Carbon Token Introduction
This article explores two concepts of carbon tokens derived from climate projects under voluntary carbon standards:
- Traditional Registry to Blockchain: Carbon credits are initially issued on traditional registries, and their digital representations, known as carbon tokens, are issued on a blockchain. Functionality depends on the rules of the traditional carbon registry and the smart contract used for digitization.
- Direct Blockchain Issuance: Carbon credits are issued directly on the blockchain as carbon tokens, with rules defined solely by the original digital registry.
Characteristics of Carbon Tokens
Carbon tokens are defined by the following features:
- Asset-Backed: Supported by a real-world asset (carbon credit).
- Price Correlation: The token’s price is tied to the underlying carbon credit, particularly if the token can be converted back to the original credit.
- Fungibility: Can be fungible (interchangeable with identical tokens from similar projects) or non-fungible (unique due to varying carbon standards, methodologies, or vintages).
Challenges and Solutions for Carbon Tokens
1. Complexity and High Cost of Traditional Trading
Challenge: Trading carbon credits under voluntary standards is complex and costly. Participants pay high fees to open and maintain accounts, and the process of finding sellers, negotiating prices, and handling paperwork is lengthy.
Solution: Transferring carbon credits to a blockchain enables carbon tokens to move between addresses with minimal involvement, reducing fees. Tokens can be traded on marketplaces or apps, eliminating the need for expensive brokers.
2. Inaccessible Registry Data
Challenge: Carbon credits issued by traditional standards are stored in registries that are difficult to track, creating risks of double-counting, where the same credits are claimed by multiple parties.
Solution: Carbon tokens on a blockchain can be tracked at any time and are held in a single digital wallet, preventing double-counting.
3. Opaque Pricing
Challenge: Price information is often obscured by intermediaries seeking to maximize profits.
Solution: Marketplaces for carbon tokens enable 24/7 global trading, with prices determined transparently by supply and demand.
4. Metric Ton Minimum Unit
Challenge: Carbon credits are typically traded in metric ton units, which is inconvenient for offsetting smaller carbon footprints, such as those from specific events, services, or purchases.
Solution: Carbon tokens can be divided into units smaller than one metric ton, offering greater flexibility.
Approaches to Carbon Tokenization
1. One-Way Bridge
This mechanism converts carbon credits into tokens without allowing reversal.
- Offset-Based: The carbon credit owner retires credits in the standard registry (without specifying a beneficiary). The tokenizer receives retirement data and issues an equivalent number of carbon tokens for trading, holding, or retirement. No further interaction with the standard registry is required. Example: Toucan Protocol’s Base Carbon Tonne (BCT) and Nature Carbon Tonne (NCT) for Verified Carbon Standard credits.
- Redemption-Based: Carbon credits are retired after the tokens backed by them are retired. Conversion back to credits is not possible. Example: MOSS’s MCO2 token.
2. Two-Way Bridge (Custodial)
The tokenizer locks the client’s carbon credits as custodial holdings and issues carbon tokens in return. This allows conversion back to traditional carbon credits through a reversal process, where the token is destroyed on the blockchain, and the original credit is returned.
- Example: Flowcarbon’s Goddess Nature Token and Toucan Protocol’s CHAR.
- Retirement Process: Retiring a carbon token on-chain triggers the tokenizer to retire the corresponding carbon credit in the standard registry, removing the token from circulation permanently.
3. Issuing Naturally as Carbon Tokens
Some carbon standards issue credits directly on the blockchain as tokens. Examples include REGEN Network, Tero Carbon, Carbify, and Coorest, each with their own rules for issuance.
The Future of Carbon Tokens
Tokenization of Traditional Carbon Credits
Major voluntary carbon standards, such as Verra, Gold Standard, ACR, and Climate Action Reserve, currently oppose third-party tokenization of their credits. However, they acknowledge the potential for enhanced liquidity and are developing their own tokenization frameworks (yet to be finalized).
Through experience, standards and market participants have identified key principles for future universal tokenization:
- Reliability: Only carbon credits from internationally recognized or national standards should be tokenized.
- Standard Control: Standards should have exclusive authority to permit or prohibit tokenization and track credits and tokens.
- Circulation Requirement: Tokens should only represent carbon credits in active circulation.
- Consumer Protection: Token issuers must comply with Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations.
- Investor Guarantees: Tokens not directly linked to underlying credits must align with clients’ goals, needs, and risk tolerance, particularly for Decentralized Autonomous Organizations.
- Sustainability: Digital technologies used must be inclusive, open, sustainable, safe, and low-carbon.
- IT Security: Systems must be protected against cyber threats.
- Public Registry: Tokenized credits must be issued and tracked in a public registry linked to the standard.
- Carbon Neutrality Claims: Permitted only after retiring tokens and their associated credits in the registry.
Blockchain-Native Carbon Tokens
Projects issuing carbon credits directly on blockchains remain operational but hold a small market share. Reasons include:
- A conservative market favoring established standards over newer blockchain-based ones.
- Perceived risk associated with blockchain technology among traditional buyers.