How a crypto protocol pushes companies to reduce their carbon emissions
Welcome to the first edition of the Climate Chain newsletter from All for Climate DAO! We are a community of crypto enthusiasts interested in using crypto to accelerate the transition to a new sustainable society, or as they say: "system change, not climate change". This newsletter will report on the latest projects happening at the intersection of crypto and climate with the goal of giving them more visibility, and getting you excited about joining their tribe or supporting them in whatever way you can.
The first project we will cover is KlimaDAO. Their goal is to make it more expensive for companies to write off their carbon emissions by buying carbon offsets. This makes it more attractive for new technologies to offset carbon, and increases the incentives for companies to reduce their emissions in the first place instead of paying to emit. KlimaDAO makes these carbon offsets more expensive by buying some themselves, increasing their demand and ultimately their price. These carbon offsets are then stored in the DAO's treasury, which allows them to say that they sequester carbon on the blockchain. I hope that got you interested :-) Let's dig into what they do, how they do it, and what it means for the carbon market.
The carbon offset market
First, let's look at how the carbon offset market works today. Here's an example use case of an entrepreneur interested in building a wind farm. Currently, wind farms can expect two revenue streams. The first is from selling electricity on the power market. The second is by selling carbon offsets to companies with high emissions. These carbon offsets are a reduction or removal of carbon emissions to compensate for emissions made elsewhere. Companies decide to buy these offsets to compensate for their own emissions and achieve their carbon neutral pledges. Note that they are different from carbon credits, where some governments give out the right to pollute. Companies in those jurisdictions can only pollute within the limits of their own carbon credits but can buy credits from other companies. KlimaDAO is currently focused on carbon offsets.
These wind farm projects can get registered with Verra, an NGO that facilitates the verification of carbon offsets for projects around the world. These projects are tracked in the Verra Registry. For example, The Red Hills 123 MW Wind Power Project has been verified for 300k tons of emissions reduction and it can sell them as carbon offsets to companies that wish to offset their own emissions.
The crypto ecosystem now proposes a new path for these projects. The Toucan protocol offers a bridge to bring carbon offsets on chain, as TCO2 tokens on Polygon (a sidechain to the Ethereum blockchain that only requires a fraction of the energy by using proof of stake). Each TCO2 token represents one ton of carbon offsets and is labeled with the origin of the offset and the offset type (renewable energy project, direct carbon air capture, etc). TCO2 tokens have different prices as demand for offsets may differ by type or even country of origin. For example, offsets made in the USA may be more expensive as American companies decide to link their carbon neutral program with supporting the local economy. As a result of these differences, TCO2 tokens are not very liquid and their price discovery is more complicated. This makes them harder to trade and harder to use in decentralized finance applications. That's where carbon pools come in.
The Toucan protocol also offers different carbon pools, including the base carbon pool that was designed in collaboration with KlimaDAO. The idea is that anyone can deposit a TCO2 token in the base carbon pool and receive a Base Carbon Ton (BCT) token in exchange. All BCT tokens are then backed by a pool of different carbon offsets, so a BCT token represents an average ton of carbon offsets from that pool and its price will also be the average price of a ton of carbon offsets in that pool. This process turns the illiquid TCO2 tokens into liquid BCT tokens. If trading TCO2 tokens was equivalent to trading wine from different vineyards and vintages, trading BCT tokens is equivalent to trading wine as a commodity.
We finally come to the KlimaDAO protocol itself. KlimaDAO is a fork of Olympus (of the (3,3) meme) that runs on Polygon. Both protocols are designed to create a reserve-backed currency that is not pegged to other currencies like the dollar. In the case of Olympus, they issue their OHM token that is backed by the stable coin DAI and other crypto assets. In the case of KlimaDAO, they issue their KLIMA token that is backed by BCT tokens, which are themselves backed by real carbon offsets.
KlimaDAO increases demand for carbon offsets
For KLIMA to become a successful currency, KlimaDAO needs to grow their reserves in carbon offsets. A large reserve means they can issue more KLIMA tokens that people can then use in various applications, like they would with any other currency. That's where the interesting bit comes in. To grow their reserve, they need to acquire BCT tokens, which creates demand for BCT tokens and creates demand for carbon offsets, increasing their price.
There are two mechanisms in place to incentivize people to sell their BCT tokens to KlimaDAO:
Bonding: You can buy KLIMA bonds with BCT tokens. This means you would sell your BCT token to the Klima protocol, in exchange for KLIMA tokens at a discount, with a lockup period of 5 days. For example: if your BCTs are worth $2000 and the discount is 10%, you would earn $2200 worth of KLIMA tokens. This creates an arbitrage opportunity to buy BCT, and sell them against more KLIMA.
Staking: You can stake your KLIMA tokens on the protocol (this is similar to putting your money in a savings account) and the protocol will reward you with a very high annual percentage yield (APY). At time of writing, the APY for staking is above 75,000%. This creates a lot of demand for KLIMA, because people want to be exposed to those gains, which in turn creates demand for BCT through bonding. An advantage of their staking design is that they use a rebasing token to track how much each address is staking. This allows them to automatically compound your rewards, so you don't need to re-stake your rewards every so often.
A few things to note on their token economics:
The crazy APYs will lead to KLIMA token inflation. This is offset for token holders by the large APYs themselves, if they stake their KLIMA on the protocol.
