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Is KYC for Carbon Tokens Killing Innovation? | Web3Carbon Week#38
+ Will KYC Kill Innovation?
+ News from 9 projects
+ 2 new projects in the directory
+ Some weekend reads
Will KYC Kill Innovation?
In May 2022, when ☑️ Verra (Registry) grinded carbon credit tokenization to a halt, it demanded KYC (Know-your-Customer) measures from web3 protocols. That course of action is well understandable from Verra’s point of view, as intermediaries need to make sure to comply with financial regulations (i.e. anti-money laundering AML) for which some sort of KYC is a requirement in most jurisdictions.
But applying KYC to decentralized web3 protocols is difficult: Because it is the whole point of web3 to enable to transact peer-to-peer without the need for permission from intermediating institutions; while providing more trust and transparency than tradional intermediaries.
Introducing KYC to web3 protocols will require some sort of centralized control, that might as well lead to exclusion of market participants. But much more importantly, KYC also adds a lot of friction to permissionless web3 protocols and introduces barriers that might hinder or even kill innovation.
The issue with Verra’s recursive demand for KYC
Verra’s current requirements for KYC as specified in Verra’s document for public consultation on third-party crypto instruments seem to overstep and add unnecessary recursion. Not only does current proposal demand strict KYC from everyone who holds a carbon token, or anyone who holds a token that holds a token, but would probably also require KYC from anyone who interacts with a smart contract that holds a token etc.
“KYC checks would apply not only to holders of crypto instruments or tokens issued on the back of VCUs, but also any holders of crypto instruments or tokens that are issued on the back of those crypto instruments or tokens, and so forth.” (see pdf P. 5)
This seems very impractical. Because it ads overhead with no obvious utility. It implies for instance that KlimaDAO token holders need to do KYC with Verra because the Klima protocol holds Verra certified Carbon tokens in its treasury. Questionable to demand this from 40k participants in a decentralized protocol, and probably difficult to enforce.
Strongly applied KYC might not only remove the benefits of decentralization of carbon. It could kill a lot cool future applications: e.g. automated retiring of a tokenized carbon credit as part of any product, interacting with smart contracts that also hold carbon credits (for instance a liquidity pool). This outcome of the consultation is sub-optimal for everyone. As many of those applications are building blocks to create an innovative ecosystem on top of on-chain carbon credits.
Toucan’s compromise to KYC
🐣 Toucan, the company that is bridging carbon credits from off-chain registries to blockchains and back, is in a fragile position: On one hand, Toucan wants to comply with requirements of the legacy carbon registries who push for KYC. On the other hand Toucan needs to remove all barriers that could block innovation to bloom on its tokenized carbon credits. In a blogpost this week Toucan outlines its approach to KYC in Web3 carbon markets. It seems to compromise in a smart way. Toucan suggests: Mandatory KYC for tokenization and de-tokenization. No KYC for pools, marketplaces, smart contracts, or on-chain retirements.
Some similar ideas were also brought forward in a earlier response to the consultation by KlimaDAO. Toucan’s solution would allow the registries to comply with anti-money laundering regulation, but it would also allow the web3 community to permissionlessly build on top of its composable carbon credits. Smart.
Goldstandard is more open than Verra
KYC is also the topic of the latest edition of the Week in ReFi Podcast by Rez of Solid.World and Slaptain Shwirv. Among other thoughts, they deliver a thorough comparison between Goldstandard’s and Verra’s tokenization consultation process and give many clear examples with issues of wrongly implemented KYC. Rez praises Goldstandard’s process as being more open to adapt to existing best practices. He discuss other web3 examples where real world assets and KYC are handled in a less intrusive way (Goldfinch KYC or USDC).
It is very probable that the outcome of the consultation process with the registries (regarding KYC) will require that some sort of KYC gets implemented. If the KYC measures taken are not compatible with building innovation on top of tokenized credits, tokenization will fail. There is a high likelihood, that legacy registries will be disrupted by new participants. New participants that somehow allow for more permissionless composability. So, KYC will not necessary kill innovation in web3carbon, but it will take more time for alternative registries with integrity to evolve and to innovate on top of carbon.
Web3Carbon Project Updates
🍧 KlimaDAO (Carbon Reserve Currency) moving down the value chain? KlimaDAO rfc’s its community whether it should move into a forward carbon project. A first proposed project is cookstove carbon avoidance project in Bangladesh.
♻️ Return Protocol (Onchain Offsetting) raises $2.5M in Pre-Seed Funding led by Cherry Ventures
🌞 Reneum (Renewable Energy Marketplace): ReFiDAO Podcast introduces Reneum: A Renewable Energy Credit Marketplace.
📆 Event tip: Some ReFi folks are organizing the #ReFi Zurich Conference on November 26, 2022 at the University of Zurich. Tickets are on sales now.
Newly Added Projects to the Kuoka Repository:
🍧 KlimaDAO’s blog has an analysis of the top 5 reasons businesses overpay for carbon credits: It explains how opaque markets and unreliable price discovery, high fees and margins, variety and stratification of carbon credits, limited carbon credit availability, resource-intensive documentation lead to a lot of capital not arriving at the carbon projects and not being invested efficiently.
👩💻 Thallo (Carbon Credit Exchange) has conducted an interesting webinar with Verra, and others about COP27 Implications for Voluntary Carbon Markets discussing general questions like: will COP27 finally bring clarity on Article 6 of the Paris Agreement? but also specific web3 stuff like whether and how the rise of web3 players in the carbon market help or harm its growth?
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