The common essence of carbon trading and air coins: reshaping the power of rule-making

This article is from the WeChat public account "Dai Guan," author: Iris.

Editor's Note (by Alen): In the context of carbon neutrality, ESG (Environmental, Social, and Governance, including environmental protection, ethical standards, human rights, etc.) has become a prominent field that can generate premiums. As digital currencies increasingly break into the mainstream due to the explosion of NFTs, discussions related to environmental protection naturally follow suit. Especially in recent days, the "performance art" of burning physical artworks mirrored on the blockchain has emerged endlessly, along with the "Renaissance" topic of Bitcoin's energy consumption, which has become a topic of discussion among environmental enthusiasts during their leisure time.

Coincidentally, my good friend Iris comes from a 985 environmental economics background and is currently navigating the secondary market. I can say that my understanding of new energy and semiconductors comes from her; our daily conversations often involve various dark humor and personifying companies.

Iris's thesis from years ago was a study on carbon trading, which is quite profound. Under my influence, I can't say she's an expert in the crypto space, but she is certainly familiar with it. Through our discussions, we found many similarities between environmental protection, carbon trading, and "air coins," leading to the following interview, hoping to inspire interested audiences. Enjoy!

The TL;DR version is as follows: 1. The premise for the argument that Bitcoin consumes a lot of electricity is that this electricity could be used in more valuable places than mining; otherwise, mining actually solves many electricity consumption issues.

2. Environmentalists could consider inventing the concept of "green Bitcoin" to categorize Bitcoin based on its power generation sources.

3. Environmental protection itself can be seen as an air coin, where various administrative means empower it until three consecutive bullish candles change beliefs, using the carbon tax's price necessity to reach a consensus.

4. Countries are now calling for carbon neutrality because, over the past n years, Europeans have created so many concepts based on carbon emissions, indicating that environmental protection/ESG/carbon neutrality is a very useful tool. These tools can achieve many purposes: using new energy as a selling point to attract votes, attracting more customers, increasing company valuations, etc. At this point in time, top players and politicians worldwide have coincidentally chosen this script for their different goals.

5. The Kyoto Protocol and the Paris Agreement are like different public chains under the name of environmental protection; the Kyoto Protocol is a more centralized alliance chain with some requirements similar to mandatory lock-up, which ultimately failed due to various nodes having ulterior motives and various issuance bugs. Thus, a more decentralized public chain 2.0 version, the Paris Agreement, emerged, which, lacking mandatory lock-up requirements, instead spurred various nodes to sit down due to their economic and political demands, thus thriving.

6. I don't know what carbon trading and the crypto space will ultimately become, but one thing is certain: more and more people are getting involved. The destination of the journey is not important; what matters is who you travel with. Alen: Can you introduce yourself first? Iris: I studied Environmental and Natural Resource Economics in college and ended up working as a laborer in the secondary market. My thesis was on carbon trading, and I chose this topic not because I liked it but because I believed the defense experts wouldn't know what carbon trading was. After writing it, I found that carbon trading is essentially a belief system; disbelief is the biggest obstacle. Later, I realized many things are the same; belief only needs one reason. Disbelief can have a thousand reasons.

Alen: What do you think about the argument that Bitcoin mining is energy-intensive and not environmentally friendly? Iris: This actually depends on your preset stance. First, high energy consumption is relative to what? Secondly, is high energy consumption necessarily negative?

If we were to neutrally describe this fact, we should say that Bitcoin consumes a large amount of electricity during the mining process.

I understand the criticisms of Bitcoin's high energy consumption, but the premise for this argument is that this electricity could be used in more valuable scenarios than mining. If this proposition doesn't hold, then can we say, "What's wrong with Bitcoin using some electricity?"

However, with the price of Bitcoin breaking 60k, there have been reports that some internet cafes in certain areas have started mining, and in this scenario, the electricity used can indeed be argued about.

From my limited understanding of mining, most of the electricity used for mining should not have better uses, or rather, that electricity would not be used by anyone else—hence the extremely low price of electricity.

