Green finance in need of functioning voluntary carbon markets

Carbon markets convert CO2 emissions into a commodity or tradable item by assigning a monetary value to them. These markets will benefit from the blockchain and smart contracts.
The United Nations Climate Change Conference, known as COP26, in Glasgow, Scotland, catalyzed a commitment to carbon neutrality, which requires cutting emissions as much as feasible and balancing the remaining emissions with the purchase of carbon credits.

A carbon credit decreases, prevents, or eliminates carbon emissions in one location in order to compensate for inevitable emissions in another location via certified green-energy initiatives. Carbon credits are equivalent to one ton of CO2 emissions reduction.

They are 1) avoidance or reduction programs, such as renewable energy (wind, solar, hydro, biogas), and 2) removal or sequestration projects, such as reforestation and direct carbon capture, aimed at the voluntary carbon market (VCM). Carbon credits can be resold several times until the end-user who wishes to claim the offset’s impact retires them. Carbon credits may also offer co-benefits such as job development, water conservation, flood mitigation, and wildlife preservation.

Carbon registries keep track of carbon credits provided by third-party independent and internationally accredited auditors or verifiers who adhere to independent standards. The verifiers provide serial-numbered credits, and the offset reduction claim is transformed into carbon credits that can be sold or retired. By assigning a monetary value to CO2 emissions, carbon markets transform them into commodity or tradable environmental assets.

Carbon allowances are exchanged in the compliance market. There are currently 64 compliance markets in operation throughout the world, with pricing determined by emitters and polluters. The European Union’s carbon market, or Emissions Trading System (ETS), is the largest, accounting for 90% of global commerce.

Entry into the EU ETS is limited to significant polluters and their brokers, who are monitored by the program’s operators. Credit supply is also managed in order to manage to price. Only carbon prices exchanged in the EU ETS reflect the real cost of carbon pollution, but market access is unequal.

Small businesses and individuals can only participate in the voluntary carbon market, where they can purchase credits at their leisure to offset emissions from a given activity. Voluntary credits are typically not tradeable under the compliance market framework.  

According to the “Taskforce for Scaling the Voluntary Carbon Market Final Report January 2021,” voluntary carbon markets are predicted to rise 15-fold by 2030 to meet rising private sector demand for climate solutions. The fact that carbon credit prices have been so low has been a key issue with VCMs. 

When compared to compliance markets, the modest costs of voluntary credits at $2–$3 R (R 31,06- R 46,59)per credit neither inspire nor encourage project developers and thus do nothing to capture the full cost of climate pollution.

“The Good Is Never Perfect: Why the Current Flaws of Voluntary Carbon Markets Are Services, Not Barriers to Successful Climate Change Action” is an amazing paper for understanding VCM. Oliver Miltenberger, Christophe Jospe, and James Pittman outline major challenges concerning the design, function, and scaling-up of VCMs in this article.

Greenwashing. This occurs when corporations with deceptive energy efficiency claim to be more environmentally friendly than they are, resulting in a high rate of useless credits being utilized to offset corporate emissions.

Accounting for carbon emissions. Given ecosystem restrictions, the number of claims for offsetting emissions is implausible. Net-zero objectives should be subject to transparency rules and auditing. Double-counting can occur on purpose, but it can also occur as a result of a lack of proper accounting rules and a lack of alignment between market jurisdictions or operators.

Failures and inefficiencies in the market. One prominent criticism is the possibility of unfairly overloading product and service markets with compliance costs, and there are limited incentives for businesses that take voluntary steps to reduce their environmental impact.

Monitoring, reporting, and verification The costs of these operations can account for the bulk of a carbon credit’s market value, lowering the incentive for adoption.

Baselines and additionality Carbon removal projects rely on baselines that are fundamentally subjective.

Permanence. This refers to the assurance that carbon will remain in stock for a long time, often 30–100 years. However, even in circumstances with shorter-term permanence, there is a chance to maintain and develop carbon sinks, promote low-carbon production, and enhance the flow of carbon from the atmosphere to short-term and lasting stock.

Inclusion of stakeholders and inequity Local livelihoods may be disenfranchised as a result of projects. The financialized carbon benefits in several early REDD + programs hindered local residents’ access to their customary land and livelihoods.

These can aid in the following areas: standardized accounting protocols for interoperability across accounting scales and systems; more openness from VCM operators and credit purchasers; freestanding certifications on credit rights and ownership; and better traceability. Traceability, liquidity and smart contracts enable carbon credits to be used in novel ways, increasing overall VCM demand.

Analytics can reduce development costs and boost measurement rigour when integrated with remotely sensed data from satellite imaging, drones, laser-detecting devices, and Internet-of-Things devices, as well as machine learning and artificial intelligence. Southpole remarked:

“Blockchain technology offers huge potential for addressing climate change.” However, this is only true when the proper safeguards are in place to preserve environmental integrity. Web3 apps can contribute to climate change mitigation, but they must be planned and implemented correctly.”
While the potential exists, we must make an effort to address the issues in VCM, which include:

  • Increasing the financial incentives for decarbonization
  • Carbon pricing is urgently needed, as is increased price transparency.
  • lowering the cost of creating carbon credits lowering transaction costs and providing more liquidity
  • Making spot and futures market prices higher and more reliable

Creating a viable asset class out of carbon credits by providing predictable returns on investment and including value protection for buyers and sellers. Creating protections to protect one’s reputation and legal mechanisms for resolving issues
Clarity on carbon credit taxation exemption, shifting from “polluter pays” to “polluter invests,” and complete price discovery go to the green owners on the ground implementing direct climate action on their behalf.

“Merely accepting carbon credits on-chain does nothing for price discovery,” said Kishore Butani of the Universal Carbon Registry in India. It’s much worse when the broker and middlemen buy cheap and manufactured tokens like we’re seeing now, completely isolating the project owner on the ground.

What is required is not an NFT [nonfungible token] from the carbon market’s buy-side, but direct interaction with carbon repositories that assist rural developers and green project owners in creating carbon NFTs.” He also stated:

“Can we learn from Bitcoin and price all mining years equally, making participation into the VCM accessible to developing-country rural poor, and cease channelling carbon finance to projects in Annex 1 countries?” These countries are bound to go green, but my country, India, is not.”
VCM are an important means of catalyzing action, but they require significant improvements to fulfil that role.

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