Impact Accounting and Externalities
When we look at impact, we see that the main thing happening in this space is an accounting of the positive and negative effects on the environment and societies that those companies create, and then, a rebalancing of that impact.
Why do companies do this? My cynical side says marketing… period. There’s also a side in me that says that this is part of being responsible and a part of the world as we would like to see it – I admire those companies that present this as true to their cause. I also have a side (cynical as well) that says, it’s OK that it’s marketing – so long as the company is really doing the work and not just greenwashing and lying about it.
Looking at impact accounting, we are essentially talking about the internalization of externalities. Environmental externalities refer to the costs or benefits of economic activities that are not reflected in the market price of a good or service. These costs or benefits are "external" to the market because they are not accounted for in the price that buyers pay for a good or service, and they are "environmental" because they relate to the impact of economic activity on the environment.
Environmental externalities can be both positive and negative. For example, a company that operates a power plant may generate electricity that is sold to consumers at a certain price, but the company's emissions may also have negative impacts on the environment, such as air pollution or greenhouse gas emissions. These negative impacts are external to the market because they are not reflected in the price that consumers pay for electricity (in most cases).
Environmental externalities can be difficult to address because they involve agreement on the extent and costs of the damage/benefit. One way to address negative environmental externalities is by regulations, taxes, or other policy instruments that internalize the external costs of economic activity. For example, by making the polluter (say, an energy company) bear the cost of the pollution they generate. Another way to address negative environmental externalities is by carbon pricing mechanisms, such as carbon taxes or cap-and-trade systems, which create a financial incentive for companies to reduce their greenhouse gas emissions.
One of the main tools at our disposal to internalize externalities (alluded to in cap and trade) is the idea of carbon credits. The carbon credit market consists of a voluntary and a regulatory market. The voluntary carbon credit market is a market for carbon credits that are not mandated by governments or international bodies. Instead, it is made up of voluntary participants who choose to participate in order to offset their greenhouse gas emissions or to support climate change mitigation projects. These credits are typically used by companies, organizations, and individuals to offset their own greenhouse gas emissions or to demonstrate their commitment to sustainability.
The regulatory carbon credit market, on the other hand, is a market that is created and governed by regulatory bodies such as governments or international organizations. These markets are established as part of a larger regulatory framework designed to reduce greenhouse gas emissions and mitigate the impacts of climate change. The most well-known example of a regulatory carbon credit market is the European Union's Emissions Trading System (EU ETS), which was established as part of the Kyoto Protocol to regulate greenhouse gas emissions from power plants and heavy industry in the European Union.
In summary, the main difference between the voluntary and regulatory carbon credit markets is that the former is driven by voluntary participation, while the latter is established and governed by regulatory bodies as a means of achieving specific greenhouse gas reduction targets.
The regulatory market makes good sense, but why do companies volunteer to do this? There are several reasons why companies, governments, and individuals may choose to participate in voluntary carbon markets. One reason is to demonstrate a commitment to sustainability and to reduce the carbon footprint of their operations. In addition, purchasing carbon credits can serve as a way for companies to offset the emissions that are difficult or expensive to reduce directly.
While voluntary carbon markets have the potential to help reduce greenhouse gas emissions, they have also been the subject of criticism. Some critics argue that voluntary carbon markets lack transparency and that it can be difficult to determine the true environmental benefits of the carbon credits being traded. In addition, some critics argue that voluntary carbon markets may be used as a way for companies to "greenwash" their image, rather than making real efforts to reduce their emissions. John Oliver summarizes this beautifully here:
Despite these criticisms, voluntary carbon markets continue to be a popular way for companies, governments, and individuals to offset their carbon emissions and demonstrate a commitment to sustainability. As climate change continues to be a major concern, it is likely that voluntary carbon markets will continue to play a significant role in efforts to reduce greenhouse gas emissions. Moreover, these imperfect tools are becoming more robust, verifiable, and transparent. In recent years, there has been increasing interest in using web3 technologies to facilitate the trading of carbon credits in voluntary carbon markets for these reasons.
Web 3 and examples from. the field
Web3 applications and protocols have the potential to bring greater transparency and accountability to the carbon credit trading process, as well as streamline and automate certain aspects of the process. This growing space in the web 3 world has been dubbed ReFi, or Regenerative Finance, and is a play on the more dubious, DeFi. A deep dive into this world by John Ellison of the ReFi DAO can be illuminating:
One example of a web3 application in the carbon markets is the Open Forest Protocol which focuses on using decentralized monitoring, reporting, and verification (MRV), for carbon credits. The platform aims to increase transparency and reduce the risk of fraud by using a diverse set of systems to create robust verification of tree planting.
One of my favorite systems being developed is Regen Network. Regen works with regenerative farmers and practitioners to develop methodologies and on-chain credits for regenerative practices. By using on-chain credits, independent and decentralized methodology development with experts, and working with grassroots stakeholders, I believe they embody all that is going to make Refi the best use case for web 3.
Web3 applications in the carbon markets are still in the early stages of development, and it remains to be seen how widely they will be adopted. However, these technologies have the potential to bring significant improvements to the carbon credit trading process and to increase the effectiveness of voluntary carbon markets in reducing greenhouse gas emissions. My favorite examples of this “bringing on-chain” of credits are Toucan Protocol. Toucan is a "bridge" that takes real-world, verified carbon credits on-chain so they can be traded in crypto markets. One of their main users is a DAO named Klima which uses these credits as part of its treasury.
New Tokens and Credit Classes
In addition to carbon credits, there are a number of other ecological assets that represent environmental impacts and offsets. These assets can be used in a similar way to carbon credits, to offset the environmental impacts of an individual or organization. Examples of these assets are water credits and plastic credits. Water credits represent a reduction in water consumption or an improvement in water quality. Plastic credits do a similar process with the reduction of plastic by companies.
Water DAO is in the early stages of developing such credits. and a system to fund water projects. Plastiks is an operational company working globally with a number of companies on reducing plastic and trading plastic credits.
Another example of a new credit class is the biodiversity credit. This credit also has its roots in international systems of regulation but today has a large voluntary market. Biodiversity credits represent a conservation or restoration effort that benefits wildlife or natural habitats. Biodiversity credits can be used to offset the negative impacts of development projects or to support conservation efforts. and a lot of the time is used as part of a carbon credit. These too are being developed on the Regen Network as many of these
At the moment, most projects that have a hard time accounting for the price and impact of the work they do, say, in the biodiversity of a forest, still, tokenize the impact as an NFT. A successful project in this regard is MOSS Earth which tokenizes land conservation in the Amazon rainforest – selling NFTs and using the proceeds for conservation. This is marketed as a carbon offset interestingly enough:
Looking at all these examples, the market growth of the space and the opportunities growing, I believe we have a long way to go but are on the right track. Whether with the diversification of on-chain assets, the MRV systems that secure the assets are real, and the rules by which we define the methodologies that govern these systems. We will continue to follow this evolving landscape and share our insights as they grow.