Discussion Post: Can a Carbon Credit Ecosystem Powered by Smart Contracts Reduce Greenhouse Gas Emissions?

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Citation: Saraji, Soheil, and Mike Borowczak. “A blockchain-based carbon credit ecosystem.” arXiv preprint arXiv:2107.00185 (2021).

Background

What are carbon credits?

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.

Carbon credit challenges

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.

Smart contract solutions?

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.

Carbon credit ecosystem architecture

  • Vision: The creation of an ecosystem/DAO in which carbon credits are tokenized with transparent minting and burning protocols as well as trading rules.

  • Plan:

    • 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.

Key Problem or Topic Area

Current carbon credit systems are broken. Can we reduce greenhouse gas emissions through a more effective, blockchain-based carbon credit ecosystem?

Specific Question or Problem Statement

What are some of the positives and negatives of the authors’ proposed solution and what would be the biggest impediment to implementing this solution?

Approach or Methodology

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).

Conclusions or Key Takeaways

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.

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Excellent post! @jasonanastas. This framework of the smart contract mechanism enables policy-makers and engineers to influence controlling CO2 emission further. However, the challenge is how to integrate this framework with the existing policy based on shared interests. I look forward to the development of this idea on SCRF and other platforms!

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How successful have earlier carbon markets been? Is there any information about the volume of business transacted through it. I’m also curious how this kind of system might price in new technologies like carbon dioxide capture. Would the DAO pay for offsets?

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Thanks Mark. Yes I agree and I think this is the biggest challenge/impediment that a system like the one that the authors proposed will face. The technology is there, but if the political will is not, this is something that has to be addressed.

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Great questions! I’ll start with the second since the authors address this more directly:

I’m also curious how this kind of system might price in new technologies like carbon dioxide capture. Would the DAO pay for offsets?

As I understand it, initial pricing for a technology that generates carbon credits, like CO2 offsets, would be determined by the DAO community in some manner (perhaps voting?) and be subject to a veto by the “Validators” who are more specialized and accredited experts in environmental science.

How successful have earlier carbon markets been? Is there any information about the volume of business transacted through it.

I need to get back to you on this because there are ALOT of emprical studies on this topic! Stay tuned.

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I absolutely love this post @jasonanastas!

I am currently working with a small nonprofit to turn their carbon credits into NFTs. Though this is a small scale project that is utilizing the collectible quality of NFTs, I believe the market for carbon credits will be hugely impacted by the tokenization of carbon. Creating what could be a very efficient ecosystem of applications and companies that embed these tokens into their products or business models (because it’s already digitized and accessible!). I would like to add to the discussion a bit of perspective on the carbon market from the nonprofit lens.

Most of the carbon token projects I have seen (KlimaDAO, Toucan Protocol/Base Carbon Tons, Moss) are using credits that sequester carbon from the atmosphere rather than generate carbon savings (i.e., ‘we did something that didn’t put carbon into the atmosphere and saved potential X amount of carbon from being produced’). The latter type is less valuable in the current market (around less than $5 USD per ton). The market is also heavily dependent on brokers, which has typically been an inefficient third-party intermediary. Brokers are often looking for a substantial number of tons generated, leaving smaller credit producing organizations on the sidelines.

From a nonprofit perspective, carbon credits hold a lot of potential for cash-stricken organizations to generate additional revenue from the activities they are already doing to help accelerate the green energy transition and impact climate efforts. From my experience, nonprofits are not producing enough carbon credits to even sell to brokers. Additionally, nonprofits in the green energy space are often supporting low-income populations and those on the margins that will feel the effects of climate change at a much more substantial rate than those that are affluent. This adds a uniqueness value to the generation of the credit, because the sale will fund specific efforts in fighting poverty, multifamily affordable housing, community solar, or other niche areas of social and sustainable impact. Today, the carbon credit market is both inefficient and unable to account for the uniqueness value of how the carbon ton was generated. Therefore, the option of carbon credit NFTs became promising for niche orgs in the green energy space to tap into an asset that the current market didn’t support. NFTs in particular, can allow a P2P marketplace (overriding brokers) and engage a user to directly support a mission alongside achieving offsets.

This is a new avenue for carbon credits and, though the success of a NFT carbon credit will be dependent on plenty of other factors, the blockchain is enabling small organizations to simply participate in new markets.

Lastly, I wanted to answer your discussion question…

…I would say the system is vastly prime for innovation and efficient transfer of value. I do believe a more efficient market would incentivize sequestering efforts–which we drastically need to reduce greenhouse gas emissions. The blockchain makes the most sense to me in markets where provenance is the value, and where the efficient transaction of data could produce new markets…I think this is exactly the carbon credit space. Hope this sums my thoughts up!

