CTA: "In these threads, we attempt to further the discussion of a key problem in this category—particularly where research work has not yet answered the specific problem or question being considered.”
Citation: Saraji, Soheil, and Mike Borowczak. “A blockchain-based carbon credit ecosystem.” arXiv preprint arXiv:2107.00185 (2021).
“Carbon credits” were proposed as a solution to excess greenhouse gas emissions in the international Kyoto Protocol agreement of 1997. In this system, carbon emissions are treated as commodities and traded in a carbon credit market. Those who have more credits are allowed to emit more greenhouse gases than those with fewer carbon credits.
Carbon credit systems have had varying levels of success and have faced many challenges. A number of people claim that blockchain-based carbon credit ecosystems, powered by IoT and decentralized oracles like Chainlink, can solve many of these challenges.
In this post, I describe a proposal for a blockchain-based carbon credit ecosystem put forth in a 2021 whitepaper by computer scientists Soheil Saraji and Mike Borowczak at the University of Wyoming and ask whether this can solve many of the challenges carbon credit systems have faced.
I also discuss some of the potential impediments to the success of a carbon credit ecosystem powered by blockchain, oracles, and smart contracts.
While carbon credits can potentially reduce greenhouse gas emissions, they face several challenges including:
- Uneven implementation – Different jurisdictions and countries have implemented different types of carbon credit systems, leading to a lack of standardization that prevents the widespread adoption of carbon credits.
- Over-crediting and excess spending – Also related to lack of standardization. Different rules across carbon credit markets and lack of transparency regarding credit life and exchange value lead to over-crediting and double-spending.
- Transaction costs – Brokers and agents are required to facilitate carbon credit transactions, resulting in very high transaction costs.
- Distorted incentives – Third-party verifiers are paid by the very people they investigate, creating incentives to approve projects consistently.
These challenges, according to Saraji and Borowczak (2021) have resulted in a failure to mitigate rising levels of greenhouse gas emissions.
The authors propose a blockchain-based carbon credit ecosystem built on smart contracts and decentralized oracle networks. This ecosystem can solve each of the extant problems through the creation of a decentralized carbon credit ecosystem. In this system:
- Uneven implementation is solved by a decentralized autonomous organization (DAO) whose rules all participants agree to.
- Over-crediting and excess spending is solved through fast and secure data sharing enabled by decentralized oracle networks (DONs).
- Transaction costs from brokers and agents are eliminated through trustless, cryptographic truth via smart contracts.
- Distorted incentives can be eliminated through independent, third-party validation, potentially with the help of IoT sensors.
Vision: The creation of an ecosystem/DAO in which carbon credits are tokenized with transparent minting and burning protocols as well as trading rules.
- Credit stakeholders – eco-friendly green “generators” of carbon credits such as wind farms, tree-planting operations, etc.
- Credit consumers – greenhouse gas-generating “consumers” of carbon credits such as power plants, manufacturing plants, and so on.
- Validators – specialized and accredited consultants.
- Minting – minting of credit tokens on the blockchain occurs after validation of projects.
- Exchange – credit exchange will occur on a special decentralized exchange platform. Token price is determined by supply and demand.
- Carbon removal NFT Certificate – tokens are retired through burning by sending them to a smart contract, and are then converted to a carbon removal NFT certificate.
Smart Contracts: The carbon credit ecosystem requires a minimum of 4 smart contracts interacting with 3 stakeholders and liquidity providers. Each of these smart contracts requires decentralized oracle networks to bring external data to the credit ecosystem.
- Smart contract 1 – registry stores information about stakeholders, consumers and validators.
- Smart contract 2 – used to mint tokens.
- Smart contract 3 – used for verification of minting and burning tokens.
- Smart contract 4 – automated market maker (AMM) smart contract that allows for trading with digital currency (CBDCs etc), gives liquidity providers incentives, provides dynamic price discovery.
Figure 1: Smart contract architecture of the carbon credit ecosystem.
Current carbon credit systems are broken. Can we reduce greenhouse gas emissions through a more effective, blockchain-based carbon credit ecosystem?
What are some of the positives and negatives of the authors’ proposed solution and what would be the biggest impediment to implementing this solution?
The authors give us a broad framework for a blockchain-based carbon credit ecosystem. They do a great job pointing to some of the current failures of carbon credit systems and outline how each of those failures could potentially be solved with a blockchain-based carbon credit ecosystem.
One of the most significant challenges that such a system will face is convincing those with currently existing carbon credit systems to agree to a single, decentralized blockchain-based system.
This is where established providers of oracles and hybrid smart contracts like Chainlink can provide reassurance to participants that their transactions will be handled in a secure environment based on cryptographic truth.
While great technology will solve many of the technical adoption hurdles, politically-based hurdles related to nation- or region-specific financial, electoral or security interests remain in play and will likely remain contentious—at least for some participants.
Indeed, achieving global adoption of a standardized blockchain-based carbon credit ecosystem may require international coordination via global political institutions such as the United Nations (UN) and the International Monetary Fund (IMF).
Reducing greenhouse gas emissions using carbon credits requires a standardized ecosystem that is transparent, minimizes transaction costs, and retains a high level of integrity and honesty among participants. The authors provide a good framework for a blockchain-based system that can hit all of these points given the current state of smart contract and oracle technology.
However, their carbon-credit ecosystem can only be effective if it is adopted, which also requires overcoming technological and political hurdles. While current technological hurdles are solvable, it would be useful, for future study, to consider the political hurdles that would prevent adoption of a blockchain-based carbon credit ecosystem like the one proposed.