO were backed by other crypto-carbon tokens issued by companies such as Moss and Toucan.
However, the high price of the tokens did not imply that more money was being directed directly to environmental projects on the ground.
The Thomson Reuters Foundation discovered that speculators and middlemen received a significant share of the proceeds at times, which has caused concern among veteran carbon market players.
What comes next?
The cryptocurrency market crashed in the early months of 2022. Bitcoin, for example, is currently trading for less than $20,000.
Verra halted the tokenization of retired carbon credits on its books in May, pending the completion of a public consultation, which will last until early October.
It has been tasked with determining under what conditions credits can be tokenized and used to create financial instruments by crypto market participants.
As a result, some crypto carbon companies, such as Flowcarbon, which raised about $70 million in May to tokenize more carbon credits, have suspended operations.
Also in May, the American Carbon Registry prohibited the tokenization of its carbon offset credits unless the process was explicitly authorized.
The decision by Verra has put the value of millions of crypto carbon tokens in jeopardy. While crypto firms want a quick resolution to the impasse, registries are taking their time to figure out a workable solution for a complex asset.
The International Finance Corporation, a World Bank affiliate, announced last month that it would support a blockchain-enabled platform for trading carbon offsets, but only unused credits from an established registry that pass its additional quality checks.