One of the core competitive advantages of professional mining farms is low electricity prices. Mining farms that can persist through the ups and downs of Bitcoin prices must have some tricks up their sleeves regarding electricity prices. Some use small hydropower, while others mine in regions like the northwest where electricity resources are generally in surplus. If this electricity isn't used for mining, it would be difficult to consume locally. The result of unconsumed electricity is wasted electricity, a concept familiar to those who have traded new energy stocks.

(Alen adds: This is the logic behind secondary market speculation on energy storage; some C factories: creating energy storage is like creating a new Ningde.)

A common rebuttal from environmental keyboard warriors is that this electricity can be transmitted outside the province.

However, so far, the best solution for domestic electricity resources remains local consumption.

Transmitting electricity to other regions involves issues of loss and transmission costs, as well as transaction issues between different regional power grids. The degree of marketization in China's electricity trading is still lacking, and there are many problems to solve regarding cross-regional transmission and consumption. After adding various costs, it might be more profitable for electricity selling companies to sell electricity to local miners.

I can actually offer a tip to environmental keyboard warriors on how to properly attack Bitcoin's high energy consumption.

In traditional mining, criticizing mining for polluting the environment is a conventional program. Coupled with the green hydrogen concept invented in Europe, I suggest categorizing Bitcoin as well.

If mined using non-fossil energy, it's a pure green coin.

If mined using fossil energy like thermal power and natural gas, it's a black coin that generates a lot of carbon emissions and is not environmentally friendly. A carbon tax should be levied on holders of black coins.

Using green coins for transactions places you at the top of the carbon emission hierarchy. (Alen's note: This is somewhat like what we call the virgin coin premium; one affects privacy, while the other affects environmental protection.)

In contrast, traditional banking employs so many people, and the carbon footprint from their daily commutes, meals, and office electricity usage can be astronomical… (Alen: Two-sided needle warning)

Alen: Can you explain carbon trading in simple terms? What are carbon neutrality, carbon capture, and carbon footprint? Iris: Because the environment is a public good and does not belong to any one person. When public goods are mismanaged, it is called the tragedy of the commons.

The economic solution is to privatize and value public goods, then correct people's behavior through price signals.

Using the language system of the crypto space, we can view environmental protection as a consensus, but this consensus is not believed by many, especially in the heavily polluting industrial sector.

So we issue an air coin, which represents an environmental protection consensus. With this environmental coin, one qualifies for carbon emissions, hence also called carbon tax or carbon quota (as mentioned in the interview between Academician Ding Zhongli and Chai Jing: carbon emission rights are a form of development rights). At first, no one may recognize it, but that's okay; as long as everyone unites to speculate on it and empower it (administrative + consciousness output means), after three bullish candles, people's beliefs will change, and consensus will emerge. (Misunderstanding) This air coin can be a carbon tax or an emissions trading right. The full name of carbon trading is actually carbon emission rights trading.

Current carbon trading mandates that the industries with the highest carbon emissions must purchase this air coin by the end of each year.

Abstractly speaking, the higher the emissions of a company, the higher the unit emission intensity, and the more air coins they need to purchase.

Thus, the more expensive the air coin, the stronger the environmental protection consensus will be.

Even if companies do not believe in this consensus, when real money and various NGO alliances are involved, companies will still change their strategies. Ultimately, the actions of companies that do not believe will still be similar to those that genuinely believe.

(Alen's note: Similar to BCI's trade restrictions on cotton; moreover, I feel that carbon trading has many similarities with the crypto space, such as the initial carbon quota distribution rules, which are similar to the token distribution mechanisms of air coins, determined by the project party itself. For instance, BYD or Wuling Hongguang producing pure electric vehicles can earn points to sell, which is akin to liquidity mining. If the liquidity mining mechanism is not well designed, it can easily lead to mining disasters, which will be mentioned later.) Carbon Neutrality: Refers to the direct and indirect emissions of carbon dioxide from human activities in a certain area over a certain period (generally one year) being offset by the carbon dioxide absorbed through afforestation and other means, achieving "net zero emissions" of carbon dioxide.

How does this work in practice? Suppose I am the person responsible for this. I first take the methodology of my industry and the numbers I have recorded, and after some calculations, I arrive at this year's carbon emissions.

Then I take the methodology from the new energy and afforestation sectors and calculate how much carbon dioxide was absorbed this year.

