Bootstrapping Impact Markets: Lessons from Verified Carbon Credits / Marcus Aurelius

Transcript

great to be with you here in beautiful Prague um so today I'm going to be speaking a little bit about impact markets a lot of people are very excited about uh paying people to do great stuff that has a positive impact Beyond simply producing a commodity um so first I want to talk a little bit about the scope of the problem that we at clementow are focused on in particular the climate crisis in my view it's the most urgent problem facing Our Generation and I intend to spend the next decade plus working on it this graph is really just an overview of the State play in the emissions trajectory for the planet it's from an old McKinsey report it's a little outdated but it'll give you a general sense of scope of the

problem in particular this chart is showing the net carbon dioxide emissions in gigatons of CO2 equivalent and on the left side of the chart you basically see status quo our current emissions are around 40 gigatons a year uh and the projections from the ipcc the un's sort of climate change focused research group um are that we need to dramatically reduce emissions uh and also um aggressively Implement what are called negative emissions so those are the red bars that you see on the bottom of the chart and and the point here is that even in a perfect world where we Implement all of the Green Technology we reduce energy usage we all stop Flying you know switch to bikes and and trains instead of cars there is a certain

amount of residual emissions that we expect to continue on an ongoing basis because there are certain things that are very difficult to decarbonize uh I don't want to spend too much time on that but the point is that there's some activities that will generate carbon emissions whether it's like calf Arts if we want to continue having milk and and meat um or you know emissions from the breakdown of compost in our in our compost piles there's some amount of residual emissions and to counter those um in the steady state we need to have negative emissions and in fact pretty large scale negative Emissions on the order of tens of gigatons per year um so how do we do this um and there the the answer that we have currently in the market um is the solution called carbon credits they're somewhat controversial um and I hope that I can explain the

underlying technology here and we can address maybe some of the concerns uh during the questions but there's basically two different types of carbon credit the premise here is that you're either going to avoid emissions going up into the atmosphere in the first place or you're going to remove emissions that have already gone up and there's a few different methodologies associated with each type in the removal space you've probably all heard about tree planting direct air capture these are techniques that will take carbon dioxide that's already up there in the atmosphere draw it down and store it in some medium whether that's the body of a tree or you know underground in like a cavern full of canisters full of carbon dioxide on the other hand you have a reduction or avoidance based credits and the idea here is you're going to prevent the

carbon from going up there in the first place and both of these have a role to play for instance on the previous slide those red that red bar that only comes from removals right the avoidances will lower the top blue bars they won't remove carbon dioxide that's already up there and so you kind of need both at a certain level uh in particular I want to highlight the fact that right now avoidances are the whole Market there are very few carbon credits out there that are removable based compared to the scale of what's available for avoidance as an example there are it's much easier to go and protect existing forests from being cut down than it is to go plant trees make sure they're Healthy Grow Up strong and actually sequester a lot of carbon it

takes time and also it's very uh it's very expensive whereas if you can get some existing forest and say the Amazon rainforest that is under the threat of deforestation it's going to be cut down for logging or other purposes to clear land for agriculture it's much easier to just convince people not to cut that down and then monitor it to make sure the trees actually don't get cut down so they have a role to play but the key is there's only so much avoidance you can do and in particular uh things like protecting forests there's only so many forests out there to protect there's only so many solar panels to install and so avoidances will naturally cap out removals on the other hand don't have a theoretical limit it's sort of like What's the total amount of carbon dioxide that's been emitted into the atmosphere total and like you could draw

all of that down in theory I don't think we want to do that because then like the plants wouldn't have anything to photosynthesize with but um the theoretical upper bound is very high compared to the theoretical upper Bound for avoidance credits so they both have a role to play and the expectation is that avoidance will cap out and go down while removals will need to scale up to address that bottom red bar from the previous slide okay so now I want to Pivot and start talking more about the market structure of carbon credits and more generally try to learn some lessons from how carbon credits are structured that we can apply to other impact markets people are very excited about a lot of different stuff water credits plastic credits biodiversity credits women's education credits I mean the list goes on obviously we're here at a hackathon in

