Blockchain-based Tokenization for decentralized Issuance and Exchange of Carbon Offsets
Current carbon offset processes are opaque and rely on centralized players; blockchain technology can provide improvements by assuring transparency and decentralization.
Carbon offset processes are currently dominated by private actors providing legitimacy for the market. The two largest of these, Verra and Gold Standard, provide auditing services, carbon registries and a marketplace to sell carbon offsets, making them ubiquitous in the whole process. Due to this opacity and centralisation, the business models of the existing companies was criticised regarding its validity and the actual benefit for climate action. By buying an offset in the traditional manner, the buyer must place trust in these players and their business models. Alternative solutions that would enhance the transparency of the process as well as provide decentralised marketplaces are thus called for.
The conventional process
Carbon offsets are certificates or credits that represent a reduction or removal of greenhouse gas emissions from the atmosphere. Offset markets work by having companies and organizations voluntarily pay for carbon offsetting projects. Reasons for partaking in voluntary carbon markets vary from increased awareness of corporate responsibility to a belief that emissions legislation is inevitable, and it is thus better to partake earlier.
Some industries also suffer prohibitively expensive barriers for lowering their emissions, or simply can’t reduce them because of the nature of their business. These industries can instead benefit from carbon offsets, as they manage to lower overall carbon emissions while still staying in business. Environmental organisations run climate-friendly projects and offer certificate-based investments for companies or individuals who therefore can reduce their own carbon footprint. By purchasing such certificates, they invest in these projects and their actual or future reduction of emissions. However, on a global scale, it is not enough to simply lower our carbon footprint to negate the effects of climate change. Emissions would in practice have to be negative, so that even a target of 1,5-degree Celsius warming could be met. This is also remedied by carbon credits, as they offer us a chance of removing carbon from the atmosphere. In the current process, companies looking to take part in the offsetting market will at some point run into the aforementioned behemoths and therefore an opaque form of purchasing carbon offsets.
The blockchain approach
A blockchain is a secure and decentralised database or ledger which is shared among the nodes of a computer network. Therefore, this technology can offer a valid contribution addressing the opacity and centralisation of the traditional procedure. The intention of the first blockchain approaches were the distribution of digital information in a shared ledger that is agreed on jointly and updated in a transparent manner. The information is recorded in blocks and added to the chain irreversibly, thus preventing the alteration, deletion and irregular inclusion of data.
In the recent years, tokenization of (physical) assets and the creation of a digital version that is stored on the blockchain gained more interest. By utilizing blockchain technology, asset ownership can be tokenized, which enables fractional ownership, reduces intermediaries, and provides a secure and transparent ledger. This not only increases liquidity but also expands access to previously illiquid assets (like carbon offsets). The blockchain ledger allows for real-time settlement of transactions, increasing efficiency and reducing the risk of fraud. Additionally, tokens can be programmed to include certain rules and restrictions, such as limiting the number of tokens that can be issued or specifying how they can be traded, which can provide greater transparency and control over the asset.
Blockchain-based carbon offset process
The tokenisation process for carbon credits begins with the identification of a project that either captures or helps to avoid carbon creation. In this example, the focus is on carbon avoidance through solar panels. The generation of solar electricity is considered an offset, as alternative energy use would emit carbon dioxide, whereas solar power does not.
The solar panels provide information regarding their electricity generation, from which a figure is derived that represents the amount of carbon avoided and fed into a smart contract. A smart contract is a self-executing application that exist on the blockchain and performs actions based on its underlying code. In the blockchain-based carbon offset process, smart contracts convert the different tokens and send them to the owner’s wallet. The tokens used within the process are compliant with the ERC-721 Non-Fungible Token (NFT) standard, which represents a unique token that is distinguishable from others and cannot be exchanged for other units of the same asset. A practical example is a work of art that, even if replicated, is always slightly different.
In the first stage of the process, the owner claims a carbon receipt, based on the amount of carbon avoided by the solar panel. Thereby the aggregated amount of carbon avoided (also stored in a database just for replication purposes) is sent to the smart contract, which issues a carbon receipt of the corresponding figure to the owner. Carbon receipts can further be exchanged for a uniform amount of carbon credits (e.g. 5 kg, 10 kg, 15 kg) by interacting with the second smart contract. Carbon credits are designed to be traded on the decentralised marketplace, where the price is determined by the supply and demand of its participants. Ultimately, carbon credits can be exchanged for carbon certificates indicating the certificate owner and the amount of carbon offset. Comparable with a university diploma, carbon certificates are tied to the address of the owner that initiated the exchange and are therefore non-tradable. Figure 1 illustrates the process of the described blockchain-based carbon offset solution:
Figure 1: Process flow of a blockchain-based carbon offset solution
The outlined blockchain-based carbon offset process was developed by Zanders’ blockchain team in a proof of concept. It was designed as an approach to reduce dependence on central players and a transparent method of issuing carbon credits. The smart contracts that the platform interacts with are implemented on the Mumbai test network of the public Polygon blockchain, which allows for fast transaction processing and minimal fees. The PoC is up and running, tokenizing the carbon savings generated by one of our colleagues photovoltaic system, and can be showcased in a demo. However, there are some clear optimisations to the process that should be considered for a larger scale (commercial) setup.
If you're interested in exploring the concept and benefits of a blockchain-based carbon offset process involving decentralised issuance and exchange of digital assets, or if you would like to see a demo, you can contact Robert Richter or Justus Schleicher.