Finally, if the two numbers are equal, I can announce that I have achieved "carbon neutrality." (By the way, what does calling for carbon neutrality last September mean? It's like a whale calling for Bitcoin to reach 100k when it was at 5k.)

Carbon Capture (CCS: Carbon Capture and Storage): Refers to the process of separating carbon dioxide from industrial or other emission sources. This step is the narrow definition of carbon capture. The broad definition of CCS also includes the storage and utilization of carbon dioxide.

Thus, CCS technology can be roughly divided into several directions: capture, transport, utilization, and geological storage.

Unfortunately, apart from using CO2 for carbonated beverages (which is negligible) and geological storage (which is extremely costly), no large-scale usable scenarios have been found.

In my personal view, this can only be solved by black technology or time travelers.

Carbon Footprint: Refers to the total greenhouse gas emissions caused by enterprises, institutions, activities, products, or individuals through transportation, food production and consumption, and various production processes.

In simple terms, it is the carbon emission version of bloodline theory and genealogy. Looking back three generations, we check if it is a genuinely green and environmentally friendly product. The industrial sector tends to interpret this as a new type of artificially created barrier. Europe and America use carbon footprints to eliminate backward production capacity and can also impose high taxes under the pretext of carbon footprints.

This tactic is not new; Europe and America have already defined green hydrogen and gray hydrogen. Only hydrogen produced from renewable energy is green hydrogen, while hydrogen produced from chemical processes is called gray hydrogen. They are both H2, but green hydrogen is more valuable than gray hydrogen, carrying a green premium. Europeans have created so many concepts based on carbon emissions, indicating that environmental protection/ESG/carbon neutrality is a very useful tool.

These tools can achieve many purposes: using new energy as a selling point to attract votes, attracting more customers, increasing company valuations, etc.

At this point in time, top players and politicians worldwide have coincidentally chosen this script for their different goals.

Alen: What is the history of carbon trading? What past successes or failures have there been? How is carbon trading today different from before? Iris: Although the history of carbon trading is not long, it is filled with various notable moments. First, let me explain a few terms, and then I will introduce the entire history.

The italicized parts can be skipped initially and revisited later. (Alen's note: If you persist in reading, you will find that the English abbreviations in carbon trading are numerous; I believe this is also a form of complicating simple issues for self-amusement and a way to fleece people.) Kyoto Protocol:

The Kyoto Protocol is a supplementary agreement to the United Nations Framework Convention on Climate Change (UNFCCC). It was established at the third meeting of the parties to the UNFCCC held in Kyoto, Japan, in December 1997. Its goal is to "stabilize greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system."

The first commitment period was from 2008 to 2012, and the second commitment period was from 2012 to 2020. The second phase renewal required approval from 144 contracting parties (three-quarters of the 192 countries), but ultimately only 136 countries signed it.

Paris Agreement:

The Paris Agreement is a climate agreement adopted by 195 member states of the United Nations (including observer states Palestine and the Holy See) on December 12, 2015, during the 2015 United Nations Climate Conference; it replaces the Kyoto Protocol and aims to jointly curb global warming trends.

EU Emissions Trading System (EUETS): is a cornerstone of the EU's climate change policy and a key tool for reducing greenhouse gas emissions in a cost-effective manner. This system is the world's first major and largest carbon emissions trading market. EUETS operates on the principle of "cap and trade."

Cap and Trade:

The total emissions of certain greenhouse gases from facilities covered by the EU Emissions Trading System have an upper limit. This limit decreases over time, thereby reducing total emissions.

Within this limit, companies purchase or receive emission allowances and can trade these allowances among themselves as needed. They can also purchase international credits from emission reduction projects worldwide. The total limit on emission allowances ensures the value of the allowances.

At the end of each year, companies must surrender enough allowances to cover all their emissions; otherwise, they will face hefty fines. If a company reduces its emissions, it can save the remaining allowances for future use or sell them to another company that lacks allowances. In December 1997, the Kyoto Protocol was adopted at the third meeting of the parties to the United Nations Framework Convention on Climate Change held in Kyoto, Japan, aiming to limit greenhouse gas emissions from developed countries to curb global warming.

The Kyoto Protocol requires approval from at least 55 countries that account for over 55% of global greenhouse gas emissions to become a legally binding international treaty. It officially takes effect 90 days after signing.

