Sunday, December 4, 2022

What is Klima DAO and How Does it Work?


We wrote recently about Olympus DAO and mentioned that it has spawned many forks. Recently, a new kid in the Olympus DAO-fork block – Klima DAO – has been turning heads as it has amassed a treasury worth over $110 million in under a month since its inception. So what is Klima DAO and how is it different from other Olympus forks?

Klima DAO

In short, Klima DAO is a decentralized autonomous organization (DAO) and DeFi protocol that aims to drive climate action via a carbon-backed, algorithmic currency – its KLIMA token. Its goal is to encourage emissions cuts by pushing up the price of carbon assets.
However, before we dive deeper into Klima DAO, we have to first familiarize ourselves with the carbon market.

The carbon market is a market for trading carbon emission credits, with the aim of providing economic incentives for emissions reduction. Each credit represents the reduction or removal of 1mtCO2e (1 metric tonne of CO­­­2 equivalent) from the atmosphere. This also includes carbon sequestered or avoided due to the implementation of the project. Two types of carbon markets exist – the mandatory (or compliance) carbon market, and the voluntary carbon market.
Compliance carbon markets are legally binding schemes that enforce a maximum limit on total emissions and allow participants (e.g. countries/industries) to trade their emission allowances. Participants can profit by selling unused allowances to others who require extra allowances to adhere to their own emissions limits. Examples of this include the emissions trading systems of the EU, Australia, California, British Columbia, and others.

Carbon Markets

The voluntary carbon markets (VCM) on the other hand, are technically unregulated. They do not receive government oversight but are governed by VCM standards administrators such as Verra and Gold Standard. Unlike the compliance market, there is no maximum limit on the number of carbon credits that can be issued or traded. Climate positive projects produce ‘credits’ to sell, whereas polluters buy these credits to ‘offset’ their emissions – the terms ‘credit’ and ‘offset’ are sometimes used interchangeably.
The most active buyers in the VCM are corporates from large sectors such as energy, tech, and finance as they try to meet their net-zero targets; however, individuals can also purchase credits to offset their emissions. Nonetheless, the use of the VCM to tackle climate change has also attracted its fair share of criticism, particularly surrounding the use of carbon offsets to greenwash a company’s image, or as a convenient substitute for real emissions reduction.
There is also much debate regarding the methodologies used to quantify carbon sequestered or avoided. Not all offsets are created equal, and the VCM can be important in delivering crucial funding to more transparent and robust climate-positive projects with genuine outcomes. In any case, while the VCM only operates at a fraction of the scale of the compliance market, it is a more flexible and global marketplace that functions according to the needs of its users.
Now, let’s get back to Klima DAO.

Climate Action

So, Klima DAO is a protocol trying to drive climate action by accelerating the price appreciation of carbon assets with its KLIMA token; today, these assets refer to the carbon credits which are traded in the VCM.
Klima DAO is a fork of the popular Olympus DAO protocol. As such, the fundamentals of its monetary and economic policy are similar, with one key difference.
While in Olympus DAO each OHM token is backed by 1 DAI, every KLIMA token is instead backed by 1 BCT (Base Carbon Tonne) token. To understand what is a BCT, we must now dive into another segue explaining the Toucan Protocol.

In a one-liner – Toucan Protocol is a project bringing carbon as a new money-lego into Web 3.0, and BCT is one of these carbon money-legos. So, how do Toucan Protocol and Klima DAO intersect?
First, carbon credits are purchased on the legacy carbon market through Verra. These carbon credits are then transferred from the legacy market and moved on-chain via the Toucan Carbon Bridge. The process by which legacy carbon credits are transferred on-chain via the Toucan Protocol are as follows.
First, a batch of carbon credits from a specific project and vintage are purchased from the legacy market. These credits are then transferred on-chain via the Toucan Carbon Bridge and turned into a ‘BatchNFT’ which is an NFT containing the details of the carbon sequestration or reduction project (e.g. the type, vintage, location, carbon tonnage). NFTs are not very liquid, so BatchNFTs are then fractionalized into fungible TCO2 tokens – the ‘T’ here standing for ‘toucan’, ‘tonne’, or ‘tokenized’.
However, these fungible TCO2 tokens still contain metadata referring to the BatchNFT in which they originated and are thus still not very liquid. To solve this, ‘carbon pools’ are created to deepen liquidity. These pools possess gating criteria which allow TCO2 meeting specific criteria to be deposited. Depositors then receive fungible ‘carbon reference tokens’ such as the BCT in exchange, which represent 1 carbon token from the carbon pool.

