RFC on policies related to the vintage → issuance date delta

[johnx25bd]

Waking up

At Toucan Core we spend a good deal of our time monitoring the voluntary carbon market in order to ensure the integrity and health of the on-chain markets our infrastructure has enabled.

We have become aware of the issuance of millions of carbon credits compatible with the BCT pool — credits that we believe were, until the launch of Toucan, basically stranded assets.

Leaky floor

One of the core theses of KlimaDAO and Toucan is that a rising carbon price is necessary and important in order to drive more funding to carbon projects. The approach of “sweeping the floor” of low quality credits has been quite effective, but it is based on the premise that there is a finite amount of these low quality credits to remove.

Klima’s theory of change was that by removing these credits from the market and locking them away where they cannot be retired, actors entering the market must pay up for higher quality or newer credits over time.

The rising price of carbon serves two purposes. Higher prices give projects greater confidence that they will be able to break even, meaning they should initiate their impact projects. Higher carbon prices also mean that corporates need to pay more for offsets in order to meet net zero commitments, so they will be incentivized to do more to decarbonize operations and reduce the number of offsets they need to retire.

Issuing carbon credits costs money, and there is a certain amount of risk that projects must assume to complete the certification and issuance process.

Market conditions shortly after these vintage periods were most likely not favorable for these projects, and these projects for one reason or another did not complete this process. Now there is a liquid carbon market running on SushiSwap, due to the actions of KlimaDAO and Toucan. This, along with the increase in value of these VCUs (Verified Carbon Units), means it has become sensible for these credits to be issued.

We can see an example of this here:

Example
The vintage can be understood as the monitoring period in which a carbon reduction has taken place.
The issuance date is the date on which credits are issued onto the Verra registry.
As we see now, these two dates can sometimes be wide apart, including when a project doesn’t complete the full certification lifecycle.

While there are a finite number of these credits that are issued, the sheer quantity of these unissued carbon credits based on energy methodologies out there is vast. They effectively represent a large supply source at a fixed low price — as on-chain price of BCT rises, it will continually make sense to issue these credits and take profit.

This RFC is intended to raise this issue and openly explore ways we might agree to adjust Toucan infrastructure so on-chain carbon markets serve the purpose of driving finance to the most impactful projects.

Goals we want to achieve include:

1. Drive climate finance to projects that create new interventions that haven’t happened yet, rather than give money to projects that can clearly survive without the subsidy of climate finance, the basis of additionality.
2. Expedite the rise in the floor price of carbon credits.
3. Drive finance to high cost and high value credits.

We carefully reflect on climate justice when setting these goals, and ask the community to raise suggestions that enhance global equity.

Our options

Filtering at the bridge

One option is to apply a limit on the bridging of credits with a “delta” (Δ) of greater than n years between vintage start date and issuance date.

This will prevent the tokenization of old credits that were only issued recently. We are exploring setting the cut off at a 5 year delta, though we are analyzing delta patterns of various carbon credit classes to see if this would be an appropriate value across the board.

However, we understand that issuance patterns differ for different methodologies, and there are certain legitimate reasons why a project originator might choose to issue credits more than five years after the monitoring period.

Filtering at the pools

We are exploring the potential of applying this filter at the level of the carbon pools. This would require making the issuance date accessible as an attribute on-chain. The delta value could be incorporated as gating criteria in future pools as well. Implementing this feature would take significantly longer than filtering at the bridge.

Do nothing

Toucan creates on-chain infrastructure for the world’s carbon markets — we are connected to off-chain, operating markets. This means we inherit many of the strengths and weaknesses of these markets. There is a case to be made that this situation is simply an aspect of the way these markets operate, and we should not intervene.

Our governance process

The only way to do this properly is with you, our community. Starting today, we are engaging in a two week governance process to gather community input on how to handle this situation. With this, we hope to find a long term solution. We would especially invite community members with insights into edge cases and situations where issuance dates long after vintages are part of the plan — that way we can co-design policies that best serve the market.

Once we’ve gathered feedback and discussed a final proposal, Toucan core will take a decision, informed by your input. This is necessary as we still don’t have a governance token — we will soon be sharing plans to further decentralize governance and put these decisions fully into the right hands.

[mzdragon96]

Hey guys,
thanks for all your work.

For the 5 year delta (Bridge Filtering), say that is the new cutoff… How would a mechanism apply for currently issued BCT (Under 5 years and issued recently) to be removed from the supply (or is this still being explored…). The forum has suggested a premium to bridge BCT - to TCO2, and thus the underlying BCT is burned.

At the level of carbon pools implies the current BCT/USDC trading pool on Sushi? Any further BCT entering the market must have the 5 year Delta etc*. What would be the risk control for any 5 year Delta that was issued recently?

I def. do not agree with the “do nothing” approach as a core tenet of a crypto asset’s value is its scarcity preposition. So far, there is no check on the vintage quality issuances which has become an issue at this stage of the BCT Lifecycle (where it has built a powerful network effect). This is what started BTC and ETH on its narrative as a strong form of value, as its network effects continued to grow. If BCT has the opportunity to position itself as the pioneer in Refi, then naturally a scarcity preposition and some form of quality control is absolutely necessary to its long term success.