Viewing the Kyoto Protocol as a treasure, activating its skills is conditional; if the conditions are not met, it cannot be activated. The Kyoto Protocol is a top-down agreement. The core of the agreement, and all subsequent plans, is based on a total target: 39 industrialized countries must reduce their greenhouse gas emissions by 5.2% from 1990 levels between 2008 and 2012. The reduction targets for EU countries are 8%, the US is 7%, and Japan is 6%.

The first step is that the Kyoto Protocol allocates Assigned Amount Units (AAUs) to each country, allowing developed countries to trade AAUs among themselves. The loophole in this step is that Eastern European countries, represented by Russia and Ukraine, due to economic recession and industrial decline, do not need to take any emission reduction measures, as their carbon emissions are already declining.

Using today's terminology, because Eastern European countries have already peaked in carbon emissions, the result of issuing quotas based on historical methods is that these countries can profit by selling AAUs at low prices to countries that have not yet peaked, such as the EU. There is a specific term to describe this type of issue: hot air.

The second step is how AAUs are allocated to different industries within countries. Early on, due to a lack of historical data on carbon emissions, no one knew how to allocate them. So how to solve this?

In the first and second phases of EUETS, a bottom-up approach was adopted: all EU member states decided on the allocation of emission allowances themselves. At that time, the National Allocation Plans (NAPs) were used for calculation and submission. NAPs are based on each country's level, meaning the total allocation from all countries equals the EU's cap.

The result of self-declaration is that the allocation amount exceeds the emission amount, making the allowance price worthless, akin to air coins crashing to the floor, and the already fragile consensus collapses even faster. People quickly realized that this self-declaration method had no future, and ultimately EUETS decided to abolish NAPs in favor of National Implementation Measures (NIMs) established at the EU level to determine how many allowances each participating company would ultimately receive. The historical method (grandfathering) is also rarely used now, as there is enough historical data after so many years. Allowance allocations are determined based on continuously iterated benchmark methods.

In the third step, when companies fulfill their emission reduction obligations, they can use allowances and also utilize project-based offset credits (carbon credits).

CERs: Certified Emission Reductions (CERs) refer to the emission reduction indicators obtained from an approved CDM project, which involves collecting, measuring, certifying, and issuing one ton of carbon.

The use of CERs and ERUs in the first and second phases of EUETS was limited to about 10%, with slightly different usage standards set by each country. By the third phase, EUETS only accepted CER projects from Least Developed Countries (LDCs).

There are dozens of types of CDM projects, but most are concentrated in six areas: wind and solar power, biomass energy, hydropower, landfill gas power generation, energy efficiency improvements, and fuel substitution.

This paragraph may seem unrelated, but there exists a huge arbitrage opportunity within it, and ultimately East Asians directly broke the market, leading to the third phase only accepting LDC CERs as a patch.

Image source: World Bank. Mapping carbon pricing initiatives 2013

There are many different versions of explanations for the historical price trends of EUA and CER.

When I was struggling with my thesis, I studied for a long time and couldn't see the relationship between price and fundamentals; intuitively, price seems more related to liquidity. Now that I am an old investor, I am even more convinced that liquidity is the parent of risk assets.

When EUA was first listed, the price was high, similar to the current hype around new listings; no one knew what was being hyped first. As the financial crisis turned into the European debt crisis, asset prices naturally collapsed. Although many academic papers explain this collapse as being caused by an oversupply of allowances and changes in trading rules. Subsequently, the price of EUA stabilized around 10 euros. However, in the distant East, East Asians with new energy projects realized they could apply to register their projects and, once approved, could obtain a large number of CERs, with the price of CERs around 5 euros/ton CO2 at that time. A small project could produce 10,000 to 20,000 tons annually, a medium project could produce 60,000 to 80,000 tons, and a large project could produce over 100,000 tons annually. For project owners, this was an additional income; obtaining CERs only required some expenses for certification and application. (Alen: This is akin to a DeFi project in the crypto space being found to have contract vulnerabilities, leading to a mining disaster; a typical example is YAM, where the vulnerability could cause an additional issuance of 10^18 YAM during elastic supply, ultimately leading the project team to declare: we failed.) Subsequently, the CER output from the Chinese region surged, with the time required for CDM projects from registration to first issuance increasing from 500-600 days (in 2009) to over 800 days (in 2011).