Base Carbon Tonne

Toucan’s first carbon pool is the one that is currently relevant to Klima DAO. It is called the ‘Base Carbon Tonne’ pool, with the fungible carbon reference tokens called ‘BCT’. The gating attributes of TCO2 for the BCT pool are 1) verified by Verra and 2) of vintage later than 2008. Thus, any user can deposit TCO2 tokens which meet these criteria and receive the fungible, more liquid BCT in exchange. Each BCT represents 1 TCO2 in the BCT pool, which in the real world equates to 1 tonne of carbon emissions reduced or removed from the atmosphere.

To participate in Klima DAO, users first need to purchase BCT or KLIMA directly from SushiSwap on the Polygon network. To benefit the most from using Klima DAO, users are encouraged to obtain KLIMA via its ‘bonding’ mechanism by either depositing BCT, or the SushiSwap liquidity pool tokens BCT-USDC LP, or BCT-KLIMA LP into Klima DAO’s treasury in exchange for discounted KLIMA. Each bonding has its own discount rate depending on the treasury’s demand for such assets.
Similar to Olympus DAO, users benefit when they stake their KLIMA with Klima DAO to generate returns, with ~37,000% APY at time of writing. Currently, Klima DAO has managed to amass close to 10 million BCT in its treasury.

Klima DAO aims to drive price appreciation of carbon credits in the VCM by buying and hoarding as many credits as possible from the market and locking them away in its treasury. The project posits that this could lead to a supply squeeze for carbon credits, driving prices up. On top of that, demand for credits is expected to increase as the market for carbon offsets is projected to be worth over 50 billion by 2030. To place this into context, the total value of VCM currently sits just below the $1 billion mark.
A price hike on carbon pollution pressures the heaviest polluters – who traditionally rely on purchasing offsets to adhere to voluntary emissions targets – to take swift action on cutting emissions, or risk negatively impacting their bottom line. More expensive offsets mean that they can no longer buy their way out of the problem.
At the same time, pricier offsets could also result in crucial financing being channeled towards genuine sustainability projects which tackle our environmental issues. More expensive offsets also have the added effect of encouraging more climate-positive projects to emerge as it becomes more profitable to sell credits to the market.
Klima DAO’s founders argue that the perfect currency should be regenerative for our planet by pricing in the cost of carbon. Within Klima DAO’s model, more economic activity within the system increases the supply of KLIMA, which can only be minted when tokenized carbon is locked into its treasury. It may be hard for non ‘climate-natives’ to see how this backing is significant, but it becomes clearer when they realize that carbon (or specifically perhaps, how much carbon is in the atmosphere) is a proxy for important things such as climate stability or biodiversity. These are literally things that underpin life and society on earth as we know it.
At the same time, individual environmental action such as shifting one’s diet to be more plant-based or flying less typically requires a sacrifice of convenience, and is not explicitly beneficial to those lacking an intrinsic motivation to perform them. Klima DAO provides a novel way in tying climate action directly to economic benefits for users – the more KLIMA tokens you own, the more carbon you’re locking away, and the more returns you’re making through staking. Klima DAO’s goals of creating a currency backed by environmental regeneration instead of the exploitation of resources could create a massive shift in society’s view towards money.

However with Klima DAO’s lofty goals, concerns have naturally been raised regarding the project’s mechanics to achieve its goals and whether they can have their intended impact.

