Written by Dr Kyle Wong and Dr Amanda Lim
The Market: The growth potential of VERs
The current market size of Verified Emission Reductions (VERs) and the broader carbon verification market, as of 2023, is valued at approximately US$ 12.73 billion. It is projected to experience significant growth, with an expected reach of US$ 64.16 billion by 2030, growing at a compound annual growth rate (CAGR) of 26% from 2023 to 2030 [1]. This substantial growth potential highlights the increasing importance and financial opportunity within the voluntary carbon market, driven by global efforts to mitigate climate change through the reduction of greenhouse gas emissions.
Under the emissions trading scheme, each industry has its own cap on total emissions allowances. After regulators issue carbon credits or quotas based on the cap, the credits can be allocated free of charge or through auctions. The number of available emission rights decreases every year, and the total upper limit of each industry also decreases. The value of emission rights will increase accordingly, which in disguise encourages the market to invest in clean energy and achieve the purpose of emission reduction [2].
The voluntary carbon market is small compared to the regulatory market, but has high growth potential. The lifecycle of VCM roughly takes three steps:
1. early market adoption(2005–2007): During this phase, the market was characterized by pioneering companies and organizations looking to offset their carbon footprint voluntarily, often driven by corporate social responsibility goals rather than regulatory requirement.
2. consolidation and strength (2008–2016): This period saw the VCM mature, with increased participation from a wider array of entities, including corporations, governments, and individuals. Market mechanisms, standards, and verification processes improved, providing a stronger foundation for trade in carbon credits.
3. mainstream adoption(2017- nowadays): The VCM has gained significant traction, driven by growing awareness of climate change, increased commitment to sustainability from the private sector, and the development of international frameworks encouraging carbon offsetting. The market’s expansion is supported by a broader understanding of its role in achieving global emission reduction.
The voluntary carbon market was US$1 billion in 2022. It is estimated that the whole market will scale up 15 times from 2019 to 2030.The prediction of VCM is $100B in 2050. [3]
The Situation: The Role of Hong Kong
In October 2022 the Hong Kong Exchanges and Clearing Limited (HKEX) launched Core Climate, an international carbon marketplace that seeks to connect capital with climate-related products and opportunities in Hong Kong, Mainland China, Asia and beyond.
“Core Climate will facilitate effective and transparent trading of carbon credits and instruments to support the global transition to Net Zero. Core Climate participants will be able to source, hold, trade, settle and retire voluntary carbon credits through the Core Climate platform.”, according to HKEx. [4]
HKEX recognised that while most voluntary carbon markets are based in Europe and the United States, Asia has recently caught up. The region saw the most voluntary carbon offset transactions between 2019 and 2021, as suppliers to large multinationals embarked on carbon mitigation. And places such as Hong Kong, Singapore, Thailand, Malaysia, Taiwan and Indonesia have established their own voluntary carbon credit trading platforms and exchanges since 2021. [5]
Numerous discussions and research endeavors have been undertaken in the past to promote the implementation of initiatives aimed at fostering carbon credits trading in Hong Kong. Despite these efforts, no concrete initiatives have been identified thus far regarding the tokenization and activation of the carbon credit trading market in the region.
The solution: Tokenization of Carbon Credit
By tokenizing carbon credits and enabling their trade through licensed virtual asset trading platforms, Hong Kong has the potential to outpace other countries in the carbon credit trading market. Carbon credit tokenization involves the transition of carbon credit information and attributes onto a blockchain, where they are represented as tokens. These tokens, each corresponding to one metric ton of carbon dioxide avoided or removed, establish a direct and transparent relationship.
Through the use of “Carbon Bridges” connecting to established registries like Verra and Gold Standard, credits can seamlessly migrate onto the blockchain. Once bridged, carbon tokens become accessible for purchase, sale, transfer, retirement, or secure storage in on-chain accounts. [6] This innovative approach not only ensures transparency but also positions Hong Kong to lead in the dynamic and evolving landscape of carbon credit trading.
Steps in Tokenization
Tokenizing carbon credits can drive transparency and efficiency in carbon markets. But executing an effective project requires strategic planning across many fronts. Here is a step-by-step guide [7]:
1. Source Credible Carbon Credits
First, determine where your carbon credits will originate. If you run a company with internal offsets, tokenize those. If operating a market platform, carefully select reputable partner projects. Start small and local before expanding globally.
2. Map the Credit Lifecycle
Plan how credits will be generated, verified, listed, purchased, tokenized, and retired. Select standard-setters to ensure credibility. Outline how data flows through each stage.
3. Develop a Sustainable Business Model
Consider transaction fees, subscriptions, commissions, and consulting services. Combine approaches to generate revenues sustainably. Provide ongoing value to users.
4. Design the Tokenization Framework
Choose the optimal blockchain, token standard, minting approach, and accepted currencies. Prioritize security and energy efficiency.
5. Create an Informative Platform
Develop a user-friendly site and compelling content that educates audiences on your vision. Integrate marketing to attract early adopters.
6. Implement Robust Smart Contracts
Work with experienced developers to program airtight smart contracts. Conduct meticulous auditing to identify vulnerabilities.
7. Build a Functional Marketplace
Allow seamless credit listings, purchases, payments, and transfers. Make registering and transacting intuitive for users.
The Benefits: Tokenization and traded through HKVAX
HKVAX will offer an Institutional-grade trading platform built for professional investors to trade virtual assets and security tokens. It intends to meet all the requirements of Listing Rules and Guidance for virtual assets and security tokens.Tokenized Carbon credits traded through HKVAX in the future may provide a better alternative to the HKEx and have the following listed benefits. Particularly, it can significantly benefit the voluntary carbon credit market in several ways:
Enhanced Liquidity: Tokenisation increases the liquidity of voluntary carbon credits by enabling fractional ownership and facilitating easy trading on virtual asset platforms. This attracts a more diverse set of investors, including retail participants, fostering a more dynamic market.
