Carbon - a new DeFi primitive

Laying the foundation for “web🌳” by building a decentralized climate finance ecosystem!

Carbon - a new DeFi primitive

The incredibly traction behind the launch of Klima, the first major use of Toucan’s carbon credit bridging infrastructure, demonstrates regenerative finance is a force to be reckoned with. This new infrastructure is sparking an opportunity to build a climate finance ecosystem to help fight the climate crisis around a new DeFi primitive: Carbon. Let's dig in.

How do carbon markets work?

First we have to understand carbon markets. There are two main types of carbon credits, voluntary and mandatory. Because mandatory credits are heavily regulated compared to voluntary credits, DeFi mainly intersects with the voluntary side for now. Voluntary credits are a completely self-imposed carbon tax that comes from companies committing to offset their emissions. By buying offsets equaling or exceeding their emissions, companies become “carbon neutral” and a financial incentive is created to cut emissions. Carbon credits are a new market, with a volume of 272b$ but growing rapidly as consumers and companies pledge to become carbon neutral. 

Development projects can mint credits by taking actions to reduce their emissions, this is done by measuring baseline emissions, and reducing the carbon footprint by for example planting trees or adopting clean energy. Credits are issued by independent carbon standards such as Verra, that set the rules and requirements carbon projects need to follow. 

The projects then monetize carbon credits through the carbon market, which is fairly inefficient. Often, a project will sell their credits to a retailer that aggregates credits from multiple sources, and through a broker sells these credits to an end-customer (eg Microsoft). Often half or more of the value is lost to middlemen that otherwise could have gone to fund green projects due to this market structure. If there was only a technology to replace the need for middlemen….

This is where DeFi comes in

DeFi offers infrastructure that has the potential to drastically effectivize the carbon markets, by removing the need for middlemen and creating a transparent market.

The foundational layer required for DeFi to use carbon is the bridge: Toucan. Toucan is building the infrastructure to onboard carbon credits into DeFi. This works by retiring carbon credits in centralized registries, such as Verra, with a certain identification code, which then is used to mint an NFT with the same identification code, thus linking the NFT with the central registry. The NFT can be fractionalized into ERC20 tokens to be used across DeFi.

Because each project becomes its own NFT and set of fractionalized ERC20 tokens, liquidity is highly fragmented. Toucan is therefore pooling projects into standardized buckets, based on the information in the identifiers to create standards such as the Base Carbon Tonnes (BCT), which represents Verified Carbon Units from 2008 or newer. This is what is backing up Klima right now: Real, verified carbon offsets, on-chain.

In essence, the bridging and pooling into a liquid asset representing carbon, is a brand new DeFi primitive. There is an opportunity to build an entire ecosystem of products on top of this primitive. There has been a lot of talk about web3 but maybe now it's time for web🌳?

The carbon finance ecosystem

Liquid markets: BCTs or other pooled carbon tokens can be used to start an AMM market to create a liquid market for offsets. This was just launched on Polygon’s Sushiswap, and will create the first highly liquid and transparent market for carbon credits. The reason so many middlemen exist in the traditional carbon market is because of the lack of liquidity. By creating easily accessible and liquid carbon markets, we eliminate two layers of middlemen, which means more value can flow to project owners and encourage further investments into carbon projects. Liquid markets are also foundational for a range of further DeFi applications.

Lending: Once we have a liquid carbon market, we can start leveraging carbon as collateral in applications such as Maker, Aave or Alchemix. Today, carbon project owners often have to dump their credits at bad prices to cover expenses, with these lending facilities they may have increased flexibility and gain liquidity without selling credits.

Reserve currency: In the climate finance ecosystem, aka web🌳, carbon can become a reserve asset, being used as money or a treasury asset and receiving a monetary premium. Owning carbon is like owning a piece of mother nature, why would we not choose to have this as our money? A great example of this is Klima, an Olympus DAO fork on Polygon, that is using BCTs to build a carbon backed reserve asset, that has attracted tens of thousands of DeFi users and will have several million tonnes of CO2 locked at launch. Klima has proved users love web🌳.

Indices: Combining various types of pooled carbon credits (including various geographies, co-benefits etc.), we can create carbon indices that give a diversified exposure to the carbon asset class. *Index Coop entered the chat*

Carbon-compensated services: Wallet providers, dApps or NFT marketplaces will be able to offer carbon compensated services to end users, where on the back-end carbon offsets are bought and burnt. NFT projects or DeFi protocols can start using a percentage of trading fees to offset carbon.

Status NFTs: There is tremendous meme potential to build status symbols based on retired carbon credits, eg an NFT only mintable by retiring 1000 tonnes of CO2, or nature related pfp NFT projects where in a similar way carbon is used to mint the NFTs. Using your money to fight climate change can become the most chad way to flex. 

New innovations: The beautiful thing with new foundational building blocks, is that an ecosystem of new services and innovations can be built, and we have no clue today what this may one day become. 

Building the future of web🌳

By building effective financial infrastructure for carbon markets, DeFi can remove intermediaries, provide greater access to capital to carbon projects and better carbon prices to encourage a wave of new project developers to reduce emissions. Web🌳 can become the native global market for carbon, but it will require the hard work and dedication of a big community of builders and users to make it a reality. If this opportunity excites you as much as it excites me, then consider becoming a Toucan contributor, or join the Toucan/Klima Discords to explore how we can build the future of web🌳.