While every individual has an impact on the environment, it is increasingly understood that the problems causing climate change are systemic in nature. Ingenuous billion-dollar marketing and lobbying campaigns by Big Oil have worked to mislead and distract the public, infusing doubt towards climate science and shifting the focus onto individuals’ carbon footprints, while lobbying politicians to shape laws in their favour. One of the key questions is whether the VCM, which is based on pledges by the same mega industry and large corporations, can really be trusted to produce a significant impact?
Doubts have thus been cast over whether Klima DAO will work as intended. There exist reservations and criticism around VCM standards administrators such as Verra. In particular, methodologies for calculating the number of credits that can be issued based on a supposed reduction or removal of carbon are often opaque and complicated. Some of these issues are simply due to a lack of transparency or a difference in stringency between standards administrators.
For instance, a majority of offsets are made by emissions ‘avoidance’ projects, such as forest protection, which are measured based on comparing the emissions avoided as compared to a calculated average ‘baseline deforestation rate’ which can be somewhat arbitrary. Such methodologies have proven detrimental in notable incidences when using said averages does not account for important differences, and instances of over-crediting become a serious concern. These loopholes and shortfalls in carbon accounting methods create an opportunity for ‘profit-maximalists’ to exploit, a situation which could be exacerbated if selling credits were to become highly profitable.
On top of that, there is also an inherent difficulty in the processes used to measure carbon stored in natural environments which is not an exact science. Scientific estimates can vary significantly, which only adds to the uncertainty of determining how many carbon credits a project should be able to issue.
There is, fortunately, some evidence that the VCM can still be useful in forcing companies to adopt and adhere to voluntary emissions reduction targets. The VCM saw unprecedented growth during the last couple of years while the world was in a midst of a Covid-induced economic downturn, which suggests that emissions reduction commitments have remained a priority even if bottom lines were hit. Since the start of 2020, Over 200 companies have made public pledges towards emissions reduction, signalling to the public that they are committed to addressing their current and/or historic emissions, with 180 of these companies making their pledges in 2021.
Companies could opt out of these commitments at any time, but will certainly risk reputational damage due to serious public backlash. While these commitments to reduce emissions are supposed to adhere to science-based emissions elimination strategies in line with the Paris Agreement, it will not be surprising to learn that companies do not comply with them perfectly. Under-delivering on climate action ambitions is a common issue, and many companies might opt to buy the cheapest carbon offsets from the market in order to claim they have achieved climate neutrality. So if VCM credits spike in price, companies will be forced to adapt by actually reducing emissions within their operations as that may be cheaper than buying credits. However, a concern is that this could result in rising costs that are passed down to consumers.
Aside from that, companies may simply be finally facing the fact that they have to do something about the climate crisis as it is required to future-proof their business, and voluntary carbon offsets provide a streamlined way to finance climate positive projects.

For Klima DAO to achieve long-term success, its KLIMA token needs to obtain mass adoption. The KLIMA token has the tall order of competing with other established cryptocurrencies such as BTC, ETH and even OHM to be used as a widely accepted currency.
Among other things, the KLIMA token must be composable with other leading projects and DeFi protocols. The ability to use sKLIMA as collateral in other DeFi protocols would add utility for KLIMA stakers. Partnerships with other projects would also be important for Klima DAO to benefit from network effects and establish itself in the cryptoverse.
Klima DAO’s roadmap also includes plans to increase the quality of the carbon credits backing the KLIMA token. Eventually, BCTs will be diversified into various pools of tokenized carbon of different project types and carbon impact. This is important as not all carbon credits are created equal. Carbon credits with additional benefits such as supporting local community livelihoods and biodiversity protection are more valuable in the VCM. Credits from later vintages are also typically considered more robust as certifying standards improve over time. Carbon durability is also an important and more objective metric, whereby carbon which stays out of the atmosphere for longer (e.g. 1000 v.s. 100 years) is higher valued.
In the longer term, an imperative for Klima DAO is to achieve scale. The VCM is only a drop in the ocean of solutions required to tackle climate change. Even between the two types of carbon markets, The VCM is itself dwarfed by the compliance market. As of 2020, the compliance market was valued at $272 billion and had a trading volume of 10.3 billion allowances as of 2020 while the VCM sat at a valuation shy of $500 million and saw trading of 188 million credits (each allowance or credit is equivalent to 1 metric ton of CO2e). For further context, humanity emitted close to 40 billion tonnes of CO2e in 2020.
If and when Klima DAO’s experiment with the VCM proves successful, addressing the compliance market seems to be the next logical step to affect more significant change towards averting the earth’s warming trajectory. For that to be possible, similar bridging systems akin to what the Toucan Carbon Bridge does for VCM credits need to exist for carbon allowances from the compliance market.

Klima DAO is undoubtedly one of the most ambitious crypto projects to date. Admittedly in its current form, the project can only do so much to impact the trajectory of climate warming. It is crucial to acknowledge that climate change can only be abated with deep emissions cuts and societal changes across the board, with high-quality offsets being used only to balance off unavoidable emissions.
Before finishing up, it may be pertinent to remember exactly why Klima DAO exists and what is at stake if humanity does not achieve its climate targets. The Paris Agreement signed in 2015 set out a global framework to avoid dangerous climate change by limiting global warming to well below 2°C, with efforts pursuing to limit it to 1.5°C. According to the Intergovernmental Panel on Climate Change (IPCC), to meet this target we need to cut emissions at least by half by 2030 and achieve net-zero emissions by 2050. Instead, our emissions are reaching all-time-highs year after year, while we sit precariously at 1.2°C of warming. While fractions of a degree may not seem significant, this infographic below puts things into perspective.

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