Digital Environmental Assets will drive sustainable infrastructure financing.

The Paris Agreement sets the goal of limiting global warming to below two degrees Celsius, compared to pre-industrial levels. Voluntary Carbon Markets (VCMs) are valuable tools that enable corporations and jurisdictions to offset their emissions in excess of decarbonization initiatives by purchasing credits generated by projects that remove or reduce emissions. To date, however, VCMs have not succeeded at scale for several reasons: the complexity and inconsistency of monitoring and verification activities, challenges in maintaining up-to-date records of valid credits, and limitations on market liquidity and accessibility.

Digital Measurement, Reporting, and Verification (D-MRV) and blockchain technologies can play a role in addressing these challenges.

Sidewalk Infrastructure Partners' latest thematic work focuses on the digitization of environmental assets with the aim of enabling additional financing of sustainable infrastructure projects. Last month, SIP and Google Cloud co-hosted a summit in Mountain View, California, with the goal of advancing the deployment of D-MRV and blockchain technologies to scale carbon markets. The summit brought together more than 100 leaders in the space: representatives from existing registries and methodology developers, academics, project developers, buyers and capital providers, blockchain players, and innovative MRV leaders.

There has been increasing interest over the past year in using blockchain and D-MRV technologies to disrupt VCMs. Existing registries often rely on manual project review processes and credit warehousing, offer limited transparency on sold credits, and facilitate only bilateral sale of credits to buyers. These existing practices will be insufficient to meet the projected demand for voluntary carbon offsets, expected to increase dramatically. While only 1.8 gigatons of CO2 offsets were issued in the 17 years from 2005 to 2022, demand is projected to reach up to 9.5 gigatons annually by 2050.

Recognizing this gap, emerging players began bridging verified, off-chain carbon offsets from registries onto the blockchain throughout 2021, to increase market liquidity. But those initial efforts were met with criticism due to the poor quality of some of the underlying credits, and they have not yet addressed the core challenge of the VCM, which is ensuring that an issued carbon credit results in credible and legitimate carbon emission reductions or removals.

To address this challenge, existing credits should leverage robust D-MRV technologies to create new environmental attributes that can be monetized. We call them Digital Environmental Assets, or DEAs. Each DEA represents a blockchain-native environmental token that is verifiable and tagged with its specific MRV attributes. DEAs can expand beyond carbon to other key environmental attributes such as clean water, recycled plastic, and recycled electronic waste.

DEAs will allow individual sustainable project developers to issue tokens reflecting the environmental assets of their specific projects. Instead of relying on a centralized registry to certify a project’s underlying MRV details, each project’s approach would be embedded within the DEA and digitally encoded onto a decentralized, immutable, auditable, and public ledger. By reducing the number of actors involved in the generation and sale of a DEA, blockchain benefits project developers by increasing their share of revenues from the sale of a DEA.

To unlock DEA issuances, two broad categories of novel MRV can be deployed onto the blockchain as Layer-3 protocols. The first is to use blockchain to create a decentralized, community-based incentive structure to verify the MRV claims of nature-based projects such as afforestation and reforestation. For example, instead of relying on time-consuming and expensive on-site inspections, a network of validators leveraging remote sensing and machine learning can stake their tokens on the blockchain and vote on whether a project developer’s claims on tree growth can be confirmed. Such validators are then rewarded with additional tokens if their votes are verified, or lose tokens in case of fraudulent activities.

The second category of novel MRV is linking on-chain tokens to real-time, site-specific project telemetry, automatically quantifying carbon removal and adjusting DEA issuance over time to match achieved environmental outcomes. For example, this would allow a Direct Air Capture (DAC) machine to be automatically linked to DEAs representing tons of carbon removal by specific machines located in specific sites and removing carbon at specific points in time. Across both MRV approaches, DEAs are generated based on actual carbon reduction and allow corporations to easily determine whether purchasing a given DEA aligns with the environmental impact they seek to achieve. For example, a corporation seeking to offset residual emissions from its activities in a specific jurisdiction could do so by purchasing DEAs generated from DAC projects in that same geography.

A number of challenges need to be resolved for D-MRV solutions to be implemented at scale. There is a shortage of developers who understand how D-MRV works. The complexity of existing systems limits the involvement of local change agents conducting validation work on-the-ground. And there is a lack of timely updates of carbon removal or avoidance methodologies compared to innovations in D-MRV.

Once DEAs are issued, they can be linked to on-chain marketplaces that provide transparency and granularity for corporate buyers and institutional investors. Over time, securing a meaningful supply of high-quality DEAs allows for their establishment as a tradeable and investable asset class, allowing them to be marked to market, lent against, and recorded as assets on corporations’ balance sheets.

We expect this to disrupt sustainable project finance; project developers can issue DEAs backed by blended environmental attributes and underlying revenues of a project. Similar to the way that the simple innovation of tax equity, by allowing tax attributes to be separately monetized, unlocked significant additional funding for projects with unique tax attributes, the ability to monetize environmental attributes through DEAs has the potential to unlock significant capital to fund sustainable infrastructure projects. Innovations such as these can improve the economics of sustainable infrastructure projects and enable the financing of previously uneconomic projects. This can catalyze real innovation and environmental progress to achieve Paris Agreement targets.

We would like to thank our co-hosts at Google Cloud for their hard work and collaboration, and the 60-plus organizations in attendance for their thoughtful and insightful comments and discussions, who together made the summit a great success.

60+ organizations, representing a broad range of Voluntary Carbon Markets participants, attended the summit. keepAspectRatio From left, Martin Wainstein, Benoît Clément, Caroline Klatt, Michael Marano, and Anna Lerner Nesbitt spoke during a moderated session at the summit on Technological Disruption of Voluntary Carbon Markets.