youth Prague and there's a lot of excitement about paying people to develop open source software as a public good and giving people certificates that prove they supported open source software so in a simple two-sided Market we were all eating food earlier if you buy you know an apple or some corn or grain at a store there's a supply chain that gets that product to you the end user and it starts with the farmer the producer who's going to go plant things in the ground and is going to harvest them and produce that commodity that will then flow through to the wholesalers who will distribute that out to individual grocery stores and the grocery stores then sell it on to you the end user and most of the value here ends up getting captured by the farmer the margins for the wholesalers and the grocery stores are actually they're

pretty thin if you know anyone who runs a grocery store they make very thin margins on most products and so vast majority of the value is being accrued back to the farmers which is important because if we want to have food to eat and feed our growing population we need more Farmers to go out and start farming and produce these commodities but this is a traditional Market It's relatively simple because the basically the goods flow in One Direction the money flows in the other direction and there's a pretty Fierce competition at all levels of this Market and so prices are are reasonable and uh and margins are relatively thin there's been talk about this notion of a hypersert as an implementation a simple specification for what an impact Market or an impact certificate might look like

this is not my idea this is coming from a group out of protocol Labs if you want to learn more check out hypersearch.org and the basic model is that you have a three-sided market and then a sort of registry where you can see the assets that are being created because unlike a commodity like an apple there's no physical thing to reference against right like there's no physical asset and so you need a way to represent that physical asset or that uh that uh impact asset in a digital form and hyperserts are like the representative the the assets that we're talking about so on the top right just like we had the farmers as the ultimate source of the value the implementers the people going out and educating women or writing open source software or planting trees to sequester carbon those are the implementers and

they're doing the hard work in my view most of the value should accrue to the implementer but there are other parties involved in addition to the implementer you obviously have the end buyer who's like putting the money in saying I want to see more open source software I want to see more trees planted and they provide funding usually through an indirect you know Market where they buy an asset um to the the project developer the implementer and then finally you have the evaluator and the evaluator plays a critical role in this market that doesn't really exist or isn't relevant for a traditional market like apples uh in particular you need to make sure that the project developer actually did what they said they were going to do right and that they didn't fake it or you know they didn't just you know cut

down the trees and they said they weren't going to cut them down so you need to check and the evaluator's role is to check that the product created by the project developer the implementer actually is what it says on the tin now in particular this hypersert registry piece is going to be really important because they're going to set a standard for what a good hyper cert looks like what is the data format what does the evaluator need to check for a given type of hypersert and this could be fairly open like for open source software I don't think we need Super strict standards about this because it's a fairly um yeah fairly widespread um practice and and the sort of effect of having a poor specification on something like uh open source software is relatively low because the software gets created and we

can all see what it is whereas when you have something like a carbon credit it's important that there's some level of standardization around that asset so that the buyer kind of knows what to expect when they buy something like a tree planting carbon credit so now I want to compare this setup with carbon credits and this diagram didn't change that much but some of the labels changed in particular the implementer is usually called the project developer in this context the buyer is the same the evaluators are usually called validation and verification bodies usually they're like consulting firms and finally we have the Registries you've probably heard some of these names Vera gold standard there's a bunch of them but those are the main leaders and this is very simplified the market is actually a lot more complex than this

but it fits well into the hypersert framework and hopefully will give you a grounding to understand what's really going on here okay this is what the market actually looks like uh this is a map from Puro Earth earlier this year and uh yeah uh let's just say it's complicated and uh it's not getting simpler it's getting more complex so there is a need to learn some lessons from this very complex Market if we're going to start building New Impact markets for things like Plastics and biodiversity otherwise we're going to end up with this again and it's going to be very difficult for buyers and participants to understand and navigate this Market these new markets okay so I want to highlight an aspect in the title I may talk around bootstrapping what does it mean to create a new market where there isn't one already

uh there's a couple different strategies you can pursue for bootstrapping a market depending on um what type of Market you're bootstrapping in particular the capital requirements are going to dictate what type of funding mechanism will work well for incentivizing people to start doing this activity uh in particular if there's a high a startup Capital requirement it's going to be very difficult for people to just go out and do it on their own they're going to need some source of funding ahead of time to fund them going and planting trees or installing solar panels to pay for the capital upfront whereas if the capital requirements are relatively low like say Building open source software you can do that on your laptop from anywhere in the world all you need is an internet connection something like retroactive funding which is what optimism is using