Accessibility for Small Investors: Tokenisation lowers the barriers to entry, allowing small investors to participate in the voluntary carbon credit market. This democratization of access can stimulate greater interest and involvement from a wider range of individuals.
Global Participation: Tokenisation encourages global participation by making it easier for international investors to engage in the voluntary carbon credit market. This increased diversity of participants can drive more interest and demand for voluntary carbon credits.
Standardisation and Transparency: Tokenisation can bring standardisation to the voluntary carbon credit market, making it easier for investors to understand and compare different credits. Blockchain technology ensures transparency and traceability, addressing concerns related to the credibility and legitimacy of carbon credits.
Innovation and New Financing Models: Tokenisation introduces innovative financing models, attracting new capital to the voluntary carbon credit market. This influx of funds can lead to the development of new financial instruments and investment products, expanding the market and creating additional revenue streams.
Automated Compliance and Reporting: Smart contracts on blockchain can automate compliance with regulatory and environmental standards. This reduces the administrative burden on market participants and ensures that carbon credits meet predefined criteria.
Increased Trust and Credibility: The transparency and traceability provided by blockchain technology contribute to increased trust and credibility in the voluntary carbon credit market. Investors and stakeholders can have greater confidence in the integrity of the credits being traded.
Alignment with ESG Goals: Tokenisation aligns with Environmental, Social, and Governance (ESG) goals, attracting investors who prioritize sustainability. This alignment can lead to increased demand for voluntary carbon credits as part of broader ESG investment strategies.
Tokenisation and trading of voluntary carbon credits through a licensed virtual asset platform can bring about positive changes by increasing liquidity, making the market more accessible, encouraging global participation, and fostering innovation. These improvements can contribute to the growth and effectiveness of the voluntary carbon credit market in addressing environmental challenges.
The Insights: Hong Kong’s Financial Center Position in Carbon Credit Trading
Strategic Financial Hub: Hong Kong, as a global financial center, has a unique opportunity to position itself at the forefront of carbon credit trading by embracing tokenization.
Competitive Advantage: Embracing carbon credit tokenisation aligns with Hong Kong’s tradition of financial innovation, giving it a competitive edge in the emerging green finance landscape.
Regulatory Leadership: Establishing a robust regulatory framework for tokenised carbon credits will not only attract international investors but also solidify Hong Kong’s reputation as a leader in financial governance.
Global Collaboration Hub: Hong Kong’s pivotal role in global finance positions it as an ideal hub for fostering international collaboration in carbon reduction efforts through tokenised trading.
Diversification of Financial Products: Tokenised carbon credits can contribute to the diversification of financial products in Hong Kong, attracting a new wave of environmentally conscious investors.
Green Finance Expertise: Leveraging its financial expertise, Hong Kong can become a center for knowledge and expertise in green finance, further enhancing its status as a leading financial hub.
Innovation Ecosystem: Fostering collaboration between financial institutions, technology providers, and regulatory bodies creates a vibrant innovation ecosystem, positioning Hong Kong as a trailblazer in sustainable finance solutions.
Brand Image and Responsibility: Embracing carbon credit tokenisation aligns with Hong Kong’s commitment to corporate social responsibility, enhancing its global brand image and reinforcing its dedication to environmental stewardship.
Hong Kong has a strategic opportunity to leverage its financial prowess and maintain its position as a global financial center by actively participating in carbon credit trading through tokenisation. With a focus on regulatory leadership, collaboration, and fostering financial innovation, Hong Kong can not only contribute to global climate efforts but also strengthen its reputation as a leading hub for sustainable and responsible finance.
Acknowledgement
The authors would like to acknowledge the research contribution from a group of very talented HKUST students, Amanda Cheng and Helen Ji under the leadership of Prof. Ki Ling Cheung.
References
Coherent Market Insights. (2023, June). Carbon Verification Market size, Trends and Forecast to 2030.
Panek, M. (n.d.). Carbon offsetting: how it works and the benefits for businesses. Lingaro. https://lingarogroup.com/blog/carbon-offsetting-how-it-works-and-the-benefits-for-businesses
HBAGLCD. (2022, August 25). 国际上都有哪些自愿减排标准. 河北省绿色低碳循环发展协会. Hebei Green Low Carbon Recycling Development Association. http://lvsefazhan.cn/index.php/msg/434.html
HKEX. (2023, January 13). HKEX LAUNCHES CORE CLIMATE, HONG KONG’S INTERNATIONAL CARBON MARKETPLACE, SUPPORTING GLOBAL TRANSITION TO NET ZERO. Hong Kong Stock Exchange. https://www.hkex.com.hk/News/News-Release/2022/221028news?sc_lang=en
Glenda So. (2023, January 13). Carbon markets: connecting capital and corporates with climate action. Hong Kong Stock Exchange. https://www.hkexgroup.com/Media-Centre/Insight/Insight/2023/Glenda-So/Carbon-markets-connecting-capital-and-corporates-with-climate-action?sc_lang=en
AskGalore Digital (2023, June 6). Tokenized Carbon Credits Can Facilitate Climate Solutions https://www.linkedin.com/pulse/tokenized-carbon-credits-can-facilitate-climate-solutions/
Wadhwani, K. Understanding The Carbon Credit Tokenization. SoluLab https://www.solulab.com/carbon-credit-tokenization/