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Carbon Trading with Blockchain

Andreas Richardson, Jiahua Xu

arXiv:2005.02474v1cs.CR

TL;DR

Existing ETS rely on trusted authorities, creating a challenge for blockchain approaches that promise disintermediation of trust. The paper proposes a permissioned hybrid model based on the EU ETS and concludes that it could be a transitional step toward wider deployment, though significant barriers remain.

  • Problem

    Existing ETS depend on trusted authorities for allowance distribution, emissions reporting, and verification, complicating blockchain adoption.

    Source: §1 · p. 2

  • Method

    The paper proposes a permissioned hybrid ETS model based on the EU ETS, combining some decentralization with a continuing role for trusted authorities.

    Source: §1 · p. 2, §3 · p. 6

  • Results

    The authors conclude that blockchain could enhance current ETS impact and reach, while significant barriers limit its applicability today.

    Source: §5 · p. 14

  • Takeaways & Limitations

    A permissioned solution largely replicating the EU ETS is presented as a viable transitional first step toward a fully decentralized blockchain ETS.

    Source: §5 · p. 14

    A decentralized international ETS faces unresolved governance and trust concerns among participants, as well as challenges in deterring criminal activity and maintaining network integrity.

    Source: §4 · p. 13

Abstract

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Blockchain has the potential to accelerate the deployment of emissions trading systems (ETS) worldwide and improve upon the efficiency of existing systems. In this paper, we present a model for a permissioned blockchain implementation based on the successful European Union (EU) ETS and discuss its potential advantages over existing technology. We propose an ETS model that is both backwards compatible and future-proof, characterised by interconnectedness, transparency, tamper-resistance and high liquidity. Further, we identify key challenges to implementation of a blockchain ETS, as well as areas of future work required to enable a fully-decentralised blockchain ETS.

1 Introduction

Emissions trading uses capped allowances and trading to incentivize emissions reductions, but existing systems rely on trusted authorities while blockchain adoption faces challenges. The paper proposes a hybrid blockchain-backed ETS that is backward compatible and future-proof.

1 Introduction

  • An ETS caps emissions, issues allowances, and lets companies trade surplus units or buy them to cover emissions.Companies without enough allowances must purchase them or reduce emissions; high allowance prices incentivize the latter.Source: §1 · pp. 1–2
  • Existing ETS designs rely on central authorities for allowance distribution and emissions reporting, plus third-party verification.These roles complicate blockchain’s disintermediation of trust; attacks and fraud in blockchain also hinder immediate adoption.Source: §1 · p. 2
  • Blockchain’s advantages over existing technologies must be weighed carefully, given caution about over-hyped promises and unmet expectations.The paper notes that frameworks for assessing blockchain implementations consider technical, organisational, and legal factors.Source: §1 · p. 2
  • The paper lays out blockchain ETS advantages and challenges and proposes a hybrid model that is backward compatible and future-proof.Source: §1 · p. 2

2 Background

The background introduces the EU ETS and outlines potential blockchain benefits alongside practical and governance challenges. It identifies room for work on implementing blockchain ETS beyond conceptual discussion.

2 Background

  • The paper presents the EU ETS as a contemporary example for discussing ETS weaknesses and blockchain’s potential, alongside a review of selected literature.Source: §2 · p. 2

2.1 EU ETS

  • The EU ETS launched in 2005 and covers over 11,000 installations and EU airlines, representing about half of EU greenhouse-gas emissions.Relative to a 2005 baseline, emissions are expected to fall by 21% in 2020 and 43% in 2030, which the paper says indicates the market mechanism is functioning as expected.Source: §2.1 · p. 3

2.2 Potential and suitability of blockchain

  • Blockchain ETS could extend carbon-market coverage and make ETS linkage more extensible, addressing limited existing coverage and lengthy linkage processes.Interlinked systems are described as increasing liquidity and market size while reducing opacity and the chance of double-counting credits.Source: §2.2 · p. 4
  • Other proposed benefits include lower transaction costs, tamper-resistant protocols, more transparent data, and consensus-based fault tolerance.Source: §2.2 · p. 4

2.3 Existing work

  • Although blockchain ETS has been broadly discussed, the paper identifies scope for practical implementation work; prior attempts have had limited impact and lifespan.The authors note that regulatory support may be needed to reach the compliance market and that blockchain has important limitations.Source: §2.3 · p. 5

3 Proposal

The proposal takes a hybrid, permissioned approach that preserves a role for trusted authorities while allowing a possible future move to full decentralization. It outlines network roles, token types, and processes as a proof-of-concept framework.

