Introduction to Carbon Tokens
When carbon units are tokenized, all their information is transferred to the blockchain. Alternatively, carbon units can be issued directly as carbon tokens by the standard.
Carbon tokens can be transferred, sold, redeemed, or stored in a blockchain wallet. The functionality of carbon tokens depends on the smart contracts used.
Characteristics of Carbon Tokens:
- Backed by Real Assets: Carbon tokens are backed by actual carbon units.
- Price Correlation: Their price is linked to the underlying carbon asset, especially if the token can be converted back into the original carbon unit.
- Fungibility: They can be fungible (interchangeable with other identical carbon tokens) or non-fungible (unique due to differences in standards, methodologies, or issuance years).
Challenges and Opportunities of Carbon Tokens:
- Complexity and High Cost of Traditional Trading: Traditional carbon unit trading is complex and expensive, involving KYC procedures, account setup and maintenance fees, and transaction fees. This makes small purchases difficult.
- Proposed Solution: Transferring carbon units to the blockchain eliminates the need for traditional registry transfers, thus avoiding account setup and transaction fees.
- Inaccessibility of Registry Data: Carbon units are issued and traded within carbon standard registries, making it difficult for external users to track them, which can lead to double counting.
- Proposed Solution: Carbon tokens can be tracked on the blockchain at any time and can only be held in one blockchain wallet at a time.
- Illiquidity and Opaque Pricing: Carbon units are mainly consumed by large corporations, and individual purchases for offsetting personal carbon footprints are rare. Acquiring carbon units is difficult due to lengthy processes, price negotiations, and documentation. Pricing information is often hidden to maximize intermediary profits.
- Proposed Solution: Blockchain technology can create markets where carbon tokens are traded 24/7 globally. Prices are determined by supply and demand. Additionally, carbon tokens can be subdivided into units smaller than one metric ton.
Approaches to Carbon Tokenization
One-Way Bridge: This mechanism involves converting carbon units into tokens without the possibility of reversing the process. In some cases, the owner of the carbon units retires them in the standard registry (without specifying the final beneficiary). The tokenizer receives information about the retired units and issues the same number of tokens, which can be sold, stored, transferred, and redeemed. Interaction with the standard registry from the tokenizer’s side is not required. A similar system was implemented by the Toucan protocol for Verified Carbon Standard credits. Examples of tokens issued using this approach include Base Carbon Tonne (BCT) and Nature Carbon Tonne (NCT).
Another variation of the one-way bridge is a mechanism where carbon units are retired only after the tokens backed by them are redeemed. This approach does not provide for the possibility of obtaining units from tokens, as implemented by MOSS with MCO2.
Two-Way Bridge (Custodial): The tokenizer locks the client’s carbon credits in a custodial account and issues carbon tokens in return. A similar system was implemented by Flowcarbon with the Goddess Nature Token and the Toucan protocol with CHAR.
This process is called a two-way bridge because it allows the conversion of carbon tokens back into the original carbon units. To do this, the holder needs to return the token to the tokenizer for removal from circulation.
Redemption of the carbon token is similar to the process of converting it into a carbon unit. The tokenizer retires the carbon unit in the standard carbon registry and removes its token from circulation.
Standard-Issued Carbon Tokens: Some carbon standards have developed their own rules for issuing carbon units directly as tokens, such as REGEN Network and Coorest.
Future of Tokenized Carbon Units
Initially, major voluntary carbon standards like Verra, Gold Standard, ACR, and Climate Action Reserve opposed third-party tokenization of their carbon units. However, recognizing the potential for increased liquidity, they began developing their own tokenization rules. Common principles for future tokenization rules include:
- Standard Reliability: Only carbon units issued according to internationally recognized or national standards should be tokenized.
- Standard Control: Standards must have exclusive authority to permit or prohibit tokenization and withdrawal of carbon units. They must also have the infrastructure for registering and tracking such units and their tokens.
- Token Issuance: Tokens should only be issued for carbon units in circulation.
- Consumer Protection/Transparency/KYC/AML: Token issuers must undergo KYC and AML checks.
- Investor Guarantees: Digital climate assets should match the goals, needs, risk levels, and knowledge of clients, especially for DAOs.
- Sustainability: Digital technology used must be inclusive, open, sustainable, secure, and have a low carbon footprint.
- IT Security: Protection against cyber threats.
- Public Token Accounting: Tokenized carbon units should be issued and registered or held in escrow in a public registry linked to the standard.
- Carbon Neutrality Claims: Such claims are allowed only after tokens and related carbon units are withdrawn from the registry.