Thanks guys once again!

[RageMan]

Thank you for giving the community a voice in the debate. I can see merit in filtering at the bridge and the pools, so I will confine my comments to the ‘Do Nothing’ option.

My views spring from your three goals.

1. Drive climate finance to projects that create new interventions that haven’t happened yet, rather than give money to projects that can clearly survive without the subsidy of climate finance, the basis of additionality.
2. Expedite the rise in the floor price of carbon credits.
3. Drive finance to high cost and high value credits.

The ‘Do Nothing’ option drives crypto climate finance to projects developed in 2008-2011. Those projects were additional at the time and important for their communities. Including credits from those dates will not achieve goal 1, and works against goal 3. Including those projects drives finance to low cost and low-value carbon credits and starves the high-value credits of our support.

How the inclusion of low value 2008-2011 credits impacts goal 2 is complicated. Is goal 2 to raise the floor price on all carbon credits? Or is it to raise the floor price on credits that meet the standards of goals 1 and 3? I think it should be the latter.

Like all financial baskets, BCT has taken on the price characteristics of the cheapest thing to put into the basket, which is 2008-2011 credits. There are tens of millions of issuable credits from that period, and those sleeping project owners are waking up and have been pushing credits into BCT. This is central to why BCT prices have fallen in 2022.

Goal 2 has an important urgency. We want to ‘expedite’ the rise of carbon prices. The inclusion of 2008-2011 credits works against anything happening fast to the target projects in goals 1 and 3. BCT can’t act as an agent for change in raising the floor price on high-value new projects while 2008-2011 credits are included, and this will cause BCT prices to languish.

Do nothing = Low BCT price forever

At the end of the two-week consultation, if you decide you are rejecting the ‘Do Nothing’ option, then that same day, please raise the minimum vintage to 2012 while you discuss the other options among yourselves. Announce the temporary move and make it UNMISSABLE to anyone bridging that you have moved the vintage cut-off.

In conclusion, doing nothing, I believe, badly damages Toucan and BCT. This community, and Toucan, were the first to unlock the potential for crypto in climate change. I am proud to be involved and want to help carry the torch as far as possible.

[Alanos86]

I’m in favor of filtering at the bridge because its a faster option. I think we need solution to this problem sooner than later. I’m against do nothing option.

[Rez]

Great initiative Toucan Core!

Fully agreed that this is an important issue that needs to be addressed. This has been an ongoing saga from the launch of BCT and I don’t think anyone really has a good grasp of the amount of these ‘stranded’, ‘floating’ or ‘dark’ credits we have yet to see. Traders have pointed this out for a long, long time.

It’s quite clear that if the project has been managed for such a long time without actually selling the credits, the value of providing these projects money is very questionable. The issuance-to-vintage filter is a good option, but I’m worried 5 years is really tight for some nature-based approaches - I would extend this to 6 years if it is applied at bridge.

If this filter is applied at the pooling stage - why not - especially for BCT (NCT would follow the point I raised above). Big IF here - I don’t think the current model of TCO2 supports this option since as far as I understand. TCO2 is a representation of project+vintage. I haven’t checked, but I’m pretty sure a project+vintage might have multiple sets of issuance, making this a bit sticky of a problem to tackle and possibly requiring a rework of the underlying representation (?)

Honestly a lot of these credits might already be blocked by moving the BCT vintage requirement up to 2014, since a lot of these seem to be older than this. If needed, I can follow up with a more detailed set of analytics about this. This generally seems like a relevant step to raise quality and not provide money to functionally unattractive assets.

The ‘do nothing’ argument I feel is misrepresenting the situation. While we do inherit the problems of the off-chain market - BCT is designed to be the most wide-reaching carbon pool. Someone had to set gating criteria though. It’s not a ‘value neutral’ position. An arguement can be made that its so wide-reaching that it functionally ignores the weaknesses of these markets by not acknowledging that some carbon assets are perhaps not deserving of liquidity in general.

As a quick aside - both interventionist options come with UX problems. Do we have confidence that people bridging will be informed enough on the viability of their credits in the ecosystem? Does the current interface adequately inform bridgers?

Finally let us address the philosophical positions of the three options:

• Filtering at bridge - credits that do not meet this criteria fundamentally do not deserve to be traded
• Filtering at the pools - credits that do not meet this criteria fundamentally do not deserve unchecked access to liquidity
• Do nothing - BCT is working as intended and this market behavior is a feature, not a flaw

I feel “Filtering at the pools” would be the most philosophically sound option - though this comes with baggage. On a technical level this seems to require a significant time investment. I feel we needed a solution to this a while ago and this solution would take time to materialize, further applying downwards pressure to BCT price by the liquidity pools leaking cash to these projects.

