Tokenized Carbon Credits and the Mysteries of Klima DAO

Klima DAO is an organization of environmentalists, developers and entrepreneurs which pools resources and directs them towards financing high-impact and validated sustainability projects, mainly through the acquisition and retirement of carbon offset credits.

Introduction

Although blockchains, particularly proof-of-work (PoW) protocols, have been broadly criticized for their electricity consumption, there are many in the Web3 space specifically positioning themselves to consume as little energy as possible. Ethereum, for instance, has gone as far as transitioning its own consensus mechanism from PoW to proof of stake (PoS) in response to these concerns. Not only can blockchains be differentiated by their consensus mechanisms or energy usage, but many of them are focused exclusively on climate activism. 

There are already a few climate initiatives leveraging the popularity of digital assets and the liquidity that blockchains offer to investors wishing to participate in them. Algorand, among other blockchain projects, has declared its intentions to become entirely carbon-neutral. Polygon is another project which has leaned into climate activism and has pledged a number of initiatives related to integrating carbon emission cuts and other environmental action into their business model.

By tapping into the liquidity of blockchains, Web3 projects can to commoditize, digitize, and automate the exchange of clean energy investments. The idea is that the liquidity associated with Web3 could lead to an influx of additional capital towards carbon reduction initiatives and cutting energy consumption. Additionally, blockchains offer additional transparency and consequently, accountability when it comes to organizations meeting their stated carbon emissions reduction goals. 

Of course, it is not always as simple as counting how much electricity was consumed by a network’s participants and converting it to a corresponding amount of carbon emissions. There are also “carbon offsets” which can be purchased or employed, which are meant to represent the mitigation of 1 metric ton of CO2 emissions produced by their business operations.

What are Carbon Offset Credits?

Since at least the early 1980s, nation states trading national debts with developing countries to protect natural resources have been employed to protect and conserve biological diversity. These swaps eventually became the model for carbon offset credits. Furthermore, the Kyoto Protocol, adopted in 1997, deliberately set out to enable developed nations to offer financial assistance in the form of carbon offset credits to developing economies which it would be impractical or harmful to apply strict carbon emission constraints. 

That is, a carbon offset credit system was devised that imposed strict greenhouse gas caps on the more industrialized nations that ratified the agreement in Kyoto. The signatories were each given an allotment of carbon emission allowances, with countries promising to reduce their emissions below the levels they recorded back in 1990,with even more ambitious goals set for the year 2012. 

Carbon offset projects are either created by national governments or by major industrial carbon emitters. One of the clever ways to help them reach their targets was to trade their greenhouse emission allowances with signatories that had surplus allowances. Another way to meet their targets was to purchase carbon credits. In fact, the Kyoto Protocol outlined three specific mechanisms by which signatories could acquire carbon offset credits:

1. A developed country with relatively high costs of domestic greenhouse reduction has been able to establish projects in other “developing countries.”
2. Developed countries can sponsor greenhouse gas reduction projects in “developing countries” where greenhouse gas reduction projects activities are more affordable, but the atmospheric effect is globally equivalent. 
   1. In such cases, the “developed countries” would receive carbon offset credits for meeting its CO2 reduction targets, while the “developing countries” receive the capital investment in green technology, or benefit directly in terms of reforestation or improvement in land use.
3. An international carbon credit marketplace was also established so countries can cover any shortfalls in their emissions targets via trading allowances for credits when necessary.

Carbon offset credits are one of the most prominent international efforts to mitigate increasing concentrations of greenhouse gasses. Carbon offset credits are standardized representations of reduced CO2 emissions from the atmosphere via emission reduction projects carried out by governments, factories, or private individuals with heavy carbon footprints to compensate for their emissions. These mitigation efforts are calculated in order to quantify the carbon offset credits, meaning this approach can be used to finance carbon reduction schemes elsewhere in the world through their coordinated efforts.

One carbon credit is equal to one metric ton of carbon dioxide, or in some markets, carbon dioxide equivalent gasses. Nation states and businesses that find it difficult or are unable to comply with their carbon emission caps can turn to carbon offset credits to mitigate their emissions in other ways. By financing renewable energy projects, reforestation initiatives, and other local carbon offset projects across the world.

Purveyors of carbon offset credits usually include investments in wind, solar, hydropower, geothermal, and biomass energy generation projects. Offsetting one metric ton of carbon theoretically means that there will be one less ton of carbon dioxide spilled into Earth’s atmosphere than there would have been otherwise.

A novel way to accomplish this is by using Web3 to tokenize carbon credits, which companies or individuals can purchase to offset their carbon emissions. By storing carbon credits as digital tokens, they enjoy the enhanced liquidity of blockchain technology, but are also more easily tracked and audited via third-party Oracles. Oracles can easily and safely integrate climate data and other off-chain data into the infrastructure of their smart contracts.

More specifically, Oracles can make use of satellite and remote sensing data to verify the sequestering or mitigating of carbon emissions before the tokens are issued. Audits can be performed periodically to provide on-chain proof that the tokens represent real carbon offsets, and prevent any fraudulent claims. Individual users can also receive benefits through various incentives like staking rewards, NFT drops, or other discounts for holding carbon credit tokens.

Klima DAO and Polygon Aim to Finance Incentives to Offset Emissions

Klima DAO first entered the crypto scene in Q4 2021, with its public profile being put in the spotlight by billionaire Mark Cuban listing that he’d invested in it. The DAO’s stated aim is to acquire as many carbon offsets as it can to drive up their value, incentivizing carbon-offsetting behaviors and activities via their token. Klima DAO has also been slated to analyze the Polygon network’s carbon footprint, helping to support its emission reduction goals and carbon offset strategies. Klima DAO’s analysis will mostly be related to calculating carbon emissions from validator nodes and the energy consumption of the hardware needed for their operations.

