by Zain Jaffer
The 1992 UN Framework Convention on Climate Change was a landmark agreement that recognized that there was such a thing as climate change. Subsequent extensions of this agreement include the 1997 Kyoto Protocol, which added a Clean Development Mechanism (CDM) which introduced the concept of “carbon credits,” which is basically a market mechanism that traded emission credits for greenhouse gas reduction.
The way it worked was that projects like wind and solar energy farms could not be justified from a financial standpoint during that time because the technology was still expensive. The CDM introduced a way where the GHG emissions that a particular renewable energy project could reduce could be measured and given a value that was traded in a market. Carbon credits did not finance the entire project, but they did give the project proponents an upfront amount at year zero of the project that would make it financially viable.
The Kyoto Protocol was a global treaty. Unfortunately, since the Republican controlled US Senate needed to ratify it, the US did not sign it. Finally the CDM expired a few years ago.
The technology for renewables has advanced steadily over the past few years. Solar and wind energy systems are now cheaper and more efficient than these were during the time of the CDM. Energy storage options like elevated lakes, gravity batteries, and new battery chemistries, have reduced the capital expenditures slightly.
What has since emerged after the decline of CDM are Voluntary Emission Reduction (VER) credits. These are not enforced by government decree or treaty. Rather these are free market mechanisms that private companies such as Fortune 500 companies or even some cities want to support. Unlike CDM which was primarily for CO2 GHG emission reduction, some of the voluntary credits can be for other GHG reduction projects like methane, black carbon (soot) and others.
Like crypto markets at the moment, these VER markets are not regulated and rely on the interest of both buyers and sellers. A buyer could be a well known global company that wants to mention particular sustainability projects in their annual sustainability reports. Sellers can be project proponents.
In between them sits a network of validators like independent test and measurement and auditing companies who ensure that the projects mentioned will definitely reduce the amount of GHG that the projects claim to do. Having other side benefits like health and ground pollution reduction impacts also help push the desirability, and thus the price upward.
Tokenization offers a way to make these projects get financing from the crypto markets. For example, one token could represent one ton of a particular greenhouse gas. The buyers and sellers that day in that market can decide how much they want to pay for that one ton of greenhouse gas.
One modification of the scheme above is to use tokens for electric vehicle EV charging. While it is possible to use cash or credit to pay to “top up” an EV, recently there have been cryptotokens that can pay for charging. This is not strictly speaking project finance, but it adds to the future cash flow potential of the project.
The advantage of moving climate finance to the crypto markets is that the deal flow traffic of buyers and sellers is already there. It then becomes a question of how the climate token is marketed, and how the auditors ensure that the token is what it claims to represent in terms of greenhouse gas reduction.