Green finance needs functioning voluntary carbon markets

The United Nations Climate Change Conference, known as COP26, in Glasgow, Scotland, catalyzed a commitment to carbon neutrality, achieving net zero carbon emissions, demanding to reduce emissions as much possible and balancing the remaining emissions with the purchase of carbon credits.

A carbon credit reduces, avoids or removes carbon emissions in one location to offset unavoidable emissions elsewhere through certified green energy projects. Carbon credits represent one ton of carbon emissions reduction. These are 1) avoidance or reduction projects – e.g. renewable energy (wind, solar, hydro, biogas) – and 2) removal or sequestration – e.g. reforestation and direct carbon capture, which target the Voluntary Carbon Market (VCM). Carbon credits can be resold multiple times until removed by the end user who wishes to claim the offset impact. Carbon credits can also have co-benefits, such as job creation, water conservation, flood prevention and biodiversity preservation.

Carbon registries store carbon credits issued by independent, internationally certified third-party auditors or verifiers, in accordance with independent standards. Serial numbered credits are issued by verifiers and the offset reduction claim is converted into carbon credits that can be traded or withdrawn. Carbon markets turn CO2 emissions into a commodity or tradable environmental asset by putting a price on them.

Related: UN COP26 climate change targets include emerging technologies and carbon taxes

In the compliance market, carbon allowances are traded. There are currently 64 compliance markets around the world, and pricing is determined by emitters and polluters. The European Union’s carbon market or Emissions Trading System (ETS) is the largest carbon market, with a 90% share of global trade. Entry into the EU ETS is limited only to major polluters and their brokers who are regulated by the operators of the scheme. Credit supply is also controlled to manage pricing. Only the carbon prices negotiated in the EU ETS reflect the true cost of carbon pollution, but market access is not fair.

Small businesses and individuals can only access the voluntary carbon market, where they buy credits at their own discretion to offset emissions from a specific activity. Voluntary credits generally cannot be traded under the compliance market regime. Voluntary carbon markets are expected to grow 15 times by 2030 to meet increased private sector demand for climate solutions, according to the Taskforce for Scaling the Voluntary Carbon Market Final Report January 2021. A significant problem with VCMs is that carbon credit prices have been low. The low costs of voluntary credits at $2-3 per credit do little to motivate or incentivize project developers and do little to capture the true cost of climate pollution relative to compliance markets.

Related: Pandemic year ends with token carbon cap-and-trade solution

A great article for understanding VCM is “The Good Is Never Perfect: Why the Current Flaws of Voluntary Carbon Markets Are Services, Not Barriers to Successful Climate Change Action”. In this article, Oliver Miltenberger, Christophe Jospe, and James Pittman shed light on key issues with VCM design, function, and scaling.

Greenwashing. This happens when companies with false energy efficiencies claim to be more environmentally friendly than they actually are, and thus high rates of inefficient credits are used to offset company emissions.

Carbon accounting. The number of emissions offset claims is unrealistic, given the ecosystem constraints. Net zero ambitions should have disclosure requirements and be audited. Double counting can occur intentionally, but also due to a lack of comprehensive accounting protocols and a lack of alignment between market jurisdictions or operators.

Market failures and inefficiencies. A major criticism emphasizes the risk of unfairly burdening product and service markets with compliance costs, and there are few incentives for companies to voluntarily take action to mitigate an environmental impact.

Monitoring, reporting and verification. The costs of these activities can constitute the majority of the market value of a carbon credit, thus reducing the incentive to implement.

Additionality and baselines. Carbon removal projects use inherently subjective benchmarks.

Permanence. This refers to the assurance that the carbon will remain in a stockpile for an extended period, typically 30 to 100 years. However, there is an opportunity to protect and expand carbon sinks, encourage low-carbon production, and increase the flow of carbon from the atmosphere to a short-term, sustainable stock, even in shorter-term tenure cases.

Stakeholder inclusion and inequity. Projects can disenfranchise local livelihoods. In some early REDD+ projects, financialized carbon benefits resulted in local communities restricting access to their traditional lands and livelihoods.

These can help with: standardized accounting protocols for interoperability between scales and accounting systems; greater transparency from VCM operators and credit buyers; stand-alone certifications on credit rights and ownership; better traceability. Traceability, liquidity and smart contracts allow carbon credits to be used in innovative ways, creating additional demand in the global VCM.

Related: How blockchain technology is transforming climate action

When combined with remote sensing data via satellite imagery, drones, laser sensing devices, and Internet of Things devices with machine learning and artificial intelligence, analytics can reduce development costs and increase the rigor of the measures. Southpole pointed out:

“Blockchain technology has enormous potential for climate action. However, this is only the case when the right safeguards are in place to ensure environmental integrity. Web3 applications can be part of the climate solution, but they must be designed and applied in the right way.”

While the potential exists, we need to take action to rectify VCM issues, including:

  • Strengthen incentives for decarbonization
  • Carbon pricing is urgently needed with better price transparency
  • Reduce the cost of creating carbon credits
  • Reduce transaction costs and provide additional liquidity
  • Make prices in the spot and futures market higher and more reliable
  • Make carbon credits a viable asset class by offering predictable investment returns and including value protection for buyers and sellers
  • Create safeguards to protect reputation and legal processes for dispute resolution
  • Clarity on the tax exemption of carbon credits, the shift from ‘polluter pays’ to ‘polluter invests’ and uncovering the full price is up to the green owners on the ground who are taking direct climate action on their behalf.

Kishore Butani of the Universal Carbon Registry in India pointed out, “Just taking on-chain carbon credits does nothing for price discovery. It’s worse when the broker and middleman buy low and create tokens like we’re seeing right now, totally cutting the project owner into the ground. What it takes is not an NFT [nonfungible token] on the buy side of the carbon market, but direct integration with carbon benchmarks that help rural developers and green project owners create carbon NFTs. He also added:

“Can we learn from Bitcoin and price all mining years the same and make entry into VCM affordable for the rural poor in developing countries and stop diverting carbon finance to projects in developing countries? ‘Annex 1 ? These countries are forced to go green, my India is not.

VCMs are an essential means to catalyze action but require major improvements to fulfill this role.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.

The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Jane Thomasson is the chairman of Kasei Holdings, an investment company specializing in the digital asset ecosystem. She holds a doctorate. from the University of Queensland and has held several positions with the British Blockchain & Frontier Technologies Association, Kerala Blockchain Academy, Africa Blockchain Center, UCL Center for Blockchain Technologies, Frontiers in Blockchain and Fintech Diversity Radar. She has written several books and articles on blockchain technology. She has been featured in the Crypto Curry Club’s 101 Women in Blockchain, Decade of Women Collaboratory’s Top 10 Women in the Digital Frontier, Lattice80’s Top 100 Fintech for SDG Influencers, and Lattice80’s Top 50 Global Thought Leaders and Influencers. Thinkers360 on the blockchain.