Co-authored by Wes Geisenberger (VP, Sustainability & ESG), Rob Allen (SVP, Ecosystem Acceleration), Jonathan Rackoff (VP, Head of Global Policy), Paul Madsen (Head of Identity), Hania Othman (Director Sustainable Impact Europe/Africa), and Mariquita de Boissiere.
In this third installment of our five-part investment thesis article series, the The HBAR Foundation Sustainable Impact Fund (SIF) builds on groundwork previously laid in “Part I: Making Climate Finance Auditable” and “Part II: Digitizing and Open Sourcing Methodologies” to illuminate how our modern system of validating and verifying carbon credits results in systemic bottlenecks that, if nothing changes, will responsible for a projected 4.8 gigatons in lost emissions reductions by 2030. We also unpack how the Guardian, an open-source, Hedera-native Policy Workflow Engine (PWE), is solving for this problem on two fronts: by building on fully auditable project value chains and opening up novel, equity-center pathways to scalability.
For carbon markets to deliver on their potential to help maintain global average temperatures within 1.5 degrees, they have to scale. And quickly. According to the Taskforce on Scaling Voluntary Carbon Markets (TSVCM), for this to happen, carbon markets need to grow over fifteen times their 2020 valuation by 2030. So far, the numbers look good. In terms of total credits traded, the Voluntary Carbon Market (VCM) underwent a sixfold increase between 2017 and 2020. But while carbon markets are on track to achieve their projected growth, there is a caveat: the supply of more recent vintage, higher-quality credits is simply failing to keep up with demand.
The 4.8 GT Bottleneck Hurting Growth and Quality in the VCM
Behind this supply crunch, according to blockchain-based aggregated carbon market Thallo, is a shortfall in reputable Validation and Verification Bodies (VVBs); the independent, qualified, third-party auditors that assess whether projects meet specific industry standards. The report warns that “verification-related delays will cost project developers 2.6 billion dollars and will prevent issuance of 4.8 gigatons of credits by 2030.” Crucially, these figures equate to “not offsetting thirty-seven million US citizens during the same eight-year period.” Furthermore, worrying reports suggest that less reputable organizations are taking advantage of rising demand by positioning themselves as VVBs to fill the gap. But far from a ‘nice to have’, due diligence through credible validation and verification is necessary to not only move the needle on emissions reductions but to actually avoid the emissions increases associated with poor quality credits. Fundamentally, building trust in a fragmented market through credits that prove additionality, and a solid impact ROI is critical in building the environmental markets we need.
The Current State of Play: Validation and Verification in the VCM
Although largely unregulated, carbon credits traded within the VCM tend to follow standards and procedures based in general on the Clean Development Mechanism (CDM). Described as “the first global, environmental investment and credit scheme of its kind,” the CDM was launched in 2006 under the Kyoto Protocol and is overseen by the UNFCCC CDM Executive Board. Like the CDM, the VCM relies upon validation and verification processes, in line with credible Quality Standards, such as Gold Standard’s Gold Standard or Verra’s Verified Carbon Standard. In this way, projects have to pass necessary quality checks in order to ensure that emissions reductions and other socio-environmental deliverables are met before credits can be issued.
The process overseen by VVBs can be broken down as follows: Prior to implementation, validation occurs as a first step, to assess a project’s fundamental viability and give an estimated accreditation. By contrast, verification takes place after implementation but before credit issuance, to ensure that the emissions reductions or other benefits outlined in the original Project Design Document (PDD) and validation report have been satisfactorily achieved. Such steps are decisive in establishing the vintage of a given credit as well as whether it meets standards related to permanence, leakage and additionality.
Quantifying intangible ecological assets, such as carbon, is not a straightforward task. It depends necessarily upon the availability of reputable VVBs that can maintain robust Monitoring, Reporting and Verification (MRV) standards. Yet, worldwide, the number of VVBs with the necessary science-backed requirements to meet this level of scrutiny currently stands at just thirty-three. Responsible for issuing nearly 89% of carbon credits between them, the majority of VVBs are registered with one or both of the two verification organizations mentioned earlier, Gold Standard and Verra. Until recently, registries have assumed the role of “sources of truth” for the entire industry. Consequently, VVBs have relied upon them to grant quasi-regulatory authority to oversee the validation and verification of carbon credits.
But digitization has the potential to disrupt and drive reforms in the carbon verification industry. Originally part of Gold Standard, certification platform SustainCert was launched independently in 2018 for precisely this reason: to improve accessibility, streamline and simplify workflows, and speed up approval processes by aggregating them into one software application, a single tool to establish a new, more rigorous norm for credible climate action. However, SustainCert still relies upon independent third-party VVBs to process PDDs, leaving the question of scaling validation and verification at least partially unanswered. In the web3 arena, by contrast, digitization and open-sourcing of methodologies combines with URL-based identifiers and cryptographically verified credentials to disintermediate VVB accreditation.