to try to incentivize open source software in the ethereum ecosystem can work really well and there's of course more traditional ways like you know debt and venture capital and crowdfunding that can supplement private Goods but for public goods many of those don't make sense because people don't want to put money into something that isn't going to bring a direct benefit back to them and so forward funding in my view plays a really critical role in these high Capital intensity impact markets I also want to highlight a trade-off that's inherent to these impact assets um which is the difference between liquidity and fungibility we all probably have heard of non-fungible tokens um sort of all the way on the left hand side of this spectrum uh you have uh Fine Art real estate you know pfps uh fall a little closer to the right a little closer to the middle and

the idea here is what is the unique class like how many comparable assets are there in this class and the fewer there are like for fine art for instance there's no liquidity for Fine Art right you're not like going to create a a liquid Market with bids and asks for Fine Art it's more like it comes up to uh it comes up for auction and if someone wants to buy at that price you know they buy at that price they might even bid up the price whereas all the way on the other side you have things like the dollar or corn which are highly liquid have Global markets trade billions of dollars every day in the case of the dollar it's trillions of dollars of movement um and the key thing is that they unlock scale you can have a global market you can have millions of participants all

over the world when you have liquidity and carbon credits fall kind of in the middle a given project might produce a few hundred thousand a few million credits and those will be directly comparable however not all carbon credits will be comparable to each other for instance if I planted trees that's a very different kind of activity than if I protected an existing forest or if I installed solar panels that's a very different activity than direct air capture where I suck the you know carbon dioxide out of the air and so they demand different prices and therefore they are not fungible so carbon credits need to strike a balance between this liquidity and fungibility trade-off to both model the unique characteristics of the project as well as unlocking liquidity and scale which are going to matter if like this whole thing makes a difference for the

climate crisis because the scale right now is about a billion tons of carbon credits ever issued the scale of the problem is around a trillion tons of carbon dioxide emitted since the Industrial Revolution so obviously there's a huge mismatch in scale and one of the key factors to unlock scale is liquidity that brings me to my next slide which is sort of highlighting the unique benefits of spot markets specifically liquid spot markets for these kinds of assets so in the traditional Market if you want to buy a credit um without a liquid Market you're going to like call somebody on the phone go back and forth over email send them a wire transfer it takes like six weeks obviously that is not going to work if we're going to scale this market up so we need to have more rapid settlement and liquid spot markets facilitate that

you also get increased transparency because the trades at least in a public spot Market are public so like if you trade on Sushi swap everyone can see what trade you executed what price you paid as well as you know which wallet purchased that asset you also get price discovery which is really important when you think about the different types of credit and that they might command different values some people might really like tree planting some people might really like installing solar panels and liquid markets allow for those assets to be priced relative to each other now the market is very complex um I won't spend too long on this slide but basically there are different strata of value as I've been saying and right now at clemental we've modeled two of those um they're sort of the two lowest levels uh price wise and uh we've got the

broad-based floor of BCT which represents mostly large-scale renewable energy projects like installing solar panels uh hydroelectricity and other technology-based avoidance on the other hand we have nature-based avoidance which is what I was talking about in the Amazon where you're going to pay people to protect some existing forests that would otherwise be cut down but there's more here there's mangroves there's direct air capture there's biochar there's ton of exciting methodologies but those new methodologies have a bit of a cold start problem in order to create a market for them uh we need to have liquidity but in order to have liquidity we need to have Supply and so there's this uh yeah cold star problem and that's why I call the top bootstrapping because we need a

mechanism for getting past this cold start and the mechanism that we're planning to use and we're in the process of executing is to use forward funding and the plan is basically in the near term we are forward funding projects basically deploying Dow Capital to pay somebody to go out and plant mangroves or whatever to launch these three pools we already have projects in flight for the small scale Energy Efficiency we're Distributing improved cook stoves to some refugees in uh in Bangladesh so that they have to spend less time gathering firewood less time cooking and also they have less carbon emissions because the the cook stoves are more efficient than a traditional three stone cook stove blue carbon we're still trying to find a deal that actually makes sense for the Dow but we're working on it and A4 station we recently

