Voluntary Carbon Markets: A Leap Towards Becoming Net-Zero?

Greenhouse gas (GHG) emissions are invariably changing the future of climate change. Human-led processes such as fuel use, deforestation, and production of cement and other materials are responsible for 53% of the level of global warming. In response, carbon markets have been slowly working towards mitigating the climate crisis by facilitating the trading of CO2 emissions while simultaneously encouraging organizations to become more eco-friendly. Voluntary Carbon Markets (VCMs), on the other hand, can include a wider range of buyers and sellers, thus enhancing the impact. While carbon markets have the potential of significantly reducing CO2 levels, their voluntary counterpart (VCMs) may be able to go the extra mile and mitigate the climate crisis while creating new market opportunities.

With a rise in climate-related disturbances, the pressure for reducing our environmental footprint is greater than ever. Projects aimed at offsetting GHG emissions (rather than eliminating them) require transformations along value chain operations that are costly, time-consuming, and are no longer viable as a primary strategy. As governments continue to drive up CO2 prices and place a cap on emissions permitted per industry, companies with large volumes of emissions will experience total costs that are no longer financially sustainable.

Carbon trading – a “market-based system designed to provide economic incentives for organizations” – offers the possibility of a more effective way of reducing GHG emissions. Carbon markets are typically reserved for large producers, distributors, and industrial establishments emitting 25,000 metric tons of CO2 equivalent or more annually. On the market, participating polluters can buy and sell allowances representing the amount of GHG emissions that have been either removed or prevented. For companies that are unable to eliminate the entirety of their emissions, carbon markets allow them to evade the pricey CO2 costs while remaining eco-conscious. This would, for instance, be the case for an industrial-scale cement plant requiring an unavoidable calcination process that makes up a generous share of their emissions.

While carbon markets have worked soundly for decades, the limits on who can participate restrict smaller emitters from contributing to impactful climate action. VCMs allow for a wider scope of actors who are not directly limited by a cap, yet are seeking to reduce their footprint. VCMs originated in the 1990s, but have only grown in influence more recently with emerging protocols like the Paris Agreement, which has committed 194 countries to reach a 1.5-degree Celsius target through a 50% cut in global GHG emissions by 2030 and becoming net-zero by 2050.

Demand for VCMs has since been steadily growing and is expected to reach a 15% increase by 2030 and up to 100% by 2050, potentially valuing the market for credits upwards of $50 billion in the next decade. This demand, while substantial, can be met with an annual supply of carbon credits of 8 to 12 billion tonnes of CO2 (GtCO2) per year resulting from avoided nature loss, reforestation, reduction of emissions, and technology-based removal from the atmosphere. Rather than simply complying to international regulations and reducing emissions, the give-and-take required by VCMs encourages alternative nature-based activities that benefit the environment, such as biodiversity protection, pollution prevention, public-health improvement, and job creation.

The shortcomings of VCMs, on the other hand, have led to a consensus on the need for a more transparent and robust system. Issues of complexity and fragmentation have been driven by limited pricing data that lead buyers to suspect whether they paid a fair price and limit suppliers’ knowledge of the risk they are taking on. In the latter scenario, suppliers may finance carbon-reduction projects without an accurate idea of the return they would get from selling carbon credits.

There has been recent exploration of blockchain technology as being used to help with the growth and efficiency of VCMs and further support the climate crisis. The scale of the market is clearly correlated with an improvement in the quality of the credits issued within the market. When an individual buyer or organization accesses the carbon market wanting to invest in a greener planet, a lack of information and systematic efficiency will inevitably deter them from making significant purchases.

Using blockchain technology to address such market failures can invite new methods of asset transactions that will increase accessibility to carbon credits. Regenerative finance (ReFi), for instance, uses the power of blockchain to address climate change while creating a more sustainable financial system. In the case of KlimaDAO, they tokenize carbon offsets and bring them “on-chain” (on the blockchain) thereby increasing “transparency, programmability, fractionalization, and composability with the emerging DeFi ecosystem.” 

What does this mean for the future of voluntary carbon trading? In integrating carbon credits into a more transparent technology such as the blockchain, there is greater incentive for individuals and smaller industries to trade. The KlimaDAO model indicates this shift as tokens are increasingly used to offset carbon emissions (17,334,115 tons of carbon have been retired and brought on-chain since inception).

As such, by transforming carbon into a digital, yield-generating asset, that can be used as collateral in Decentralized Finance (DeFi) lending protocols, nature-based activities will escalate as more people will be inclined to buy and sell credits on the market.