While Klima DAO’s token operates on Polygon’s blockchain, the carbon offset credits are actually represented on Ethereum in the form of Base Carbon Tonnes (BCT), and also MCO2 tokens. BCT and MCO2 tokenized credits were generated from carbon offset credits, certified under the Verified Carbon Standard (Verra), one of several independent bodies which standardize the process of calculating carbon offsets. Essentially, Toucan operates a token bridge which brings carbon credits on-chain.

Each token represents 1 metric ton of carbon just like typical carbon credits, but the tokenized versions offer more liquidity derived from using Web3 infrastructure. Klima DAO uses their native token KLIMA to purchase these offsets, meaning that a rising KLIMA token price empowers the treasury by increasing their purchasing power in carbon markets.

For its part, Polygon has announced its own Green Manifesto, essentially promising to achieve carbon-negative status in 2022. It further pledged $20 million in funding community initiatives that utilize technology to address their impact on the climate through their carbon emissions. Polygon announced their intentions to buy $400,000 worth of tokenized BCT and MCO2 carbon credits, which works out to the equivalent of about 90,000 metric tons of carbon emissions being offset. The announcement also indicated that Polygon would subsequently retire the purchased carbon offsets within the carbon token pools that demonstrate excellence in achieving their carbon offset targets.

Verra Prohibits Further Authorization of “Retired” Carbon Credits Due to Consumer Ambiguity

Interestingly, Klima DAO’s acquisition of so many carbon offsets has caught the ire of traditional carbon offset firms. In fact, Gold Standard CEO Margaret Kim publicly criticized Klima DAO in an interview with the Wall Street Journal, suggesting that transparency issues derived from the anonymous founders were questionable. In response, they’ve implied in several interviews that they may reveal themselves once their projects have gone more mainstream. 

However, recent controversy over the tokenization of “retired” carbon credits has resulted in Verra pulling their support from issuing any further tokenized credits based on “retired” credits. Carbon credit standardization organization Verra had originally announced that Web3 users of carbon credit tokens engage at their own risk. However, several months after the launch of Klima DAO, Verra announced a new position on tokenized carbon offset credits associated with its flagship Verified Carbon Standard (VCS) Program.

As of Q2 2022, Verra prohibits the creation of tokens based on retired carbon credits on the basis that the act of retirement is widely understood to refer to the consumption of the credit’s environmental benefit. Instead, Verra announced plans to explore the potential for “immobilizing” carbon offset credits within Verra Registry accounts, so that they can be properly distinguished and then tokenized with the transparency and traceability that participating token holders expect.

Verra considers it important that any possible approach to tokenized carbon credits should only make use of “live” rather than “retired” credits. Verra also recommended that underlying carbon credits be immobilized in their Registry while their associated tokens remain on the market, in order to prevent double-use of the credits from Verra’s Registry. If not, the underlying credits could be transferred to other accounts or retired for other purposes, thereby undermining the integrity of the associated tokens.

This plan is pending, provided it can be done in such a way that prevents outright fraud, the misleading of investors, and subsequently upholds environmental integrity as per Verra’s mission. Verra is currently involved in ongoing public consultation with Web3 firms and interested parties to determine how to proceed with their on-chain engagement, wrapping up their talks in October.

Final Thoughts

Though Klima DAO hasn’t necessarily done anything wrong, the project remains rather opaque, creating headaches for investors and those interested in their vision. In addition, its founders still remain anonymous, and their protocol is somewhat veiled by complex financialization.

For starters, it may not be immediately obvious to users that when they buy the KLIMA token, they aren’t buying carbon offsets. It may be that investors were not clearly aware that the tokenized carbon credits were retired carbon credit offsets rather than carbon credits themselves.

Furthermore, it is not immediately obvious to many token holders how the DAO’s carbon offset tokens are generated, or what measurable impact they could have made. That is not to say that the project is illegitimate, but rather it is a lament that more clarity isn’t made a priority by the team. Perhaps the future is still bright.

KlimaDAO has since been accumulating BCT, with posts suggesting it now owns more than 90% of the token’s total supply, which implies speculators must have little influence on the market. It hasn’t done much to inspire much appreciation in terms of the token’s price. In addition, some users have complained on Twitter that they couldn’t find buyers when trying to sell KLIMA tokens on SushiSwap, implying that there’s little to no liquidity to be found for those looking for the exits. 

Of course, if users know what they are getting into from the beginning, it could be nothing to worry about. On the other hand, it is likely to cause headaches for speculators who were caught unaware of the project’s nature when they decided to dump their tokens. To be fair, the DAO has yet to sell any of its treasury assets, which is certainly a positive sign. It will be interesting to see how things play out over time for Klima DAO, Polygon, and tokenized carbon offset credits more broadly.

This content is for informational purposes only, and doesn’t construe any legal or financial advice.

References

1. Camilleri, M. (2022, 2 May). How billionaire Mark Cuban got revenge on DeFi with KlimaDAO. Protos. 
2. Beganski, A. (2022, 4 Sep.) KlimaDAO engages tusk strategies to push congress to write DAOs into law. Decrypt. 
3. Mulder, B. (2022, 25 May). As Verra halts tokenization of carbon credits, Toucan vows to ‘keep Web3 ethos alive’. S&P Global Commodity Insights. 
4. Newar, B. (2022, 12 Jan.). KlimaDAO increases carbon offset stash by 50% in two months. Cointelegraph.
5. Strack, B. (2022, 19 Apr.). Blockchain tech is key to combating climate change, report says. Blockworks.

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