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How will the oracles check who is emitting as much carbon as they are allowed? isn’t that an issue with the current system?

How hard is it for non profit to go find those with a lot of carbon credits that want to sell them? Why would those sellers join a blockchain base system too?

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Hi! Great question. Might need you to rephrase it a bit, but answering to the best of my ability.

The context that I was referring to about the nonprofit was in relation to not producing enough credits to sell. Serious buyers are looking for both volume and quality. If there was a nonprofit looking to buy carbon credits, there are marketplaces, brokers, and individual sellers. It just depends how serious you are to buy and if you’re in the category of a pollutant emitting business. Some carbon credit brokers won’t even sell to organizations that have not exhausted all efforts to stop polluting in other ways.

Sellers might join a blockchain system for a few reasons:

  • To track the provenance of the credit through a secondary market
  • To tokenize the credit and participate in protocol activity (like KlimaDAO or BCT – I endorse none of these projects and link them here as examples)
  • To engage a nontraditional peer-to-peer marketplace that cuts out the middle-men of the traditional marketplace
  • To tap into a growing market of tokenized carbon that has effects on the primary market
  • Enhance a reputation for innovation
  • Enhance current marketing efforts and generate attention

I would summarize this by saying the reasons are less technical and more marketing or return-based (returns are variable). Though, you can’t get a higher price for the credit in the blockchain systems (that I know of). There are very specialized NFT projects backed by carbon credits that see higher prices, but they have put a premium on artwork and function more like a fundraiser for the project behind it and the dual impact that you’re creating by buying the NFT (See Carbon Creatures).

Hope that answers your question. If it didn’t, please ask again!

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Not meaning to dismiss out of hand a nice technical idea (and aren’t they all nice?), but have you heard of Project Haystack? Probably not, so I’ll tell you quickly that it’s an open source effort to standardize the semantic model for the IoT and the built environment. Haystack has entire libraries of tags, each one precisely defined to ensure common understanding and interoperability.

I mention it because I once interviewed one of the founders of the project who told me that if every manufacturer agreed to tag their objects (e.g., a chiller on the roof of a building) with Haystack’s tags, the whole smart-building space would be vastly farther along than it is today. But after 10 years, many major manufacturers still refused to use a standard that made referencing their objects and data easy and foolproof. And those that did use Haystack’s tags went out of their way to make it non-obvious that they were doing so.

Leveraging “cryptographic truth” would indeed make the world vastly more transparent and optimized. But we need to recognize that people in power need to want the truth. And frankly, they don’t. Those people got their power (and money) in large part by hiding the “externalities” of their behavior, which “the truth” would expose. They’re not going to give up their many advantages (like vendor-locking their customers) simply because being more transparent would be “good for society.”

To @jasonanastas’s point, which I quoted above: Looking at the track record of the UN and the IMF over the last 3 or 4 decades doesn’t instill much confidence. Aren’t those the people who gave us the Greek austerity debacle?

Am I saying there’s no hope for our poor planet’s climate crisis? Not exactly (though it’s getting awfully late). But our efforts can’t be confined to installing blockchains and fancy IoT sensors, and parsing the resulting clouds of data. The cigarette industry had tons of data too, and you see how long that farce went on. I think we have to start much lower down on the human chain, where the “fix gets put in” in the first place.

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thanks for your answers.
That’s what I was wondering. If non profit were too small to have meaningful volume, it made sense for them to try to seek bigger producers. But you laid out why this his hard in practice. It is a really great insights from your experience to understand how hard it would be to apply such protocol in practice.

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Thanks @rlombreglia some great info in your reply, especially regarding Project Haystack.

I also agree with many of your points. Personally, I would like to see more causal evidence on the effectiveness of carbon credits to reduce pollution more generally and more work describing how carbon offset systems can effectively change the behavior of polluters.

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Thanks @jasonanastas for this wonderful summary I was able to understand a lot about carbon credits ecosystem But I went further to do a research about how this carbon credit works,a carbon credit represents one metric Of carbon dioxide sequestered or avioded as a result of specific activity,The number of credit is determined by using statistical modeling prescribe by the rules, or protocols of a carbon credit program, they are developed by carbon registry,or nonprofit or a government agency,with significant public and scientific review,
The amount of carbon sequestered or avoided by an offset project is calculated using the protocol methodology.

  • A third party verification process.the carbon registry issues unique determines the Number of credit for each ton of carbon dioxide,which can be sold on the open market.
    *Companies or Private individuals can purchase the carbon credit to offset their carbon footprint
    *The income generated form the sales of credit can be put back into managing the land or acquiring new conservation and recreation.