The CBL Nature Based Carbon Offset index has performed in line with the S&P 500 over the past month. While a loss of 9% in a quarter is far from ideal, the asset class has avoided the tremendous volatility seen in tech and crypto.
At Flowcarbon, we believe the carbon market is poised for tremendous growth over the next decade and think the power of web3 can unlock its full potential. We are not the first to recognize this opportunity, but we believe our approach to building it is particularly strategic.
Let’s look at the performance of existing on-chain carbon assets over the same time period.
Why are we seeing this divergence in price performance between on- and off-chain carbon. The answer is relatively simple: the markets are fundamentally disconnected. If I am a holder of an on-chain carbon credit, there is currently no way for me to take my credit to the off-chain market. Currently, there is no way to arbitrage, or profit off a difference in prices of the same asset in different markets, on- and off-chain carbon credits. Arbitrage is a critical function that keeps prices consistent across markets.
To illustrate this point, let’s take the example of USDC. USDC is a stablecoin backed one-to-one with US dollars held in US financial institutions. At any point, a holder of USDC can exchange their USDC for one real US dollar. Let’s say that the price of USDC briefly drops to $0.99. People purchase the USDC on an exchange for $0.99, take it to Circle and trade that USDC for one real US dollar, obviously worth $1.00. In this instance, the trader made $0.01 on every USDC he was able to purchase at $0.99. If enough people take advantage of this price discrepancy, the demand for USDC will rise and the price of USDC will return to $1.00. In effect, Circle has created a two-way bridge that allows users to take a dollar on- and off-chain at will, ensuring that the two assets will always return to the same price.
Flowcarbon is building a two-way bridge to connect the on- and off-chain carbon markets. Holders of off-chain carbon credits can request to tokenize their credits and bring them on-chain. The off-chain credits are transferred to a bankruptcy removal vehicle and remain there unretired, retaining their full off-chain value. Tokenized carbon credits are sent to the provider of off-chain carbon credits. These tokenized carbon credits can be bundled, retired on-chain or redeemed for the off-chain credit.
Let’s take a look at an example of the power of our two-way carbon bridge. Sarah bought 100 nature-based carbon credits off-chain for $12 a piece. She notices that Flowcarbon’s Goddess Nature Token (GNT) is currently trading for $15. She uses the bridge to tokenize her carbon credits, pays the tokenization fee (2% of credits) and immediately bundles her tokenized credits into GNT. So now she has 98 on-chain credits in the form of GNT. At $15 a piece, this gives her holdings a total value of $1,470 (98 x $15). This is a significant gain compared to the off-chain value of her tokens which was $1200 (100 x $12). A few months later, Sarah sees that off-chain nature-based credits are trading at $17.50, but GNT is trading for $16. She decides to redeem her GNT tokens for the underlying credits to take advantage of the price difference. Again she uses the bridge, pays the tokenization fee (again 2% of credits) and receives back the off-chain credits. Now she has 96 credits worth a total of $1,680, compared to the $1,568 (98 x $16) her credits were worth on chain. Sarah and her friends will continue to take advantage of these arbitrage opportunities until the price of on- and off-chain carbon levelize and the opportunity no longer exists.
In the context of today’s volatility, we believe our two-way bridge is a critical piece of market infrastructure. It gives crypto investors access to a token backed by a real-world asset and gives traditional carbon investors access to the liquidity of decentralized finance without the need to sacrifice their off-chain value. Web3 can help address many of the pain points of today’s voluntary carbon market, but a disconnected on- and off-chain carbon market is of no use to anyone. These markets must grow together, and we believe that our two-way bridge is the tool to make that happen.