The price of CERs also progressed towards zero under the nearly infinite supply from East Asians.

I remember Alen telling me he participated in YAM and then said it went to zero a few days later, followed by a 2.0 version.

I recall a related report stating: YAM caused a loss of $760,000. What a huge loss.

I want to complain that if EUETS had known that they could patch things up with such a small amount of money, the mess caused by CER wouldn't have been so significant. The amounts involved and the number of participants would have been much greater.

Regardless, this small episode with CER in 2011 allowed Europe and America to witness the wool-pulling power of East Asians for the first time.

After introducing my favorite little episode, let me explain why the Kyoto Protocol failed and why it was replaced by the Paris Agreement.

From 1997 to 2005, the Kyoto Protocol was generally harmonious, and participants were quite active. However, as actual energy-saving and emission-reduction efforts began, discordant voices emerged.

In March 2001, George W. Bush announced the unilateral withdrawal from the Kyoto Protocol, citing "reducing greenhouse gas emissions would impact the economic development of the United States" and "developing countries should also bear emission reduction obligations." The first part is easy to understand; the second part implies that China, as the second-largest emitter of greenhouse gases at the time, should not claim to be a developing country and avoid participation in the Kyoto Protocol. To put it bluntly, unless China participates, the US won't play.

However, as the largest emitter at the time, if the US withdrew, the Kyoto Protocol's activation conditions requiring 55% would turn gray. Thus, the EU persuaded Russia to participate to prevent the Kyoto Protocol from collapsing due to the US withdrawal.

Ultimately, Russia approved the Kyoto Protocol in 2004, and 90 days later, the Kyoto Protocol met the activation conditions again.

By 2005, participating countries still had faith. However, with the 2008 financial crisis and European debt crisis, when people couldn't even afford to eat, naturally, there was no faith in environmental protection…

Every climate conference negotiation from 2008 to 2012 aimed to renew the Kyoto Protocol for a second phase. Participating countries aimed to raise their emission reduction targets while trying to persuade China and the US to join. Each year's climate conference followed the same script, with representatives from island nations most affected by rising sea levels delivering tearful speeches, and representatives from African countries stating, "I participated, but where is the promised technological and financial support from developed countries?" The response from developed countries can be described using a popular term of the time: "ten moves, then refusal." Developed countries were very moved, and then refused to renew the second phase of the Kyoto Protocol.

After years of back-and-forth, we arrived at the first year of the second phase of the Kyoto Protocol in 2013. At this point, Russia announced its withdrawal because China and the US were not participating. Countries like Japan, New Zealand, and Canada also announced their withdrawal. Ultimately, the greenhouse gas emissions of the contracting parties of the second phase of the Kyoto Protocol accounted for only 15% of the global total. However, agreements are dead, and people are alive. Ultimately, through direct amendments to the activation conditions, the Kyoto Protocol was forcibly salvaged.

In the end, everyone realized that pursuing a top-down mandatory climate agreement had no future; setting activation conditions ultimately led to self-destruction. Thus, the bottom-up, voluntary Paris Climate Agreement emerged.

Unlike the Kyoto Protocol, which aimed for legal binding force from the outset, the Paris Climate Agreement resembles a new blockchain project that looks interesting; it has no top-down national climate goals and no mandatory requirements. The Paris Climate Agreement only provides a broader framework for action, allowing countries to voluntarily commit to emission reductions and to enhance their commitments every five years.

The Paris Agreement is one where you participate if you believe (let's go!), and if you don't believe, you don't participate (no go), completely voluntary.

Why does the Paris Agreement seem to be gaining strength recently? Because the whales have rushed in, bringing their calls to action.

*** (Alen: It sounds like environmental protection is a public chain, and carbon taxes are like gas on that public chain. The Kyoto Protocol is a more centralized alliance chain with some mandatory lock-up requirements, which ultimately failed due to various nodes having ulterior motives and various issuance bugs. Thus, a more decentralized public chain 2.0 version, the Paris Agreement, emerged, which, lacking mandatory lock-up requirements, instead spurred various nodes to sit down due to their economic and political demands, thus thriving.) ***

Carbon neutrality by 2060! Japan: I will achieve neutrality by 2050! South Korea: 2050+1! Alen: What improvements are needed to truly achieve carbon trading? Iris: Many people think that China's carbon trading market just started this year. There is a significant misconception here; China has been piloting carbon trading markets since 2013, with a total of seven pilot areas: Beijing, Shanghai, Guangzhou, Shenzhen, Tianjin, Hubei, and Chongqing.

