Tokenizing Carbon Offsets And Incentives in Regenerative Finance (ReFi)

An introductory look at ReFi

The field of Regenerative Finance, also known as "ReFi," is one that is expanding within the Web3 ecosystem and provides an opportunity to rethink how we approach finance, investing, and the growth of sustainable economies. Instead of taking an approach that is primarily extractive, ReFi takes a more holistic approach to finance and development. This approach takes into account the environmental, social, and economic impacts of financial decisions.

The end goal of this approach is to create an economic ecosystem that is capable of self-renewal. The field of decentralized finance (DeFi), which is built on blockchain technology and aims to create a more equitable monetary system by doing away with intermediaries, automating transactions through the use of smart contracts, and having transactions that are both fully open and transparent, served as the foundation for the development of ReFi. The economic interdependence of nature and the economy, the fragility of extractive economic systems and supply chains, and the use of blockchain technology to enable natural regeneration for climate causes at scale are some of the trends that are driving the growth of ReFi. In order to acquire an understanding of a practical application of ReFi, we are going to investigate the application of tokenized carbon credits, the problems that these tokenized credits solve, and approaches to regulation that are grounded in common sense.

Characteristics of the Defi

When considering ReFi, it is helpful to begin by thinking about existing DeFi implementations, as these use many of the same technologies and philosophies. This is a good place to start when thinking about ReFi. Both domains make use of decentralized blockchain technology, the ability to execute smart contracts without requiring permission, the capacity to tokenize digital or physical assets, and the elimination of intermediaries in incentive structures. The elimination of the need for third parties to mediate transactions, the automation of transactions and agreements through the use of smart contracts, and the vast majority of the removal of costs and barriers for market participants are the primary reasons that decentralized finance has the potential to revolutionize how we conduct finance and transact with one another. As a field of study, decentralized finance (DeFi) is still in its infancy, and there is not yet an established legal framework in place to facilitate the field's growth in ways that are beneficial to users' safety.

ReFi Goals

The goal of the ReFi project is to mitigate many of the negative effects of globalization that have become apparent over the past four decades. Because the technology enables entrepreneurs and communities to define their own incentive structures for priorities that are defined by the community itself and not by a remote corporation with little awareness about the reality on the ground in local situations, ReFi is an essential component of the solution. ReFi projects and their proponents want to shift the emphasis back to a greater number of local communities, establish supply chains that are more robust, and design economic systems that do not prioritize shareholder growth over these ReFi objectives. When it comes to people, communities, and the environment, economic models that are solely based on the goal of increasing shareholder value can frequently have a negative impact.

Businesses and organizations in our interconnected world that fail to take a comprehensive view of the larger system that they are a part of are at a greater risk of being vulnerable to unexpected and compounding shocks. The neglected components of the system that each entity constitutes are frequently the source of these shocks. In order to assist in resolving these issues and developing new incentive frameworks, ReFi plans to make use of web3 technology and decentralized coordination.

Decentralization

Decentralization is an essential component in the creation of value that is sought after by regenerative projects, including ReFi protocols and decentralized autonomous organizations (DAOs). In the current economic system, corporations and larger banks frequently serve as intermediaries between market participants; however, these market participants frequently have their own agendas and interests, and corporations and larger banks frequently do as well. There are times when the objectives of market intermediaries are in direct opposition to those of market participants, and in other instances, they are in direct competition with those objectives. Utilizing customers and users as resources that can be exploited can result in monetary gain for shareholders. This gain can take many forms. With smart contract-enabled programs enabling value exchanges to occur peer-to-peer, blockchain technology provides a way out of this coordination trap. This eliminates the possibility of an unseen counterparty either weighing the game in its own benefit, using capital as a lever to manipulate the outcomes, or gaming a system of interaction that is not in the best interest of the market participants. Blockchain technology also eliminates the need for centralized intermediaries to verify transactions. Once they have been activated, smart contracts are unable to be modified in any way because they are executed on a decentralized blockchain and cannot be tampered with or stopped. This makes it possible for communities, businesses, and individuals to create businesses, organizations, and systems on the blockchain that they design, without having to worry about unseen counterparties unfairly weighing the game. The use of tokenization brings us directly into another essential component of ReFi, which is smart contracts.

