Tokenization of Carbon Credits: What It Is and How to Make It Work

Achieving net-zero carbon emissions is an ambitious goal made possible by the development of a carbon credit system. While some companies must purchase carbon credits and offset their carbon footprint, others can buy them voluntarily in addition to their primary net-zero programs. This has encouraged the development of a carbon offset market where stakeholders can buy and trade carbon credits and help climate change organizations implement carbon reduction projects. 

As with any exchange system, carbon trading presents many challenges, especially when it comes to digitalization.

At Unicsoft, we’ve been exploring how we can use our expertise in blockchain to streamline the tokenization of carbon credits and bring more efficiency and visibility to carbon credit trading. 

But before we get into the technical aspects of carbon credit tokenization, let’s answer a fundamental question.

What is tokenization of carbon credits?

Carbon credit tokenization is the process of creating a tool within the cryptocurrency ecosystem that can be used as an investable asset in carbon credit cap and trade. That’s already complex, so let’s explain. 

An organization that directly contributes to the emission of greenhouse gases (GHGs) is usually obliged by the government to compensate for (offset) their emission. Offsetting can be done by paying direct taxes or by using an emission trading system (ETS) to buy carbon credits (i.e., the right to pollute in exchange for funding projects aimed at GHG research and reduction). 

One credit equals one tonne of CO2 or other greenhouse gas, so a company that emits, for example, 300 tonnes of CO2 per year is required to buy 300 credits. But what if the company reduces its emissions and still has, say, 50 credits it paid for?

With carbon credit trading, the company can sell these credits to an organization that produced more emissions than it paid for or that wants to participate voluntarily in carbon imprint reduction. 

This is the point of tokenizing carbon credits. 

Carbon credits can be used as tokenized assets in cryptocurrency trading, thus bringing liquidity to carbon markets and helping everyone reach their net zero goal faster. 

Since virtually any piece of information can be linked to a blockchain, cryptocurrency and blockchain platforms are ideal for supporting the carbon credit market. In particular, a blockchain ledger offers the following advantages over traditional carbon credit trading:

• Transparency of transactions and data. Every token is linked to traceable data, which prevents a climate change organization from illegally trading the same credits with multiple investors or buyers.
• Improved liquidity. Organizations can easily exchange credits before they expire or retire.
• Pricing signals. Each party in a transaction has access to real-time market data, so they can make the best investment.
• Data standardization. Blockchain can remove data inconsistencies caused by typos and misspellings and also prevent ill-intentioned data change.

Faced with the reality of the irreversible impact of carbon emissions on the environment, many countries have adopted new ways of dealing with it and have expanded carbon credit initiatives. 

Let’s look at the market background for carbon credit trading. 

A brief overview of the carbon credit market

In this article, we consider two types of carbon credit markets: certified and voluntary.

The certified emission reduction (CER) market deals with units (or credits) that were created through a government-regulated framework (third party). 

The voluntary carbon offset (VCO) market issues credits that can be used to fund carbon reduction incentives. These credits aren’t issued by government-approved entities and can’t be used to buy companies the right to emit GHGs within the mandatory compliance framework.

Despite its voluntary basis, the VER market is effective and growing fast. Here are a few recent stats:

• According to a McKinsey report, in 2020 the buyers retired (i.e., bought to fulfill their obligation completely) carbon credits for the equivalent of 95 million tons of CO2. The number of credits has doubled since 2017.
• The global demand for carbon credits could reach up to 1.5 to 2.0 gigatons of carbon dioxide (GtCO2) by 2030 and up to 7 to 13 GtCO2. 
• The Institute of International Finance believes there is “huge upside potential” for voluntary carbon credits, predicting the market could be worth as much as $100 billion per year by 2050.
• The cost of one tCO2e is estimated to rise to $80-150 by 2035.

Voluntary market offsets are an opportunity for experimentation and innovation. Contrary to standardized offsets, they can serve niche projects too small to be covered by compliance programs and companies that want to extend their corporate responsibility. 

How does it look technically?

The industry uses a marketplace for companies wanting to buy/exchange carbon credits, projects that initiate carbon credit creation, and smaller startups and corporations who want to go the extra mile to reduce their carbon footprint. Before we look at some examples, let’s look at how a carbon credit trading platform works.  

How a carbon credit trading platform works

A carbon credit trading platform brings together organizations that own, issue, regulate, and trade voluntary carbon credits. The platform allows users to tokenize a specific pool of eligible credits. One token has the value of one carbon credit (one tCO2e) and contains all the information related to the specific credit. This information includes

• Third-party credit certification data, if applicable
• Transaction records
• Auditing details
• Project data

This information forms the basis for smart contract creation: a program stored on a blockchain that runs if predetermined criteria are met. A third party can easily verify a token’s background information, and once ownership is confirmed, the contract executes automatically. This eliminates the need for intermediaries and creates a completely transparent process.

Carbon tokens follow the data encryption standards inherent to the blockchain, allowing easy and transparent integration with decentralized finance (DeFi) markets. With smart contract verification, decentralized exchanges (DEXs) can offer a range of financial instruments to owners of tokenized carbon credits.