Although the carbon trading market being established this year is said to be national, in reality, only national power companies are participating. Other industrial sectors, such as cement, steel, and electrolytic aluminum, are only planned to be included, and the timeline for inclusion has not yet been announced.

As for why only power companies are participating, one realistic explanation is that maintaining a reasonable IRR for photovoltaic and wind power projects requires selling CCERs as a new source of income.

China's carbon trading market essentially replicates the EUETS, trading in allowances and CCERs (Chinese Certified Emission Reduction). Initially, allowances were primarily allocated for free. From the name, it is evident that CCER fully inherits the name of CER from back then. The gap in allowances for power companies is about 5%, and the usage limit for CCERs is also 5%.

The current issues in the carbon trading system are very apparent, with significant loopholes in the methodology (pricing system and standards).

These loopholes have not gone unnoticed; at the macro level, former central bank governor Zhou Xiaochuan recently hinted at the difficulties in determining total targets.

At the micro level, loopholes have been continuously exposed since the pilot period began in 2013: for example, in the power sector, employees of power companies do not understand carbon trading, and their job responsibilities are limited to compliance. Therefore, during the data submission phase, this data may not be actual measurements but rather default values. The third-party verification agencies' checks on the data are almost nominal.

These loopholes, viewed positively, can be patched up gradually, but this requires time and substantial human and material resources.

Negatively speaking, the extent of these loopholes equates to having a backdoor. This backdoor leaves a significant operational space, and how the final numbers are calculated could be very artistic.

Putting all data on the blockchain can solve some of the trust issues regarding data. Additionally, because carbon trading itself is a low-frequency transaction, the trading volume typically only significantly increases as compliance deadlines approach, while the trading volume is low at other times. These characteristics align well with the current limitations of blockchain, which can only support low throughput. Alen has shown me several projects in the crypto space that claim to be related to carbon neutrality; my impression after reviewing them is: as expected in the crypto space, they quickly discovered the greatest weapon of establishing their own standards. Those involved in environmental protection and the secondary market have yet to address this issue, perhaps out of fear.

Another significant problem is that the penalties for non-compliant companies are nearly nonexistent. EUETS imposes a fine of 100 euros per ton of CO2 for non-compliance. Some carbon trading pilots in China have tried fines that are 3-5 times the market price; with carbon prices around 40 yuan per ton, fines would be around 100-200 yuan per ton.

The weak penalty strength is not the only issue; fines essentially set a price ceiling for the air coin that needs to be speculated on. With such a low ceiling, the price naturally remains low. A low price means a weak consensus; this is the harsh reality.

Alen: The more I listen, the more I feel that carbon trading is somewhat similar to the crypto space. What similarities do you see? Iris: In the crypto space, consensus leads to price. In carbon trading, the reverse is true; price leads to consensus. (Alen: Actually, the crypto space is also… no one can escape the temptation of three bullish candles.)

Both started with very few believers, but as prices rise, more and more people believe, and the logic keeps emerging as prices increase.

However, from an observer's perspective, environmental protection is still environmental protection, and Bitcoin is still Bitcoin; there is not much difference now compared to ten years ago, but the prices and people's perceptions of them have changed dramatically. The theoretical flaws of environmental protection or controlling greenhouse gas emissions have not changed; only people's hearts have changed.

Skeptics will still refer to the graph showing changes in carbon dioxide concentration since the Cambrian period, will attack Al Gore's motives for making "An Inconvenient Truth," and will argue that water vapor has a far greater impact on warming than carbon dioxide.

Bitcoin has not changed since its creation, but people's views have changed. Whether skeptics or hodlers, they still repeat the same clichés.

A new consensus, of course, relies on early users' experiences, but it also needs to consider the historical process. (Laughs) I don't know what carbon trading and the crypto space will ultimately become, but one thing is certain: more and more people are getting involved.