By
Dimitar Bogdanov
May 11, 2023
4 Min Read
Blockchain technology is gradually finding ways to impact new industries and aspects of life. Lately, the technology has been increasingly recognised for its potential as a driver of ESG (environmental, social and governance) innovation.
Indeed, blockchain technology’s unique strengths and features can be harnessed to power innovative solutions for sustainability, environmental awareness and renewable energy. On that note, an area where blockchain can have an immediate impact is carbon credits. Indeed, we’re already seeing signs that tokenized carbon credits could be a strong driver for better digital carbon credit markets.
Before we move on to the actual sustainability use cases for the technology, we need to address a common criticism that has been leveled at blockchain practically since the early days of the technology. This criticism, which revolves around the energy-intensive nature of PoW networks, hasn’t been unwarranted. The argument of the critics is that the high energy cost for running a blockchain network is bad for the environment and outweighs the potential benefits that the technology brings.
Last year’s Ethereum Merge, the biggest event in the Web3 space of the past few years, was in part a response to that criticism.The Merge finalized Ethereum’s transition from the energy-intensive Proof-of-Work consensus mechanism to the much more efficient Proof of Stake. Following the Merge, the energy consumption of the Ethereum network decreased by over 99%. This is important because Ethereum is by far the largest platform for smart contracts and dApps, which makes it the preferred platform for building Web3 solutions.
So with that out of the way, let’s now look at how the power of blockchain can be harnessed for the benefit of a more sustainable future.
This is one application of blockchain technology that is fairly straightforward to implement even today. The carbon credit system has been established with the goal to help businesses and countries to manage and reduce their carbon footprint. The way it works is that a company has a quota of how much greenhouse gas emissions it can use, measured in carbon credits. If its carbon footprint exceeds the quota, the company must buy extra credits to make up for that. Conversely, if a company has operated within its quota can sell any spare credits it may have on the open market. This is how carbon credits become its own asset class and attract people looking for alternative investment opportunities.
And thanks to the power of smart contracts, carbon credits can easily be tokenized and traded on a blockchain like Ethereum. Basically, we can write a smart contract that ‘mints’ so called tokens - blockchain-based digital assets that are imbued with certain utility and are programmed to serve specific purposes within a Web3 protocol. So we can have tokens that represent different real-real world assets, including carbon credits.
Ethereum supports several token standards, the most popular being the ERC-20 standard for fungible tokens and the ERC-721 for NFTs (non-fungible tokens). This makes the platform flexible enough to support different tokenized carbon credits solutions.
So let’s say that a company has its carbon credit information verified and immutably stored in a Web3 registry. Based on that information, it may tokenize any unused carbon credits and then use those tokens as it sees fit, for example to sell them on a Web3 carbon credit market place. When the credits are eventually retired they can be easily ‘burned’, which simply means sending them to inaccessible Ethereum addresses.
The process described above already gives us some hints about what tokenization can bring to the table. Here are some of the key advantages of tokenized carbon credits over their real-world counterparts.
One of the biggest advantages of blockchain technologies is the fact that a blockchain ledger is essentially an immutable distributed database. So any information that is recorded on the blockchain is easily verifiable and cannot be tempered with. This leads to better traceability and verification of carbon credit history and can address issues like double counting.
Another advantage of Web3 solutions is that they do not rely on intermediaries and excel at facilitating peer-to-peer interaction. For example, instead of hiring a third party to broker a carbon credit trade, the seller can interact with the buyer directly on a Web3 marketplace. This can result in lower transaction fees, quicker settlements and greater overall efficiency.
Tokenizing carbon credits gives the product exposure to new markets that can operate 24/7. It streamlines the trading process and extends the product’s reach by introducing it to a large pool of highly active investors. This will in turn lead to greater liquidity and will ultimately improve the public’s awareness of the carbon credit initiative.
Tokenized carbon credits will also be divisible, meaning that investors will be able to buy a fraction of a carbon credit, something that is not possible with real-world carbon credits. This would further drive liquidity, make carbon credits more accessible and potentially create new use cases for them.
Speaking of use cases, another advantage of tokenized carbon credits is that there could be uses for them outside of trading. After all, they are crypto tokens and, as such, can be programmed to serve specific purposes in a decentralized application or a Web3 protocol.
Tokenized carbon credits are a powerful example of how Web3 technologies can be used for environmental causes. And they already have practical applications, with a number of Web3 startups like Toucan and the AirCarbon Exchange already driving innovation in that space. It’s still early days, but the potential of the technology is already clear.