announced a project as well so I'll just highlight those quickly we have the kip32 where we are funding 250k usdc for improved cook stoves and uh also kp34 we funded 227 okay for reforestation in Africa um and so there's some key takeaways these verified ecological benefit assets impact markets impact assets they need to they're going to play a critical role in mitigating a variety of social issues in particular carbon credits address the climate crisis forward funding is a necessary tool for bootstrapping these impact markets at least if there's High Capital requirements like there are for carbon credits and liquid spot markets are really important for giving realistic pricing so that if you're entering into

a forward agreement with a project developer they know what their credits are supposed to be worth and you can't Hoodwink them as a financer and pay them under what the credits are actually worth because they can't tell if there's no spot market and finally that you know we're using forward agreements as a bootstrapping mechanism to get carbon credits today at a certain price launch a liquidity pool which will then allow other project developers to reference that liquidity pool in their negotiations of these forward agreements to bring more carbon credits Supply to Market and therefore have a greater impact on the climate crisis that's it uh if there's any questions I'm happy to take them otherwise feel free to get in touch wonderful thank you very much Marcus um would anyone like to ask a question

we have a few minutes left um so he's going to be doing this for the next 10 years I'm so proud of it because like all these longevity people want to live forever but they don't think like what Earth we're going to inherit right um what challenges do you see in terms of like expanding the scope and scaling the Dow in in the next 10 years um I'd say the biggest challenge facing the carbon Market specifically right now which is where we're operating at the moment um is that they're basically demand the people need to want these things to happen if there is not pressure on corporations if there is not um a desire from like individuals like you or I

organizations like the uh like Live Events like youth Prague who are committed to spending a little bit of their money to support these projects it's going to be very difficult for this Market to scale and and I'm from Australia and so we well my family has a property and we got some carbon credits by keeping you know Acres of our land with and letting the shrub grow but a lot of people scammed it and they stopped it and so how who gets to um yeah that's where the valuators come in and yeah I would say that like historically the carbon markets uh let's just say they haven't been the most Avid adopters of digital technology I mean most of the way that these

projects are verified is by like going around with tape measures and clipboards and like counting yeah it comes to your property and you have a bee with him and you say you know don't check the back you know you're online exactly so there's this movement away in the carbon credit Market um to create what's called digital monitoring reporting and verification dmrv and the idea is to use you know sensors satellite data a variety of different digital input streams maybe with some auditing you know to just spot check the projects um to dramatically increase the the speed to issue the credits and also reduce the possibility for fraud and manipulation definitely it's an important issue wonderful thank you yes foreign thank you so much for for the presentation I wonder uh when you

explained hypersearch uh when we do the retrospective of attractive funding whatever we want to call it uh does the money go to fund the original impact so is it like an alone or is the money then used for whatever the the person or the the organization that executed upon that impact like yeah is it their decision it depends a lot on the structure of the agreement um and so there's there's different ways to structure this it could be structured as a loan um where like the financier provides you know dollars say and then they expect to be paid back dollars in the future um and there might be some spread right where like the project developer makes a little bit of money um and the rest gets paid back to the loan provider um but actually a lot of these forward

Agreements are structured as Equity sort of where like there's risk in the project developer the project developer failing to deliver uh in which case the person funding might not get their money back um and yeah there's there's risk inherent to that but what I would say is when you forward fund a project when you buy by the credits that haven't been issued yet you are directly financing that activity right so like claimant output about 500k of usdc to directly fund these projects when you're buying a spot credit an asset that's already been produced think about like an apple when you go in the store you don't expect uh that the apple is gonna like magically appear as soon as you walk in the store and reach out your hand for it right it's already there and that's and as it was produced like weeks ago and then

farmed in so there's a supply chain there um but the key is when you buy the Apple you're sending a signal to the farmer hey there's the demand for more apples and that's what I'm saying is the big risk if people don't want to actually eat the apples they don't want to retire the carbon credits and claim I helped support this project even if indirectly then there won't be farmers who want to go produce apples I.E project developers who want to go Implement because they'll be worried that they're going to do all this hard work spend all this money take risk and then no one will actually want to use their asset wonderful buy credits make credits retire carbon yes exactly thank you very much Marcus give everyone [Music]