Market Structure, Liquidity and Trade Lifecycle

Interoperability: the misused word in Carbon Credits Markets Technology

By Zero13||Est. Reading Time: 4 minutes|

Article highlights

  • There is a significant climate financing gap hindering a climate-resilient future. Financial capacity building is hindered by fragmented and analogue approaches. To address climate change, we need to question and challenge the current business models and take a completely different path.
  • Ørsted, a Danish energy company, has successfully transitioned from fossil fuels to renewable energy. Their commitment to renewable energy shows that ambitious and transformative approaches can be successful in combating climate change.
  • Existing carbon exchanges and financial market infrastructure are not embracing change fast enough. They are adopting outdated models that do not work in the distributed and interconnected carbon market. A new model, Digital Carbon Exchange 2.0, is needed, which requires industry collaboration and distributed interconnection across jurisdictions to achieve greater positive climate impact.

According to the World Economic Forum, there is a $4-5 trillion dollar climate financing gap hindering a climate-resilient future, yet financial capacity building is also being hindered by fragmented, siloed and analogue approaches. To seriously address climate change, we must question and challenge what is already before us. It is not as simple as taking the next step up the ladder or adding to what you already have, it is about going back to the business model basics, clarifying what you want to achieve and taking a completely different path to do so.

Ørsted, the Danish energy company, is leading the way on climate action by developing, constructing, and operating offshore and onshore wind farms, solar farms, energy storage facilities, and bioenergy plants. In 2009, 85% of Ørsted’s energy production was based on fossil fuels and only 15% on renewables. The company committed to switching to 85% renewable energy and only 15% fossil fuels by 2040. Many thought they were overly ambitious and said it couldn’t be done, but this transformative approach is proving successful.

Their commitment to renewable energy inspired us to launch ZERO13, our Platform-as-a-Service ecosystem focused on the 4Cs – Climate, Communities, Companies and Countries. The ecosystem instils trust, enables interoperability and supports monetisation between buyers and sellers of climate projects/carbon credits and other ESG assets with a focus on water, energy and food.

What does this mean for exchanges and financial market infrastructure in the context of carbon markets? A good place to start is to learn from the past to see what might happen in the future: after the emergence of electronic markets, exchanges, for some time, became complacent towards innovation and the idea that there would be any real competition. Regulation then became more demanding, forcing the exchanges to react and create opportunities for start-up trading venue firms with progressive ideas and ‘disruptive’ technology to bring in new solutions. Interestingly, regulation could also be viewed as ‘disruptive’, as it was the driving force that pushed the exchanges to adopt innovation and adapt with the market in the face of competition.

That said, exchanges are not embracing change fast enough, and when they are looking at carbon credits markets, they are merely adopting ‘old-school’ models based on a traditional ‘walled garden’ approach. This ignores how distributed the carbon market is, as climate finance requirements and carbon credits supply could be in one country, while the finance and demand is in another. As such, a singular centralised exchange model simply does not work. The model needs to be distributed. But this also does not mean that a singular blockchain approach is the answer, as that too creates singular insolvency and custody risk.

Old-school models adopted at carbon exchanges launched over the last few years have not worked. These venues generally have very little liquidity and while they say they are digital, many use a manual account at a registry such as Verra and input that information into the exchange system. Some may tokenise that input, but the majority still return to a ‘walled garden’. If carbon credits stop being sold or pledged, the ‘walled garden’ approach means they cannot now get back into the registry and are effectively orphaned at the exchange. In addition, buyers may be in a country with its own registry or may want to use a different registry to the seller of the credits, yet are forced to open accounts at multiple registries as it’s not possible to move inventory around.

Despite all these factors, it astounds me that some exchange technology and post-trade market infrastructure vendors are stating that they have an interoperable carbon credit offering when they actually do not. Instead, they are merely offering an old-school centralised exchange model with integrations that take years to get in place. With the speed the market moves at, this approach cannot scale.

It is much like everyone wanting to run their own cloud when we know it’s impossible to achieve economies of scale. No matter how you wrap it up or market it, providing just a matching engine does not make it a digital carbon exchange solution as there is no post-trade offering for climate assets. It is deployed into these exchanges standalone, so it’s akin to being landlocked and isolated, where ships of liquidity can’t sail. If each exchange has its own system connected to the market, they are effectively detached entities which are unable to help new markets grow, increase liquidity and address the climate challenge.

In working to address the climate challenge we are not only dealing with some organisations ‘greenwashing’, we are also faced with organisations ‘technology washing’.  The use of the term interoperability is often used incorrectly to describe solutions that are, in fact, vertical and closed. It is time for those looking to deploy carbon market infrastructure to wake up and take a reality check, as by making incorrect claims about their technology, they are not only doing a disservice to their shareholders and customers but also to the climate.

An interconnected digital carbon market infrastructure is needed to address fragmentation and siloed approaches by encompassing interoperability across both APIs and blockchains, to bridge both traditional and newer digital approaches. This is what we are doing at ZERO13 with our COP28 award-winning solution, which utilises multi-blockchain technology and will scale climate finance in a way that did not exist in the market before, using a collaborative ‘network of networks’ approach.

It is evident that exchange and financial market infrastructure Model 1.0 is not fit to support the carbon markets and will likely become extinct over the coming years as standalone exchanges will not be able to survive. Today’s exchanges are perceived by many people like the phones of the past – slow and unintuitive with limited functionality – trying to operate in the era of iPhones and smart technology. Can we think of a time before the smartphone? Technological innovators like Apple and Samsung revolutionised and democratised the way we access and generate information, and are seen as providers of knowledge rather than simply products. The days of supplying technology and commanding a premium for supplying products and services are over.

Model 2.0 is all about industry collaboration and distributed interconnection across jurisdictions to achieve greater positive climate impact, and ZERO13 are firm believers of this. We should be collectively working towards Digital Carbon Exchange 2.0 – the much-anticipated climate-focused sequel.