All this being said - I’d vote for “Filtering at the bridge”, but increasing the delta to 6. I’m willing to sit down and do an analytics session to figure out if this would be restrictive enough to have any significant impact if needed.

PS: I also feel a 2-week governance process is too long for this question if no work around this is happening during that period. There is also a serious risk of these bridgers getting spooked and bridging as much as they can in a last-ditch effort to capitalize on the available liquidity. This could lead to a sudden downwards surge.

[Meaningful_name]

I tend to like the idea of a 6 year delta. But it would be useful for someone at Toucan to take a look at the crediting periods for project types, to see if this needs to be a bit more nuanced. I’m worried too that nature-based credits might need a bit longer. The other issue though is that some crediting periods can be re-upped once or twice. So for example, if a crediting standard’s rules are such that a project can have 5 year crediting periods with the ability to be reviewed with a new new 5 year crediting period, how does this play into the proposal made by Toucan here?

[Rez]

Okay so here is a self-contained post on this subject to elucidate the whole delta discussion.

A statistical look at vintage-issuance delta in the Verra registry

On March 25 — a bit over a month ago at the time of writing — Toucan wrote a governance proposal outlining an approach to curb undesirable credits getting on-chain. This was later followed by Carbon Plan explicitly pointing out a large amount of ‘zombie credits’ that have found a home in the BCT pool. This article is a statistical look at the impact that a vintage-issuance delta would have in stopping undesirable credits from reaching on-chain.

Stats were compiled by Marcus Aurelius (of KlimaDAO), and Rez (me). I’m sure you can find us on the internet if you want to chat. You can see the stats by clicking on this link.

What is a vintage-issuance delta?

Vintage refers to the period of time that the credits are rewarded for. If an afforestation project issues credits this year for vintage 2019 — this would mean that the credits they just had issued are based on the project’s trees having removed carbon from the air during the year 2019.

In the Verra registry, issuance rights for credits are rewarded at some point after the climate-positive action has taken place. For nature-based methodologies — this can take a while. However — even though the project has the ability to issue credits, it doesn’t always translate into them issuing the credits right away. This is because Verra charges a fee for credit issuance, and if the project hasn’t found a buyer for their credits — there is no point in paying to have them be issued. Lost money.

The vintage-issuance delta is the period of time that it takes from doing the climate-positive action to turning it into a carbon credit that you can sell off. It is normal for this delta to be longer for nature-based solutions, where issuanced rights take more time to get. This means we need to look at these kind of numbers by category in order to not skew the results.

I’m sure many would rightly notice that if a project is 1) unable to sell off its credits or 2) doesn’t want to sell its credits — this is a red flag. Carbon projects, by definition, should be motivated by the sale of credits. This is also partially why fresh credits are considered preferable for offsetting.

There is a case that the vintage-issuance delta doesn’t address — credits having been issued and then being held for the purposes of owning a (presumably) appreciating asset. This is more or less ‘fine’ because someone had to hold these credits on thier balance sheet instead of being an unknowable quantity in the shadows.

This is what motivates Toucan to apply a vintage-issuance delta for the purposes of protecting against ‘zombie credits’ in the short term. In order to talk about a vintage-issuance delta, we have to consider what constitutes ‘normal activity’. This is where the stats come in!

What do normal issuance-vintage deltas look like?

Let’s look at all retirement events in the Verra registry — these are credits that have been actually used by someone to offset their footprint. This data explicitly excludes Toucan tokenizations which we will be comparing it with.

Based on looking at all historical retirements — a 90th percentile delta would be approximately 8.2 years. This means accross all historical retirements, 90% of them had a delta smaller than 8.2 years.

Let’s look at this by category:

We can see that in most cases, 90th percentile deltas are nowhere near 10 years, with the major exception of Afforestation/Reforestation, where timelines can often be very long. For hydro this makes sense as there was a historical oversupply that didn’t have appropriate demand until recently.

What do tokenized vintage issuance deltas look like?

For credits tokenized by Toucan, the 90th percentile delta is ~12 years — a stark difference from the 8.2 we see in retired Verra credits. Digging deeper into categories we can see some differences as well:

Very old energy efficiency and hydro projects have found their way into being tokenized. The major category of on-chain credits is large-scale Chinese hydro, which biases the entire data. These are generally also the kinds of credits that can be called ‘zombie credits’.

The way forward

Based on the data observed, a good stop-gap vintage-issuance delta would be 10 years. It would be permissive enough to let in almost all credits with the major exception of very old hydro and energy efficiency projects. In general a 10 year delta seems to safely exclude very old, normally unused credits from being tokenized going forward.

Afforestation and reforestation projects COULD be excluded from this filter, though this might end up just causing more confusion. A major counterargument here would be that since the NCT pool (the pool any nature-based projects would gravitate to) has a rolling 10-year vintage cutoff anyway, this would have functionally no impact on what gets tokenized. Even if very old AFF/REFO credits were bridged — they would not be liquid, so the incentives to bridge these kinds of credits currently doesn’t exist.