Tokenization of assets

Tokenization of assets that exist in the real world. The DeFi model is expanded to include non-traditional financial markets by ReFi, which also introduces new tokenization methods for a wider variety of asset classes. Tokenization and representation of both digital and physical assets can now take place on blockchains thanks to smart contracts. Each token is a symbol for an underlying real-world or digital asset, and it is cryptographically secured against interference and control from a third party. Tokens can only be exchanged for the underlying asset, which can be digital or physical. Tokens make formerly immovable and illiquid assets liquid, while also enabling independent verification and real-time auditing on blockchain networks. It is important to understand the values and context that are underlying the efforts to build with the technology, especially since ReFi uses web3 technology for the creation of public goods and projects that regenerate ecosystems.

Carbon Offsets

Carbon credits are a representation of carbon offsets, which can be defined as anything that captures carbon and removes it from the atmosphere. Carbon offsets are defined as anything that takes carbon out of the atmosphere. The carbon credit may very well be the primary source of lifeblood in the carbon market. This is because the carbon credit represents offsets, and businesses want to acquire as many offsets as they possibly can. One strategy that countries are employing to achieve carbon neutral status and meet their climate goals is offsetting and the acquisition of carbon credits. Everyone, including individuals and businesses, leaves behind some amount of carbon. Any endeavor that results in the emission of carbon into the atmosphere is referred to as leaving a "carbon footprint." Even taking a shower contributes to the emission of carbon into the atmosphere, as does the consumption of non-locally sourced food, the use of electricity, the operation of gasoline-powered vehicles, the charging of electric vehicles, and so on. It is common practice to consider offsets less as digital assets that could be traded on the carbon credit market and more as compensation to an environmentally conscious individual or organization.

The use of Carbon Credits

One ton of carbon dioxide that is released into the atmosphere is equivalent to one carbon credit. The "cap" on a company's emissions, also known as their "limit," is represented by the carbon credits that are given to them under the cap-and-trade system. If a company is below their cap, the idea is that they can trade their excess credits for a profit, typically to other businesses that have already exceeded their cap and are forced to buy credits to make up the difference for what they have emitted. Carbon credits can be bought in states that have cap-and-trade laws, but offsets can be used by anyone who wants to reduce their carbon footprint. Carbon credits are derived from offsets, but they can only be used in accordance with cap-and-trade laws. Offsets, on the other hand, can be used anywhere and can be carried out by anyone, whether they are an individual or a business. There is a wide variety of programs available to cut down on carbon emissions, each of which varies significantly from the others. There are those who believe that carbon offsetting and credits are nothing more than empty gestures that do little more than pay lip service to the problem rather than actually helping to solve it. It is estimated that 85 percent of carbon reduction projects have a low likelihood of actually reducing emissions to the extent that they claim they will.

Different kinds of credit

There are two primary categories of carbon credits: those that are based on natural processes and those that are based on technological processes. Reforestation, grassland restoration, and other forms of regenerative agriculture are all examples of nature-based projects. The second category is technologically driven and can refer to a variety of different technologically driven solutions that either remove carbon from the atmosphere or convert it into another substance. The various methods by which carbon removal can be accomplished are referred to as "other types of credits." These can also be referred to as removal credits or avoidance credits. Projects that qualify for removal credits aim to directly reduce the amount of carbon that is emitted into the atmosphere. Avoidance credits are awarded to projects with the primary objective of preventing the emission of any carbon in the first place.

Carbon Markets

Also known as greenhouse gas trading systems, Carbon Markets are marketplaces that facilitate the trading of credits that represent reductions in carbon emissions. It has been demonstrated that environmental markets are effective. In the 1990s, acid rain was a significant issue, primarily as a result of the production of sulfuric acid. This issue was also connected to the production of carbon, and as a result, credits for sulfuric acid were introduced. The implementation of this program resulted in a significant reduction of acid rain across the United States by the late 2000s. The ability to trade offsets has been available ever since the Kyoto Protocol was established. The price per ton of compensation can range anywhere from $8 to $125. Carbon credits are a relatively new innovation, but they have the potential to significantly grow the carbon market. There are currently thirty carbon markets, known as "compliance" markets, that are active around the world. These markets require participants to either buy or sell allowances for the emissions they produce. These markets cover approximately one fifth of the world's total greenhouse gas emissions and have a combined value of more than $850 billion as of the year 2021.