3 Proposal

  • The proposed hybrid model combines some decentralization with trusted authorities to ease transition for existing ETS participants and preserve a route to full decentralization.Source: §3 · p. 6, Figure 2 · p. 6

3.1 Taxonomy

  • The taxonomy defines network entities including authorities, enterprises, installations, projects, and verifiers, with roles and responsibilities specified for each.Source: §3.1 · pp. 6–7

3.2 Tokens

  • Two token types are envisaged: an emission token for verified GHG emissions and a permit token representing an allowance or verifier-granted credit.The tokens are intended to mirror current ETS bookkeeping.Source: §3.2 · p. 7

3.3 Processes

  • The processes section presents smart-contract pseudocode as a simple framework for a proof of concept, including authority-controlled changes to enterprise roles.The authors note that a custom-developed blockchain may be more appropriate at international ETS scale.Source: §3.3 · p. 7

1 Function setRole(address sender, address target, string newRole)

The supplied passages describe a role-change authorization condition, permit types, and permit minting, but provide only a brief implementation outline.

1 Function setRole(address sender, address target, string newRole)

  • The role-change condition requires an authority sender and a requested role different from the target’s current role.Source: §1 · p. 7
  • Permits can represent allowances issued by an authority or credits issued by a verifier.Source: §1 · p. 7
  • An authority can mint permit tokens in an amount typically corresponding to the desired cap, through direct allocation or auction.The pseudocode is inspired by Solidity smart contracts.Source: §1 · pp. 7–8

1 Function mintPermit(address signer, address target, uint256 amount)

The model issues permit tokens as allowances or project credits, while verified enterprise emissions are recorded separately as emission tokens. Permit tokens may circulate freely, but emission tokens are restricted to the described burning and surrender process.

1 Function mintPermit(address signer, address target, uint256 amount)

  • Verifiers can grant permit tokens to enterprises with carbon-reducing projects, increasing the circulating permit supply.The grant requires both a project check and a verifier signer.Source: §1 · p. 8
  • Any enterprise may mint emission tokens when a verifier co-signs that they reflect the enterprise’s emissions.The minting function requires a verifier signer.Source: §1 · p. 8
  • Permit tokens representing allowances or credits may move freely among participants, who can also send them to an exchange or create derivatives.The paper gives swaps and options as examples, as in the EU ETS [19, p.71].Source: §1 · p. 8
  • Emission tokens are burned alongside at least an equal number of allowance or credit tokens, and enterprises cannot transact in emission tokens otherwise.Enterprises may voluntarily surrender excess allowance or credit tokens, as is possible in the EU ETS [19, p. 131].Source: §1 · pp. 8–9

1 Function burnToken(address sender, uint256 amount)

The model combines token burning and exchange rules with authority controls over token prices. An illustrative bookkeeping example compares smart-contract execution with double-entry journalisation.

1 Function burnToken(address sender, uint256 amount)

  • Burning requires sufficient permit tokens; when the requested amount exceeds the emission balance, the process supports voluntary surrender beyond that balance.The code distinguishes burning only part of the emission balance from burning beyond it.Source: §1 · p. 9
  • Bancor protocol [40, 25] can automate price determination through a smart contract as organisations trade permit tokens with the authority.The model proposes this mechanism to support market liquidity and token tradability.Source: §1 · p. 9

3.4 Market adjustment

  • Lower emissions-reduction costs can increase surplus allowances and credits while reducing demand, pushing token prices down and making offsets cheaper than direct reductions.The stated price movement follows the described change in supply and demand.Source: §3.4 · pp. 9–10
  • Reducing reserve fraction F or increasing stablecoin reserve C0 raises token prices; the authority can lower prices by reversing those adjustments.The authority can also restrict allowance supply by changing the cap level.Source: §3.4 · p. 10

3.5 Carbon bookkeeping on and off blockchain

  • The example tracks a permit-token value of 20 e on January 1, rising to 24 e on June 30 and falling to 22 e on December 31, 2020.It also records issuance, transfers, emissions, sales, purchases, and surrender across the year.Source: §3.5 · pp. 10–11
  • Table 2 juxtaposes smart-contract execution with double-entry journalisation for carbon accounting.The example records “Emission permit” using the fair value method, following [39, 36].Source: §3.5 · p. 11, Table 2 · p. 12

4 Further challenges and considerations

A blockchain ETS must address platform performance and implementation trade-offs alongside governance, enforcement, and real-world measurement. Permissioned systems still depend on trusted authorities and stakeholder-developed rules, while decentralised linkage raises additional challenges.

