The time for real DLT asset application is now

It feels a lot like we’ve seen this all before: the realisation that new technology isn’t a viable business before it actually is a business; the necessity for a change in direction only to become obvious after the change has happened … then there’s the crash.

Recently, the #crypto exchange FTX imploded and laid plain how sound practices, processes and reporting are necessary pillars for a sustainable business. Even more so, it showed that once the fascination with a new #technology wears off, it’s difficult to maintain the notion that #digital representations hold a value unto themselves unless they’re backed by real assets. Nowhere is this clearer than when looking at the volatility of crypto currencies, although one could reasonably argue that the ability to execute anonymous transactions constitutes a real asset in itself.

It would be all too easy to dismiss anything related to #cryptocurrency and #blockchain technology as simple distractions to real-life business. This would be a crippling mistake, however, as there is tremendous potential in applications of Distributed Ledger Technology (DLT), including blockchains. Simply put, it seems that DLT has been a solution desperately seeking a problem, and the technology has now reached a crossroads. It could even be argued that the time is ripe for turning the corner and letting business needs determine the application of blockchains rather than inventing ways to commercialise their benefits.

Carbon certificates offer foot in the door for DLT credibility

DLT offers extraordinary efficiency gains compared to traditional financial and commercial processes by eliminating the need for trusted third parties and complex settlements. It’s little wonder then that established players are averse to surrendering their business to new solutions, which essentially render their services legacy. Still, the last century has rammed home the need for robust prevention of fraud and other types of financial crime, a need that doesn’t disappear because new technology streamlines process execution. The answer is to apply DLT solutions to the underlying problems rather than giving up the hard-earned knowledge in blind pursuit of simplification. Furthermore, to circumvent the resistance of the incumbent system, it would be wise to start with a line of business that isn’t currently served by a well-established sector.

Enter #carboncertificates for the Voluntary Carbon Market (VCM). Established as part of the Kyoto Protocol as a means to channel capital towards projects removing #greenhousegases (GHG) from the atmosphere, carbon certificates resemble financial instruments but are not regulated as such. Hence, the certificates are not subject to the same level of scrutiny and control as financial instruments but could, potentially, serve as vehicles for some of the same criminal activities the financial system has been designed to prevent (e.g. #moneylaundering and sanction breaches).

As discussed in the first article of our DLT series, the VCM is dependent on the credibility of the carbon certificates and their underlying GHG removals. Historically, the VCM has been plagued by low-quality certificates building on highly questionable removals of CO2 from the atmosphere. Many corporations have been accused of #greenwashing – buying certificates to “finance” ineffective or non-existent GHG removal projects – which has been criticised for giving certificates lack of validity. However, the VCM is undergoing a change with participants pushing hard to increase the quality of carbon certificates. New nature-based projects within agriculture (e.g. soil carbon), as well as direct CO2 capture technology projects, are emerging and market standards are gaining trust. More and more projects are brought to the VCM by credible certificate issuers who offer farmers and other originators a supported method to harvest financial benefits for their efforts. Agreena is such an issuer, with focus on enabling the transition from conventional farming to regenerative agriculture. With 572,000 hectares under management in Europe already in its second year of operation, Agreena is a leading driver of the regenerative revolution and its associated benefits within carbon capture, biodiversity, soil quality and water retention.

Market participants need to get their ducks in a row

Like all participants in the VCM, Agreena is facing an illiquid market with little to no transparency of certificate prices and quality. While market standards such as Verra and Gold Standard provide much needed quality alignment, certificate sales still rely on thorough due diligence from leading buyers and a leap of faith from less sophisticated ones. Quality notwithstanding, the lack of transparent pricing makes certificate purchases even murkier for entities without the scale or resources to conduct independent market research. This is a prime example of a problem for which DLT/blockchain could provide a potent solution.

The key to improving #market maturity for the VCM is to move it towards the best practices known from the financial system, even if it’s not yet regulated. This includes the application of thorough Know Your Customer (#KYC) practises as well as monitoring transactions, sanctioned entities and internal processes to enable employees to spot unusual activity. It’s likely that carbon certificates either have been or will be used for money laundering, and when such abuse is exposed, it’s likely authorities will take a much more critical view on the VCM. Hence, market participants should get their ducks in a row and start improving their Anti-Money Laundering (#AML) processes. Some have already begun the work, but the whole sector needs to be onboarded.

At Agreena, we’ve decided to focus our efforts in two distinct areas. We’ll continue to strengthen our internal processes to prevent the abuse of our certificates for financial crime purposes. As mentioned earlier, this should become a ticket to play in the VCM within the next few years. In addition, we’re also pushing for the expansion of the services offered to originators, carbon certificate buyers and off-setters. The ability to trade certificates and execute the related payments securely and compliantly are key requirements for taking the VCM from its current, immature state to an efficient marketplace with #transparent #pricing and trustworthy counterparties.

In order to move forward, it’s time to let go

While such a marketplace can be established within the traditional financial infrastructure, DLT and blockchains offer a much more attractive alternative if done right. Agreena has announced partnerships with frontrunners within both real-money, blockchain-based payments and DLT-based trading platforms. The common denominator is that all of them are already licensed and regulated by EU financial authorities or are in the process of becoming so. With ZTLment and Monerium , we’ve established the payment rails?on the Algorand Technologies blockchain to execute secure transactions in e-money (central bank-backed electronic versions of real-life money). This enables us to pay our customers, regardless of whether they’re already onboarded to the blockchain or not. The beauty of the system is that customers need not know or do anything specific to receive their money. On the other hand, we now have the infrastructure to connect our payments to smart contracts and start working on all the additional business opportunities this leads to. With Deon Digital AG and the Danish Financial Services Authority, Finanstilsynet Danmark , we’re investigating the path towards a regulated, DLT-based trading and settlement platform. It is Agreena’s hope that such a platform can eventually enable the sale of our carbon certificates and related instruments with all the benefits of a mature marketplace (e.g. liquidity, pricing transparency, trustworthy counterparties, monitoring, etc).

DLT and blockchain are far from dead as business enablers. However, it’s time to let go of the misconception that radical transparency and other benefits of DLT can completely replace all the measures and controls developed over many decades. One size doesn’t fit all and the real benefit of new technology is only harvested when it’s applied to the underlying needs and elements. When dealing with the money of real (and legit) people and companies, 80/20 is not enough to protect the integrity of the process and its participants. For the VCM, the solution is to embrace the yoke of regulation and design for the protection it offers, even if not yet required by authorities. For other lines of business, the solution may be different but the essence is the same. Out with the old and in with the new – but keep the underlying experience, which has enabled us to move forward while maintaining security along the way.