The protocol cannot mint more KLIMA tokens than they have BCT tokens in reserve, this means there will always be at least one BCT per KLIMA token. This creates a price floor for the KLIMA token.
The protocol is currently extremely over-collateralized, i.e. they have way more BCT tokens in reserve than they have issued KLIMA tokens. At time of writing, there are 3.6M BCT in the reserve for 740k KLIMA tokens in total supply. This is because KLIMA has a much higher price (currently at $785) than BCT (currently at $7). When someone buys KLIMA bonds, they might sell 112 BCTs to get 1 KLIMA, which in turn means the protocol now has room to issue 111 more KLIMAs to stakers.
The big difference in KLIMA price and BCT price comes in part from these crazy APYs, which creates a lot of demand for KLIMA, which in turn means the protocol can afford to offer crazy APYs.
The APYs go down as the token supply grows, incentivizing people to get in early.
The 5-day lock up period for bonds means the buyer has skin in the game. They will want the protocol to succeed so their KLIMA tokens will be worth something when the bond matures. This aligns the incentives of the protocol and of the buyer.
One of the main criticisms of Olympus and its forks, like KlimaDAO, is that this all sounds like a ponzi scheme where you continuously need to bring more investors into the system to pay out high returns to the existing investors. To this, their community responds that ponzi schemes end up with the currency worth zero while KLIMA has a "risk-free value" backed by their reserve. The risk-free value of a KLIMA token is the value of one BCT token. Indeed, KlimaDAO will always have at least one BCT in reserve per KLIMA that was issued, so you will always be able to redeem one BCT for one KLIMA. In turn, BCTs will always have a non-zero price through demand for carbon offsets in the carbon market. This means there won't ever be a rug pull that brings the currency to zero, though it may see a substantial decrease in value over time through high inflation, and staking protects you from that inflation. As the protocol grows, the lower APYs will also stabilize the currency.
Increased demand for carbon offsets impacts the real world
To summarize, Olympus and KlimaDAO have found a way to bootstrap a reserve-backed currency by making it attractive to sell them the reserve currency. The KLIMA currency is backed by BCTs, chainlinking demand for BCTs to TCO2s to (increasingly more lucrative) real world carbon offsets. What are the consequences for the carbon market? It’s more expensive to emit carbon, which will foster true emissions reductions, and it is more attractive to offset carbon, paving the way for new technologies to come to maturity.
So what should we make of all this? Well, getting in early on KLIMA tokens to benefit from the high APY frenzy may not be for everyone, especially if you feel the currency is currently overpriced through ponzi mechanics. As the currency stabilizes over time though, it may feel safer to use KLIMA as an actual currency and staking on their protocol might become the best savings account with the most positive impact on climate change.
It’s also quite exciting to have on-chain carbon offsets as BCT tokens. For starters, one might start offsetting their own carbon footprint by buying and burning BCT tokens. Though this is something we could already do without crypto, these transactions now exist on an open verifiable ledger. Artists can now also create on-chain art as NFTs that contain locked up carbon offsets. Imagine if instead of flexing our CryptoPunk, we could flex a CarbonPunk? Or to join a solarpunk community, you have to show that you have purchased a certain amount of carbon offset coming from solar energy (in the same way that you need to have 75 $FWB tokens to join the Friends with Benefits community). Even cooler, the artwork below owns KLIMA tokens that were staked, and those KLIMA tokens compound thanks to the high interest rates, so the art keeps on accumulating carbon offsets that can never be resold!
It will also be exciting to see if and how KlimaDAO manages to move into the carbon credits market, where companies are obligated to comply compared to hoping for companies to buy carbon offsets. It may be necessary to reach some of the most polluting companies that don't care about looking good by making carbon neutral pledges.
I hope this piece gave you new ideas, and it got you excited about the new tools that crypto can offer in the fight against climate change. You might even want to join their communities or contribute to their protocols.
Find us on Twitter @thorgutierrez and @all4climatedao
Other things happening right now:
If you want to help mobilize people to address the climate emergency, go take a look at THE WEEK, a new playbook for climate mobilization. The project is led by Frederic Laloux, who wrote the book Reinventing Organizations and inspired countless DAOs. They are currently raising funds on mirror to finish filming of this new kind of documentary. There will also be an open discussion with the founder about how DAOs can help climate on change, on Monday Dec 6th.
Gitcoin is doing a round of funding for climate projects using quadratic funding, there are 20 projects looking for funds, go check it out and donate! The quadratic voting mechanism means even small donations have a lot of impact on how much each project receives in the end. Here is a good walk through of how to donate.
Below are resources to learn more about the different protocols mentioned in this post
My Climate Journey episode with Toucan founders: https://www.myclimatejourney.co/ctss-episodes/toucan
Bankless episode with KlimaDAO founders:
Dune Analytics: https://dune.xyz/Cujowolf/Klima-DAO
Babylonians episode on Olympus:
Olympus FAQ https://docs.olympusdao.finance/main/basics/basics
Note that carbon offsets can represent very different kinds of reduced carbon emissions. For example, wind farms don't sequester carbon, but instead reduce carbon emissions from power plants that burn fossil fuel.
DE-Fossilization is the goal!