Problems

The voluntary carbon market (VCM) is becoming an increasingly popular solution for carbon concerns among businesses all over the world. Unfortunately, there is a lack of oversight in the voluntary carbon market. This is a problem. Many claims regarding the reduction of carbon emissions are based on hearsay, are dishonest, are inflated, or are otherwise spurious. The expansion of voluntary carbon markets could pose a challenge because many of the projects offering reductions in emissions are based on speculation rather than real data to support the credits they offer. One of the arguments against the VCM is that its proponents will use many terms to mislead the general public. These terms, which are ultimately buzzwords and allow for deception, include "carbon neutral," "science based," and "Paris aligned." Carbon credits have the potential to cover purported reductions in carbon emissions; however, it can be difficult to convince legitimate agencies to verify these purported reductions and to hold companies accountable for their actions. Because fossil carbon and biological carbon cannot be substituted for one another, the concept of "carbon credits" is fraught with complications. Companies are encouraged to choose to participate in these markets on their own volition, not necessarily out of a sense of altruism but rather because doing so is beneficial to their bottom line and profits. If our governments intend to meaningfully reduce the amount of carbon dioxide emissions produced by the current economy, they will need to take more drastic measures.

WEB3 Carbon Credits

Carbon credits have been considered as a potential candidate for tokenization within ReFi due to the fact that existing markets suffer from inefficiencies, illiquidity, and even outright fraud. According to a report that was published not too long ago, as many as 90 percent of the rainforest offset tokens sold by the industry-leading carbon standard Verra do not represent real reductions in carbon emissions. 2 Tokenized carbon credits, proof-of-impact certificates, and community-based tokens are a few examples of the different types of assets that are being investigated in the ReFi space as potential drivers of regenerative, positive-sum action. Tokenized carbon credits have the potential to be incorporated into a wide range of businesses and organizations through the use of permissionless smart contracts. This would create a regenerative component that would enable all types of businesses to become carbon neutral and even carbon positive. Impact certificates are certificates based on NFT that are issued to verify impact on a variety of causes. These causes are chosen by the community or organization that is issuing the certificates. Lastly, community-based tokens can have rewards for people who patronize particular small businesses and return automated royalties to a shared community treasury for the purpose of funding projects that benefit the public.

Various Protocols for Tokenization

Tokenized carbon credits offer a way forward, increasing the liquidity of carbon credit markets by providing transparent market transactions for all participants, creating more efficiencies by standardizing how carbon credits are produced and creating independently verifiable audit capabilities, and eliminating fraud by providing cryptographic verification that makes it impossible to duplicate carbon credits. Building the Web3 carbon market is the focus of several different protocols, including Toucan, Flowcarbon, and Nori, each of which takes a slightly unique approach. What they have in common is that they offer carbon credits that are openly verifiable, transparent, and liquid. This helps to resolve the inefficiencies that exist in today's markets and could potentially incentivize tokenized carbon credits in a variety of different contexts. The opaque nature of the current carbon markets, which exist at a time when businesses and individuals are highly motivated to take action to combat climate change, reduces the amount of tangible action that companies can take to offset the impact of their own carbon emissions.

The tokenization of carbon offsets offers a solution to the problem of establishing a single "source of truth" regarding the precision of carbon credits. Tokenized carbon credits offer interesting applications beyond simply improving illiquid carbon credit markets. These applications include: Because carbon credits are smart contracts, they can be automatically incorporated into a wide variety of different formats, such as blockchain games, virtual metaverse experiences, DeFi applications, trading platforms, and many more. This may open up an entirely new path of possibilities that serve as an incentive to take positive action regarding the environment.