Implementation

  • Platform selection weighs Ethereum’s public, permissionless model against Hyperledger Fabric’s private, permissioned model; both have been identified as promising candidates.Prior evaluations considered programmability, operating cost, security, and usability.Source: §4 · p. 12
  • Building on established code offers audited or open-source foundations, while customisation and standardisation affect implementation choices and interoperability.The paper recommends weighing the benefits of an established system against the desired degree of customisation.Source: §4 · pp. 12–13

Governance and trust

  • Permissioned networks require participants to trust the authority that establishes the network and issues tokens; linked jurisdictions may not trust all authorities equally.Rules enforced by smart contracts must first be developed with stakeholders.Source: §4 · p. 13
  • Without explicit governmental oversight, trust asymmetries could challenge the fungibility of tokens from different entities and fragment the network; standardisation is one possible response.The paper presents standardisation as a possible solution, not a guarantee.Source: §4 · p. 13

Enforcement

  • A fully decentralised international ETS lacks a clear participation incentive, and deterring criminal activity may require a supranational enforcement body.Current ETS use legislation to compel enterprise participation.Source: §4 · p. 13

Measurement, reporting and verification (MRV)

  • Real-world measurement, reporting, and verification remain difficult: EU ETS verification and accreditation can be burdensome, and decentralisation requires alternative MRV methods.Blockchain records do not by themselves ensure the quality of input data.Source: §4 · p. 13
  • IoT-based sensing and automated data flows are expected to reduce MRV costs and time, support a faster compliance cycle, and increase trading activity; satellite data could strengthen verification.The EU ETS currently follows a yearly compliance process.Source: §4 · pp. 13–14

Performance

  • Alternative consensus mechanisms have been proposed to improve blockchain performance and reduce its environmental impact, but networks can perform poorly relative to simple databases, especially in electricity use.One estimate put Bitcoin’s power consumption at approximately Ireland’s, with forecasts of more than threefold growth.Source: §4 · p. 14

5 Conclusion

The paper presents a permissioned blockchain ETS modeled on the EU ETS as a transitional step toward decentralisation. It concludes that significant legislative and legal barriers still limit deployment today.

5 Conclusion

  • A permissioned blockchain solution largely replicating the EU ETS is presented as a viable transitional first step toward a fully decentralised blockchain ETS.The paper says such a decentralised system could significantly accelerate deployment of emissions reduction tools worldwide.Source: §5 · p. 14
  • Blockchain could enhance the impact and reach of existing ETS, but significant barriers limit its applicability today.Source: §5 · p. 14
  • Significant legislative and legal barriers remain before a decentralised blockchain ETS can realise its full potential on implementation.Source: §5 · p. 14

A Bancor algorithm for token exchange

The appendix explains how the Bancor protocol prices permit tokens algorithmically rather than matching buyers and sellers. Under a stablecoin exchange assumption, it derives reserve and pricing relationships used to calculate token purchases and stablecoin payments.

A Bancor algorithm for token exchange

  • The Bancor protocol provides constant token tradability by setting prices algorithmically rather than matching buyers with sellers.The paper uses notation in Table 3 to explain the protocol.Source: A Bancor algorithm for token exchange · p. 14, Table 3 · p. 15
  • For demonstration, the exchange medium is a stablecoin measured in e and circulating on the same blockchain as permit tokens.Source: A Bancor algorithm for token exchange · p. 14
  • The stablecoin reserve C is defined as a predetermined fraction F of token price P multiplied by outstanding token supply s.The passage introduces this relationship as an equation, but does not provide its displayed form here.Source: A Bancor algorithm for token exchange · p. 14
  • The derivation combines reserve and purchase relationships to express token price as a function of supply, then derives the exchange reserve as a function of supply.It considers the reserve increase when the exchange sells an infinitesimal token amount at price P(s).Source: A Bancor algorithm for token exchange · pp. 15–16
  • A purchase starting at supply s0 increases outstanding supply by e and the stablecoin reserve by t.This setup describes the token-purchase transaction used in the derivation.Source: A Bancor algorithm for token exchange · p. 16
  • The purchase procedures calculate stablecoins paid t from desired tokens e, or tokens received e from stablecoins paid t, using outstanding supply s.The two directions are assigned to Algorithms 7 and 8, respectively.Source: A Bancor algorithm for token exchange · p. 16
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