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What happened when crypto companies entered the carbon market?
Representations of cryptocurrencies in this illustration taken January 24, 2022. REUTERS/Dado Ruvic
What’s the context?
Cryptocurrency players have created digital tokens based on carbon credits but doubts surround their green claims.
- Crypto firms aim to bring liquidity to carbon market
- But they have fueled speculation and instability
- Tokenization of carbon credits has been suspended by Verra
RIO DE JANEIRO/LOS ANGELES - In 2021, crypto companies were riding high. Last November, the world's largest cryptocurrency, bitcoin, jumped to a record high of around $69,000 as investors piled into a bull run.
Meanwhile, blockchain - the distributed ledger technology behind cryptocurrencies - was being touted as a solution to many of the world's problems, including climate change, by increasing transparency and facilitating the sale of carbon offsets.
A number of prominent crypto projects have started creating digital versions of carbon offsets and trading them online.
The underlying assets are credits that companies can buy from green projects on the voluntary carbon market that reduce planet-heating carbon dioxide (CO2) emissions via initiatives like protecting forests or building renewable energy facilities.
The buyers usually then "retire" the credits - meaning they are removed from the market and cannot be resold - to offset greenhouse gas emissions from their own activities.
But instead of using them to compensate for emissions, some crypto players have put these credits on the blockchain ledger, and floated them on crypto exchanges where they can be bought, sold and traded for other cryptocurrencies.
The Thomson Reuters Foundation found that one major pioneer in this new market, Brazilian "green" crypto firm Moss, bought carbon credits it said privately were of "low quality" - a judgment it later reversed in response to the investigation - and mixed them with others to back its digital token, selling them on for far more than it paid.
Here's how crypto players have impacted the voluntary carbon market:
How do crypto companies claim to help fight climate change?
Crypto firms say they want to help fill a big financing gap for projects that tackle climate change, arguing that their involvement will expand the market for carbon credits that fund emissions reductions and nature conservation efforts.
A 2021 McKinsey report said about $4 trillion in new funding is needed over the next 30 years to expand such projects - to produce clean energy, deal with waste, or preserve forests and other ecosystems - on the scale needed to curb climate change.
Crypto companies claim that by putting carbon credits on the blockchain, they can expand liquidity and reach a wider customer base, driving more money to conservation efforts worldwide.
One crypto carbon project, KlimaDAO, which issues tokens backed by carbon credit projects, reported more than $3 billion in transactions during the last three months of 2021.
How does tokenization work?
To put credits on the blockchain, crypto firms first "retire" them on the Verra system or on other carbon credit registries like Gold Standard and the American Carbon Registry.
This is a way of showing that the emissions reductions represented by each credit (one tonne of CO2) have been counted towards a corporate or individual's goal - essentially, used up.
Based on this, crypto companies then issue a digital token worth one carbon credit, which can be traded on crypto exchanges or "burned" by the buyer to offset their emissions.
What has gone wrong?
Since 2019, crypto companies have put carbon credits on the blockchain, making it easy for them to be bought and sold.
But researchers have found that a share of these were so-called "zombie credits" - offsets issued more than 10 years after a project had made the emissions reductions claimed.
On registries, they went largely unsold because their quality was dubious, research by nonprofit CarbonPlan found.
But that did not stop the digital tokens backed by them reaching high prices on exchanges, where transparency on the quality of the underlying credits is low.
At the peak of the crypto market, in late 2021 and early 2022, the crypto-backed carbon tokens boomed.
KlimaDAO's coins traded at more than $1,000 each for a brief period, even though the carbon credits behind them sold for less than $10 each.
KlimaDAO's tokens were in turn backed by other crypto-carbon tokens from companies such as Moss and Toucan.
But the high price of the tokens did not mean more money was flowing directly to environmental projects on the ground.
At times, speculators and middlemen reaped a significant share of the proceeds, the Thomson Reuters Foundation found, which has caused concern among veteran carbon market players.
What happens next?
In the early months of 2022, the cryptocurrency market crashed. Bitcoin, for example, is now trading at under $20,000.
In May, Verra suspended the tokenization of retired carbon credits on its books, pending the conclusion of a public consultation, which runs until early October.
It has been tasked with deciding in what circumstances credits can be tokenized and used by crypto market players to create financial instruments.
That has led some crypto carbon companies, such as the company Flowcarbon - which raised about $70 million in May to tokenize more carbon credits - to pause their operations.
Also in May, the American Carbon Registry prohibited the tokenization of its carbon offset credits unless it explicitly authorizes the process.
Verra's decision has left the value of millions of crypto carbon tokens in limbo.
And while crypto firms want a quick solution for the impasse, registries are taking their time to work out an acceptable way forward for a complex asset.
Last month, the International Finance Corp - a World Bank affiliate - said it was supporting a blockchain-enabled platform to trade carbon offsets, but only unused credits from an established registry that pass its additional quality checks.