Regulation for Carbon Tokens and Markets

Establishing a number of important regulatory and market conditions is necessary in order to facilitate the active trading of carbon credit tokens and the widespread acceptance of these tokens. In particular, there needs to be a consensus reached on either regional or international standards for the process of producing carbon offsets as well as the carbon credits that are derived from them. Because the establishment of such standards can take several years or even several decades, aspects of normalizing markets, pricing, and valuation of carbon credits will not be an immediate result of movements to create viable carbon markets.

At a bare minimum, the quality of the carbon offsets and credits must be verifiable through the application of standardized criteria and evidence of genuine carbon offsetting achieved through the removal or avoidance of emissions. Standardization will make it possible to tokenize these digital assets on a standard basis, which will make price visibility possible, provide a common platform for meeting ESG goals, and simplify the process of trading and monetizing credits. For these purposes, smart contracts can be standardized based on meeting core carbon standards and enabling quantification and fractionalization of credits for ease of trading. These are all requirements that need to be satisfied. After being used, credits that are embedded as smart contracts have the ability to ensure that the credit is only used for the purposes for which it was intended and is not reused multiple times, which would artificially inflate the number of credits available on the market. Establishing is one recommendation that can be put into action by the protocols that were discussed earlier "a digital procedure that allows for the registration of projects as well as the verification and issuance of credits. Not only at the conclusion of a project, but also at regular intervals, verification entities should be able to monitor the impact of a project. A digital process could improve the credibility of corporate claims related to the use of offsets, lower issuance costs, shorten payment terms, accelerate credit issuance, and accelerate cash flow for project developers. It could also allow credits to be traced."

In the same way that regulators and legislatures are applying anti-money-laundering and know-your-customer guidelines to prevent fraud in the trading of cryptocurrencies, they can also create basic regulatory guidelines for creating governance mechanisms for qualifying carbon offsets and credits, supervising markets, and overseeing carbon markets. These guidelines can be modeled on previously established regulations, but they should also take into account the digital nature of tokens and the benefits that are provided by these digital assets. By addressing issues related to participant eligibility, participant oversight, and market functioning, such regulations might make it possible for VCMs to operate more smoothly.

Additionally, it would be helpful if legislators and regulators did not overregulate the types of entities that can participate in such markets. This would be a positive development. At the very least for the purposes of reporting to necessary regulators, there is no reason why preexisting governmental entities, corporations, non-profit organizations, cooperatives, and decentralized autonomous organizations cannot participate in such markets through wallets that are linked to the organizations. Tracking the trading of tokens into wallets that are hosted on blockchains that are open to the public will provide significantly more information about trading than is currently available through banks. Trading can take place on blockchains that require permission, allowing for the confidentiality of market participants to be preserved while still allowing regulators access to the data in the event that probable cause exists for an investigation.

Conclusion

In the same way that regulators and legislatures are applying anti-money-laundering and know-your-customer guidelines to prevent fraud in the trading of cryptocurrencies, they can also create basic regulatory guidelines for creating governance mechanisms for qualifying carbon offsets and credits, supervising markets, and overseeing carbon markets. This would be similar to the way that regulators and legislatures are currently applying anti-money-laundering and know-your-customer guidelines to prevent fraud in the trading of cryptocurrencies.

These regulations can serve as a model for these guidelines, but the guidelines should also take into account the digital nature of tokens as well as the benefits that are provided by these digital assets. Such regulations might make it possible for VCMs to function more smoothly by addressing issues relating to participant eligibility, participant oversight, and the functioning of the market.

In addition, it would be helpful if legislators and regulators did not overregulate the kinds of entities that can participate in such markets. This would help prevent market fragmentation. This would be an improvement over previous events. There is no reason why preexisting governmental entities, corporations, non-profit organizations, cooperatives, and decentralized autonomous organizations cannot participate in such markets through wallets that are linked to the organizations. At the very least, this is possible for the purposes of reporting to necessary regulators. Tracking the trading of tokens into wallets that are hosted on blockchains that are open to the public will provide a significant increase in the amount of information that is available regarding trading in comparison to what is currently available through banks. Trading can take place on blockchains that require permission, preserving the confidentiality of market participants while still providing access to the data for regulators in the event that probable cause exists to warrant an investigation into the matter.