ReFi: ClimateTech or Blockchain? Why not both?
Regenerative Finance. Platonic chariot allegories. Greed-for-good. Toucan Protocol. And the promise of on-chain DAC markets.
Dinner with an Old Friend
I was catching up with one of my most thoughtful friends at dinner the other week when the topic of crypto came up. She’s been working at a hot climate tech startup so she was… well… less than enthusiastic about my growing interest in crypto.
“Do you realize how much energy that wastes?” She asked.
The only honest answer is “A lot.” In 2019, Bitcoin mining used roughly as much energy as the Netherlands. Ethereum does a little better. It consumes roughly as much energy as Austria.
If there’s a saving grace here, it’s that modern protocols fare better. Solana transactions, for example, are not much worse than a Google search. Ethereum’s switch from proof-of-work to proof-of-stake will reduce its carbon footprint by 99%.
As for Bitcoin – well – there’s not much to offer in its defense.
“OK fine, it’s getting better,” my erstwhile companion protested. “But don’t you think Silicon Valley should be less focused on blockchain and more focused on climate tech?”
This is the important question.
It’s the one that pulses in my mind while I write pieces about the market dynamics of cartoon apes. Because my friend is right. The hour is getting late. The situation is dire. And it’s not a stretch to say that the future of the world depends on what we do over the next decade.
But I will tell you what I told her: I believe there’s a critical role for the blockchain to play in that future. I believe we are going to need to coordinate global responses on an unprecedented scale. I believe we’re going to need every coordination mechanism we have at our disposal to do that. Governments, of course. But also transparent markets of unprecedented scale.
So, to make my argument to her, I broke out my most pretentious Plato reference…
The Allegory of the Chariot
Plato imagined a human mind as a charioteer driving two horses.
The first horse represents the better angels of human nature. It represents morality and restraint.
The second horse represents the unbridled hunger of the human spirit. It represents passion and appetite.
The task of the chariot driver is to make the horses work together. If we focus only on the righteous horse, or only on the passionate horse, the chariot will go off of its path. The trick, Plato argued, is in balancing both halves of our nature and guiding them to productive ends.
I’m not much of a Gordon Gecko “Greed is good!” kind of guy. But self-interest is part of our survival DNA. I do not believe, like many of my more leftwing friends, that our project as a society is eliminating greed. I believe our project is learning how to harness it to our collective betterment.
As Adam Smith once explained, “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest.” There is no tool as effective at harnessing greed as the invisible hand of the market.
The Second Horse: A Market-Driven Vision for the Future of Carbon
We can think of the Good Horse in climate matters as regulatory intervention. This horse calls upon tools like minimum emission standards and forbidding certain sources of energy. At an extreme, the government could order all polluting businesses to stop operations altogether. There is a path to a zero-emissions world that looks a lot like turning back the clock to 1800.
It would stop climate change. It would just cause riots and revolutions.
If we want to come out of the climate crisis without massive political upheavals, we will need to find a way to keep costs low while hitting our targets. That's a job for markets. Because wherever there’s a market, we can rely on greedy humans to help us achieve our goals in the cheapest way possible.
Our Other Horse is ready to ride.
A well-functioning marketplace needs three things:
buyer demand for a product,
seller supply of that product
an efficient mechanism for matching buyers and sellers.
The good news is that buyer demand for carbon credits is growing. The voluntary market is tiny, but growing – it hit $1B in sales last year. The European ETS market, by far the world’s largest, hit $851B last year. New regulated markets are springing up in China, the UK and regional coalitions in the US. So we do have market-demand that we can bet on.
Supply, on the other hand, is a massive issue.
Here’s a chart from the Global Carbon Atlas showing the relative scale of all available registered offsets (in green) vs global emissions and those from companies in the Russell 3000 (a US stock market index):
That's a big supply shortfall.
When there’s lots of demand and low supply, it should drive up prices. The higher prices should attract new suppliers. That’s how well-functioning free markets work. But the Global Carbon Credit market is not a well-functioning free market.
Our third prong of a successful market – the ability to reliably and efficiently match buyers and sellers – is completely broken.
As a McKinsey & Co. Study puts it, “Overall, the market is characterized by low liquidity, scarce financing, inadequate risk-management services, and limited data availability.”
Low Liquidity Leads to Under Investment
Different cap-and-trade markets use different quality standards. These markets are not interoperable across borders. This regulatory complexity and fragmented demand make it impossible to create a liquid carbon market.
