Crypto Carbon Credits Offer a Solution to the Wrong Problem

Crypto—often used as an umbrella term to encompass all things cryptocurrency—has garnered a lot of and polarized attention over the past decade. Today, industry leaders have entered the carbon market with: complaints that integrating these markets into the blockchain could lead to huge gains in eco-friendly business approaches. But skeptics aren’t sure exactly what problem crypto is trying to solve and whether it will succeed in reinvigorating the carbon credit market as countries race towards net-zero targets.

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What are carbon credits?

Carbon trading – or the carbon market – was first developed and introduced in the 1990s. Taxing the environmental damage of CO2 emissions allowed companies in theory to track and offset their own emissions. By purchasing carbon credits linked to ‘green projects’ on the market, companies in different sectors can continue their practices while also offsetting emissions and thus reducing environmental damage.

For example, a mining company subject to an emissions cap could purchase an offset credit from a forest owner who agrees to use this money to delay or reduce a crop. This would then allow the mining company to pollute beyond the stated limit and use the avoided forest emissions as credit.

Figure 1: The mechanism of carbon offset credits

Today, nearly three decades after the introduction of the carbon market, policymakers and activists are uncertain about its success. The market remains largely unregulated and discussions often revolve around which projects should be included. In fact, several Recent research pointed out that often associated projects are too expensive or have little or no positive impact on the environment. In fact, a study of California forest carbon offsets (worth over $2 billion and the largest program in the US) found that nearly a third of all offsets were credited. In total, this represents almost 30 million tons of extra CO2 emissions

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This excessive credit problem has frustrated critics of the carbon market. The combination of a lack of transparency and a systematic error in the way these credits are calculated has resulted in projects constantly miscalculating both pollutant and saved emissions.

Taking the California study as an example, there are often major misconceptions about what constitutes an eco-friendly offset project. The vast majority of these projects do not involve the growth of new forests, as is often thought, but the development of practices known as ‘Improving forest management’ (IFM), which are significantly more incremental in environmental benefits. This single example highlights some of the problems with carbon markets and their often exaggerated usefulness.

double counting – a term referring to a situation where two separate parties are claiming the same carbon removal project or credit – has also emerged as a problem with the current carbon market. This is indeed a huge problem that has highlighted the gap between theory and practice of carbon markets. So what’s up?

Usually, double counting occurs when the organization offsetting the emissions and the country organizing the project to achieve climate goals fall under the Paris Agreement claim the credits. This is of course problematic: both a country and a company claim to be carbon neutral and yet nothing has been achieved in terms of emission reductions. In addition to the immediate environmental impacts, double counting also discourages countries from taking action to meet long-term climate goals.

Proponents of crypto believe that one solution lies in this carbon market. Industry leaders have argued that the traditional carbon market is outdated, disorganized, and often devoid of incentives. They suggest that by moving carbon credits to the blockchain — a digital, open database — the crypto economy could encourage companies to become more environmentally friendly.

Moreover, crypto traders claim that if more people get involved in crypto carbon credits, it will drive up the price of the credits. By doing so, they hope to force companies to pay higher prices to reduce emissions or to incentivize them to invest in more energy-efficient operations.

The crypto industry’s initial approach was to: ‘sweep the floor’† This involved using a transition process to buy carbon credits already circulating in the conventional market and migrate them to the blockchain, in which case a token would be issued to the owner. These tokens can then serve as tradable objects through which trading can take place on the blockchain. While proponents of such a move to blockchain often tie their mission to environmental goals, there is a clear financial incentive for the move. In the current market, the price of carbon offset credits has been traded in the perimeter from 1 to 2 USD, while virtual tokens hit an all-time high of about 3,000 USD; clear benefit to those involved.

While open-source blockchain technology offers greater transparency in theory, an analysis of some of the earliest crypto carbon loans issued revealed two striking results. The first was that a significant number of “zombie” projects – projects that were inactive until the economic incentives generated by crypto carbon credits had been generated – had appeared on the blockchain. The second was that nearly all of the credits migrated to the blockchain came from projects that were originally banned from the current carbon market due to project quality concerns. So what do these two results mean for climate action?

What are the weaknesses of crypto carbon credits?

The appearance of “zombie” projects may seem positive at first glance. In theory, more carbon offset projects should lead to lower emissions. But often, if these credits fail to find buyers in the traditional carbon market, it’s because the buyers were initially concerned about the quality of the projects. Migrating these credits to the blockchain does not eliminate these concerns. Instead, previously unsaleable loans and projects are simply being used to generate income by owners who have “swept the floor” rather than generating exciting new projects with real potential. But these projects are not the only areas of concern.

The Paris Agreement defined the rules of the carbon market in the trade rules Clean Development Mechanism under Article 12, which bans credit trading before January 2013. This is to ensure that any new carbon offset request complies with the revised standards. But a narcotic 84.8% crypto the carbon credits traded would not have complied with the rules of the Paris Agreement as they had been registered before 2013. In short, the crypto carbon credits just seem to be commercial projects that would not have found buyers in conventional markets. By doing so, this technology only amplifies existing structural problems within the current carbon market and avoids the regulatory standards introduced under the Paris Agreement.

Proponents of crypto say the benefit of migrating to blockchain would be to address an outdated, non-transparent and disorganized carbon market. By doing so, they hope to either drive up the price of carbon emissions or force companies to seek more energy-efficient practices. While it’s true that the price has gone up for some credits, it seems to have benefited the owners of the credits; while the environmental benefits of this practice are negligible or in some cases exacerbated.

But if crypto is not the answer to the problems of the carbon market, then what is?

Can we fix the current carbon market without crypto?

To solve the important problem of double counting, adjusting the national emission targets in Article 12 was a good first step. This meant introducing a policy of highly controversial “corresponding adjustments”. These adjustments mean that the carbon emissions reduced or removed by the offset are subtracted from the project country’s greenhouse gas inventory. This mechanism ensures that for every carbon credit purchased on the market, only one country claims the reduction in emissions.

Ultimately, the biggest problem with carbon credits is the the lack of a single quality standard. This means that it is very likely that many sub-optimal projects will eventually be evaluated and commercialized, even if there is no environmental benefit. If markets are to take climate change seriously, they must move away from financing small individual projects and paying entire companies, and therefore entire industries, to reduce emissions. Ultimately, crypto encouraged the funding of these smaller, insignificant and often defunct projects, which goes against the solutions suggested by experts.

In order to have a single quality standard, a reliable and verifiable benchmark for the reduction of emissions must be established. By targeting individual companies and then industries as a whole, voluntary and compensated markets can be enhanced as the world moves towards a low-carbon future.

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