Even though this sounds ambitious, this digital approach is real and booming. Here are some examples of carbon credit trading and exchange platforms active today. 

3 Most Popular Carbon Credit Exchange Platforms

Organizations can buy carbon credits in two ways: as offsets for their CO2 or equivalent emissions or as a direct trade with developers of carbon projects. Organizations can trade their carbon credits on digital platforms due to blockchain technology. Here are some of these platforms: 

Carbon Trade Exchange (CTX)

Carbon Trade Exchange (CTX) is the world’s first carbon trading blockchain platform and a collaborator with the United Nations CDM registry. Its services support the full carbon credit trading lifecycle. CTX trades Gold Standard, Verified Carbon Standard, and UN CDM credits (VER, CER, VCU, EUA, EUAA).

AirCarbon Exchange (ACX) 

AirCarbon Exchange (ACX) is a carbon trading platform launched in 2019 in Singapore. The platform uses both traditional central order book architecture and blockchain technologies to accelerate carbon credit purchasing, clearing, and settlement. Its engines can match nearly 10,000 trades per second with complete blockchain transparency. ACX now has over 90 clients, including corporate entities, carbon project developers, startups, and other industry stakeholders.

Toucan 

Toucan was launched in 2021 to bring the tokenization of carbon credits to Web3 and improve liquidity and accessibility in the digital carbon market. It uses Base Carbon Tonne (BCT) and Nature Carbon Tonne (NTC) as carbon credits that, after tokenization, form unified reference tokens (TCO2). Once converted to TCO2, carbon credits share standardized data regardless of their source registry, which de-siloes the market and enhances trading accessibility and transparency.

While these carbon credit exchange platforms are growing rapidly, carbon credit tokenization has several issues that platform developers should be aware of.

Challenges of Tokenizing Carbon Credits

The use of blockchain in carbon credit tokenization helps secure transactions, keeps data intact, and provides complete visibility and traceability, but it comes with its own share of challenges. Here are a few that platform developers will usually need help with.

The legal link between tokens and carbon credits 

A voluntary carbon credit market lacks the legal framework to function more efficiently. While there have been some positive steps, such as the UN’s commercial partnership with the Carbon Trade Exchange, it takes time to bring a market out of the gray zone. Another legal issue on a smaller scale is transferring rights associated with carbon credits.

Without a deep legal analysis and careful implementation of rights transfer, the whole idea of ownership can be jeopardized. NFTs (non-fungible tokens) offer one way to solve ownership issues, but the industry still needs regulation. 

Effective digital identity verification

Carbon credits can be used for money laundering if digital identity checks aren’t in place. KYC (know-your-customer) procedures, such as those used by high street banks, are essential for creating a safe trading space. The sale of carbon credits can be used for money launderingCarbon credits can be used for money laundering if digital identity checks aren’t in place. KYC (know-your-customer) procedures, such as those used by high street banks, are essential for creating a safe trading space. 

Establishing token and project quality

The quality of tokenized carbon credits is a major issue, as many tokens back projects that don’t add value to carbon reduction. As Toucan’s story shows, a platform may offer a bunch of low-quality credits for projects that don’t need funding or whose impact is overvalued. As a result, any reliable platform needs a way to thoroughly vet projects and their background.

None of these challenges are easy to overcome alone. Fortunately, a reliable tech partner can help you mitigate the risks and create a platform that’s a reliable and safe carbon credit platform for everyone. But don’t just take our word for it: here’s a Unicsoft project that proves it.

Case study from Unicsoft: Carbon credit trading platform development 

Unicsoft created a carbon credit trading platform that allows institutional and private investors to acquire and trade NFTs backed by real, verified carbon credits. The NFTs are minted on the private blockchain and accessible only through the web platform. This allows the creation of semi-centralized tokenomics and enables accurate fee regulation. In this case, the application of blockchain ensured transactions’ transparency and reduced operational costs.

Here are the main features and characteristics of the carbon credit trading platform:

• Monetization. Transaction fees and royalties from NFT transactions allow platform monetization.
• Revenue processing. Buy/sell transactions use a custom blockchain currency (stablecoin), though platform users can receive transaction revenues in USD.
• Freeze/unfreeze function. NFT smart contracts freeze or unfreeze tokens to allow their transfer to other blockchain networks through bridges.
• Native currency. The platform uses a native currency that can be issued and burned to secure the platform against DDoS attacks and collect transaction fees.

If you’d like to learn more about this project, contact us so we can share more details.

Wrapping up 

Blockchain-based carbon trading is relatively new in the carbon credit market. However, the tokenization of carbon credits has strong potential to make digital carbon trading more transparent and accessible. 

Easily traceable tokens and transparent trading data mean that blockchain-based carbon credit ecosystems can effectively support climate change projects and net-zero initiatives. 
At Unicsoft, we know what it takes to create a blockchain-based carbon credit platform that makes the most of this exciting new potential. Contact us today, and let’s talk about how your business can grow by tapping into the world of carbon credits!

FAQ

1. Can blockchain boost the carbon credits market?
2. Key Challenges in Carbon Credit Tokenization
3. Top Trading Platforms for Carbon Credits
4. How can Unicsoft help develop a carbon credit tokenization platform?