Without a liquid market, it is difficult for analysts to value carbon credit projects. Without these valuations, potential carbon suppliers struggle to attract financing for their projects. This leads to the massive supply shortfall. But it also provides an interesting opportunity for blockchain’s market-making capabilities.
If we could create a liquid international market for carbon credits, could we accelerate investment?
The short answer is yes.
The longer answer is, "Yes, but it's still going to be hard to route money to the most effective (read: non-scammy) projects."
Toucan: Creating Liquidity, Encountering Abuse
We can see this in the trials and tribulations of Toucan Protocol. Launched less than six months ago, Toucan is the largest blockchain protocol for carbon offsets.
Toucan created a way to bridge carbon credits onto the blockchain. They allow carbon credit owners to “deposit” their credits with the protocol. This removes them from resale on other registries to prevent double-sales. It also ensures that - like all on-chain data - credits are publicly verifiable and searchable.
Once the credit has been on-boarded onto the blockchain, Toucan flexes its capabilities. They start by grouping carbon credits with similar attributes into pools. These pools issue tokens representing a fractional interest in the pooled carbon credits. These tokens are then connected into the 24/7 super liquid Ethereum token exchanges. This combination offers would-be suppliers a clear price signal for their potential projects.
The approach is scaling rapidly. In six months of life, the protocol has bridged 22M Tons of Carbon. That’s great news and a promising signal for the space’s potential.
But there’s another challenge for any carbon exchange. How can you ensure the quality of their credits? It's something that existing registries and traditional exchanges also encounter. Old projects. Double counted projects. Poor carbon impact estimation. Carbon credits are a well-known and well-intentioned mess. And as data junkies are fond of saying: garbage in, garbage out.
A popular post last month, Zombies on The Blockchain, showed that 99.9% of the credits bridged to Toucan were from projects that did not meet Paris Agreement guidelines.
Toucan has blacklisted many of the offending credits. They also argue that KlimaDAO (who on-boarded many of these credits) is "sweeping the floor" of carbon credits. By buying up the supply, KlimaDAO ensures that other businesses cannot claim them as offsets.
If there's a silver lining to this experience, it's in how easy it was for outside analysts to vet credits on Toucan. As the credits were on-chain, all of their data was publicly verifiable. As a result, these issues could be identified and corrected rapidly. That's important because the reality is that this isn’t a Toucan problem. It’s a carbon offset problem.
Even for high quality projects, it's impossible to estimate real carbon offset impact. There's no counterfactual to test against. We can't know what the world would look like without those planted trees. So public data enables better impact estimates. But the most important legacy of carbon credits may be in laying the groundwork for a new type of carbon market.
Bootstrapping Direct Air Capture
Direct Air Capture (DAC) technology uses machines to remove hazardous greenhouse gasses from the air. The technology will play a large part in our global climate mitigation strategy. The UN’s IPCC believes that by 2050 we will need to remove at least 6,000,000,000 tons of CO2 from our air every year.
Existing plants are on track to capture 8,000 tons this year. So, y’know, we got some ground to cover.
DAC doesn't suffer from many of the verification problems of carbon credits. We can measure impact precisely. We can use machine logs to verify correctness. We can be confident that CO2 removed in Shanghai is equal CO2 removed in Texas. But that accuracy comes at a price today.
Removing a ton of CO2 through DAC costs $250-600 today. Achieving that removal through reforestation costs roughly $50. The Department of Energy believes that scaling will lower the price to under $100 per ton in the decade. But scaling requires a lot of private investment, and that requires an efficient market with demonstrated demand.
Stripe and other tech companies are working to bootstrap demand through the Frontier Fund.
The Frontier Fund negotiates a price for DAC carbon removal with vetted projects. It approves a forward contract to buy credits at the negotiated price when the projects go live. The goal is to bootstrap a virtuous cycle. With proof of demand, these startups can raise capital to improve and scale their system. To achieve this goal, Frontier has pledged $925M for DAC.
This creates an opportunity for carbon protocols to double down on Stripe's play. Solid World DAO already offers forward-contracts (essentially pre-orders) for carbon credits. On-chain protocols could offer forward contracts on DAC credits. These credits would further strengthen the proof-of-demand needed to bootstrap the DAC market.
They would allow smaller buyers to invest in higher quality carbon assets. They might also touch off a speculative market for these credits, luring in more capital for DAC projects. Our Platonic Second Horse would begin to gallop.
After all, who wouldn’t want to get rich by saving the world?