Enhancing Carbon Markets Under the Paris Agreement Ahead of COP27

This month the HBAR Foundation’s Sustainable Impact Fund (SIF) submitted a policy response, joined by the Open Earth Foundation (OEF), to a public call by the UN Framework Convention on Climate Change (UNFCCC) for input on Article 6.4 of the Paris Agreement – an important part of the UN’s plan to use international carbon markets to fight climate change. These voluntary markets will be key to avoiding the worst impacts of climate change, particularly through 2030, and Web3 has an underrecognized role to play in ensuring their success.

While reducing greenhouse gas (GHG) levels using science-based targets is the highest priority, some emissions are hard to abate, and carbon pricing can help. Especially in the near term, markets have the power to drive accountability, stimulate innovation, mobilize capital, incentivize reductions, and lower costs. That in turn promises to give countries and companies alike badly needed headroom to smooth and de-risk their low-carbon transitions. But fully realizing that promise requires an active, well-functioning market; one that keeps verified data secure, promotes fairness and transparency, ensures asset quality by avoiding double counting and policing reversals, maximizes liquidity and price discovery while minimizing settlement times and transaction costs, and detects and deters fraud and market manipulation through robust oversight and enforcement.

We at the SIF and OEF believe that advances in Distributed Ledger Technology (DLT), coupled with emerging digital infrastructure technologies – such as DLT-enabled open source Digital Monitoring, Reporting and Verification (dMRV) systems – are poised to solve for these attributes and help voluntary carbon markets scale like never before. Next month, against the backdrop of human-induced extreme weather spiking all over the world, representatives from nearly 200 countries will meet for the UNFCCC’s 27th Conference of the Parties (COP 27) in Sharm el-Sheikh, Egypt to coordinate global climate action. As sustainability and ESG professionals with deep expertise in DLT as well as climate, we have an obligation to partner with these policymakers. We must ensure that they have every available tool in their toolkit, and the technical knowledge to use them.

A new market-based approach to climate action. When the Paris Agreement was approved in 2015, it signaled an emerging international consensus on the importance of substantially reducing GHG emissions. All countries pledged to set emissions-reduction targets with the goal of preventing global average temperatures from rising 2°C above preindustrial levels and pursuing efforts to keep it below 1.5°C. The inclusion of Article 6 reflected the views of proponents of market approaches to implementation. A rulebook Article 6 was finally completed last year at COP26. Its Article 6.4 Mechanism operationalizes a global, trading-based approach to emissions reduction and removal, enabling UN-recognized carbon credits to be issued to companies in one country from climate projects in that country (e.g., restoring a degraded forest), which companies in another country may buy to comply with their emission reduction obligations at home.

Concerns about offset quality (and asset value). This promises to align incentives and increase efficiencies across the climate-transition landscape – by some estimates reducing the total cost of achieving countries’ Nationally Determined Contributions (NDCs) by over 50%, or 5 gigatons of carbon dioxide per year. But the Article 6.4 Mechanism faces tough critics as well.

Offset projects have to create “real, measurable, and long-term” emissions reductions in their host country. Typically this comes from nature-based solutions (afforestation and reforestation, soil carbon sequestration, etc.). But intensifying fire, drought, and flooding threatens to reverse their environmental benefits. That risks casting a cloud over the future value of any credits they produce. Project-level MRV how we manage that uncertainty, minimize double counting, and protect the rights of indigenous peoples and local communities over the decades of monitoring generally required.

Historically, long-duration MRV has been expensive, administratively burdensome, manual-labor intensive, and dependent on the technical qualifications and continuous diligence of numerous geographically and temporarily remote actors. In an era of accelerating climate change, this is a systemic vulnerability of nature-based credits. Poor detection of human error, data corruption, or fraud (among others) undermines their environmental integrity. But as the UNFCCC Supervisory Body (SB) overseeing Article 6.4 contemplates longer and longer monitoring periods – from 40 to 100 years and beyond – auditing, enforcement, and assignment of liability could become notoriously difficult. This has led to a legitimate question: is traditional MRV up to the task, especially in the outyears?

Emerging DLT-based solutions. Fortunately, it doesn’t have to be – thanks to DLT. In fact, this is precisely the kind of real-world environmental use case for which fast, low energy, carbon-negative DLT networks are ideally suited. Coupled with purpose-built digital infrastructure tools, such as Internet of Things (IoT), Machine Learning, Decentralized Identifiers (DIDs), and Verifiable Credentials (VCs), DLT can substantially broaden and extend the capabilities of traditional project oversight. Relying on a fragmented, heterogeneous array of national, sub-national, corporate, and other non-state actors is no longer necessary. We avoid their risks of opaque data, information asymmetry, misaligned incentives, double counting, and fraud by fielding dMRV systems built using open-source methodologies on environmentally sustainable public ledgers. By leveraging nested accounting, spatial registries, and interoperable APIs, incorporating remote sensor, drone, LIDAR, and satellite data flows, using AI for error correction and fraud detection, and DIDs and VCs to establish identities and provenance across jurisdictions and governance levels, it becomes feasible to automate otherwise prohibitively burdensome compliance assurance. And because all evidence of compliance is recorded immutably on chain, public trust in the newly automated processes will rise.

 Our recommendations to the UN. Voluntary carbon markets face a range of additional objections, both practical and theoretical. We are aware of and take those critiques seriously. Our comments to the UNFCCC were limited. Healthy, efficient international markets for high quality carbon offsets are an important tool for redirecting capital flows to climate action. Sustainable public distributed ledger networks and DLT-enabled dMRV technologies will enhance implementation and governance of those markets. Therefore, the SB should require – or at least strongly encourage – fully digitized DLT-enabled climate accounting and MRV infrastructure for Article 6.4. We urged them to do so.

Our goal: to maximize transparency, discoverability, reliability, and attributability of carbon-asset data; enable project-auditability of nature-based solutions; mitigate the growing risk of centralization and commercialization of climate governance following corporate interests; and transcend negative media storylines about crypo’s environmental impact, which are rarely accurate or helpful anymore. Whether Bitcoin and its energy-intensive proof-of-work mining is worth the associated carbon emissions has become a red herring. DLT is innovating toward sustainability, with ultra low energy carbon negative networks now commonplace, and real-world environmental use cases for DLT proliferating. DLT is salient to climate now because it solves previously intractable environmental problems. For example, as noted, the weaknesses of legacy climate accounting and MRV systems could become magnified in an era of escalating climate crisis. This may erode trust in nature-based projects until we no longer allow them to generate credits under Article 6.4. But implementing DLT-enabled dMRV can help to allay those concerns, at least in part. Amplified by new digital infrastructure tools such as nested accounting, spatial registries, and interoperable APIs (among others previously mentioned), this technology brings healthier, more efficient carbon markets with fewer obstacles to stability and scale within reach.

Should the SB or any other environmental regulator need technical assistance, the SIF and OEF will provide it. Our teams stand ready to help any party – government, corporation, NGO, or academic – looking to make DLT part of their sustainability strategy, better understand the potential of these digital tools to drive climate action, or solve real-world environmental problems.