Unlocking Identity Ecosystems in Web3
On its website, Verra acknowledges the growing demand for VVBs, adding that new ones “may be located anywhere in the world.” Yet, today, of the VVBs registered or pending accreditation by Gold Standard or Verra, Latin America has just one, while for the whole of Africa there are none. The introduction of Decentralized Identifiers (DIDs) promises to change that.
DIDs represent an important frontier in digital transformation. Whereas identity has historically been manually managed and vetted by centralized authorities, such as the major registries in the case of VVBs, Distributed Ledger Technology (DLT) offers an alternative approach that is open, publicly accessible and decentralized. By creating a “trust anchor” that immutably and verifiably connects actors and roles, DLT allows for functions and characteristics/attributes to form one self-sovereign, on-chain identity. This lays a foundation for network participants to interact in a permissionless and peer-to-peer (P2P) manner.
If DIDs confer identity, Verifiable Credentials (VCs) introduce a “certification layer” that builds on top of these digital identities. In the context of carbon markets, these VCs provide a standardized model and format for fulfilling relevant data requirements and confirming that the necessary accreditation qualifies an actor to exercise the role of validator. At their core, DIDs and VCs form the basis for a modular, technically interoperable framework for confirming identity and conferring authority within (and across) ecosystems. While an existing VVB must initially approve a VC, this is a process that only needs to happen once for someone - from anywhere in the world - to be granted the role of validator. Once in hand, credentials that enable identification proof to the point of origin - such as qualifications, regional accreditations, personal identification or sensor data validation - can be seamlessly transferred and approved across distinct projects.
Just as digitizing and open-sourcing methodologies can lower the barriers to entry for the small to medium Global South-based organizations (SMEs) who have traditionally struggled to access markets, scaling validation and verification by leveraging DIDs and VCs represents another step in centering equity in markets. Resolving the VVB bottleneck means creating opportunities for a new generation of validators that are based in the same places as the communities they serve; meaning project developers in Kenya, for example, no longer have to rely on validators to fly in from Ohio or Hamburg.
The verification side of the equation uses DIDs as a cornerstone to fold in automation. As discussed above, current bottlenecks already reveal how manual verification on a project-by-project basis is unworkable if carbon markets are to meet their potential as a mechanism for driving complementary emissions reductions. In this scenario, however, the Guardian excels. In a tamper-proof, automated process, conditions set out in any given project’s PDD and validation report have to be met before carbon credits, in the form of asset tokens, are approved (minted).
Reducing Market Consolidation with the Guardian
In addition to being fully auditable, the Guardian compresses the development cycles of projects while scaling the creation of tokenized carbon assets. Based upon the InterWork Alliance (IWA) Sustainability Business Working Group & Voluntary Ecological Markets Task Force Standards, the Guardian offers an advanced set of validation functions for client-side policies and schemas. Once all roles, as well as the functions they fulfill are clearly mapped, it is capable of standardizing the MRV policies that generate the tokenized assets. This in turn is how the Guardian supports the scaling of validation and verification. With this foundation in place, automated tests for well established and highly utilized policies (IRec, Verra, and GHG policies) during the development and usage of the Guardian confirm improved consistency.
As we explored in Part II, DLT-enable digital MRV (dMRV) refers to a network of digital touchpoints providing granular visibility into asset creation. It is defined by the customized, methodology-specific availability of rich data inputs across roles and actors, traceable at the project level, scalable to new orders of magnitude, delivered faster and at lower cost than fully manual legacy MRV processes can usually attain, and recorded immutability on public ledgers. KrypC, a SIF-funded global blockchain software firm based in India, is harnessing these attributes to raise the bar on efficiency, quality, and accessibility of current validation and verification processes. Specifically, KrypC’s products leverage in-built data verification processes tied to algorithms used in methodologies for generating carbon certificates. Tamuwa, a sustainable alternative energy solutions company situated in Kenya, operates similarly. Using streamlined tokenization processes, they have already scaled biomass biofuel projects for over 6,000 farmers in the region.
Both of these SIF grantees are challenging the legacy assumptions, expectations, and biases surrounding who is - and should be - empowered to validate or verify an ecological asset. Their approaches each require automation at scale as well as transaction speeds, industry-leaving throughput (>10K TPS), and low-cost fee structures far superior to legacy systems, so as to process the granular data to necessary breadth and depth. They saw Hedera as their network of choice precisely because we coupled these features with industry-leading low carbon infrastructure designed for energy efficiency. Looking ahead, Hedera is poised to emerge from the current bear market as the de facto industry standard for sustainability-focused dApps.
Next Up: Discovering a Global Carbon Price
With DLT-enabled auditability built into natural assets created using digitized open-source methodologies that have been validated and verified on chain faster, at lower cost, and with higher levels of quality than previously possible, the question shifts to our trading infrastructure. In Part IV, the SIF addresses how web3 innovators are using sophisticated automation techniques to promote liquidity, raise transaction volume, and uncover global carbon price.
Meanwhile, we encourage creators with a vision for how to drive climate outcomes using Hedera’s enterprise-grade, low-energy public DLT network to seek funding and cross-disciplinary operational support here.