I. What is a Carbon Credit?
A carbon credit is a tradable certificate or permit that represents the reduction or removal of one metric ton of carbon dioxide (CO₂) or an equivalent amount of another greenhouse gas (GHG) from the atmosphere. It is a main instrument in global efforts to mitigate climate change, by giving a financial value to emissions reductions.
There are two main markets for carbon credits:
- Compliance markets, regulated by governments (e.g. the EU Emissions Trading System).
- Voluntary carbon markets (VCM), where companies, organisations, or individuals buy credits voluntarily to offset their emissions.
These credits are generated through projects that avoid or reduce emissions, such as: Renewable energy projects (wind, solar), Reforestation or afforestation, Methane capture from landfills or even Energy efficiency improvements. When a company buys and retires a carbon credit, it claims that it has offset one ton of its own emissions.
Why do carbon credits matter ?
Carbon credits are used by organisations to:
→ Meet regulatory requirements (in compliance markets).
→ Offset unavoidable emissions as part of their climate strategies or sustainability goals.
→ Support climate action in developing countries or regions lacking resources.
However, the effectiveness of carbon credits is often debated due to the quality and permanence of projects, heavy risks of double-counting and in general a lack of standardised verification in some voluntary markets.
II. What is tokenization of carbon credit (opportunities and issues):
The transition to a low-carbon economy requires scalable, efficient mechanisms for monitoring, reporting, and verifying emissions reductions. Carbon credits, representing certified emissions reductions, have emerged as tradable instruments to incentivize climate-friendly projects. Yet, traditional markets for these credits face challenges such as double-counting, lack of standardization, and limited accessibility.
Tokenization—the process of converting real-world assets into digital tokens on a blockchain—offers a promising solution. By embedding metadata into blockchain-based tokens, carbon credits become traceable, divisible, and easier to transact.
Previous studies have explored the shortcomings of traditional carbon markets, including administrative bottlenecks and lack of trust in verification processes. Emerging research on blockchain’s application in environmental markets highlights benefits such as enhanced traceability and real-time auditing. However, scholars also warn of new risks introduced by technological innovation, particularly around governance and interoperability. This dissertation synthesizes these discussions to establish a foundation for the analysis that follows.
Opportunities in Carbon Credit Tokenization:
- Enhanced Transparency and Trust Blockchain’s immutable and decentralized ledger ensures each tokenized carbon credit is permanently recorded with detailed provenance. Metadata about project type, geographic location, verification agencies, and emission volumes can be encoded into smart contracts. This significantly mitigates risks of fraud, double-counting, and misrepresentation. Transparency engenders stakeholder trust, a critical ingredient for scaling voluntary and compliance carbon markets.
- Increased Market Liquidity Tokenization allows carbon credits to be fractionalized, thereby reducing barriers to entry for retail investors and small businesses. Blockchain-enabled platforms operate around the clock and typically incur lower transaction costs compared to traditional exchanges. This democratization expands market participation, potentially improving price discovery and stimulating demand for high-quality carbon credits.
- Operational Efficiency Smart contracts—self-executing code deployed on blockchain—automate key processes such as issuance, transfer, and retirement of credits. This reduces administrative overhead and human error. For example, a renewable energy project may trigger automatic token issuance upon third-party verification of emissions reductions, eliminating delays associated with manual auditing.
- Development of New Financial Instruments Tokenized credits can be integrated into decentralized finance (DeFi) ecosystems. These tokens may serve as collateral for loans, be staked for passive returns, or bundled into sustainability-linked financial products. Such innovation expands financing options for carbon-reducing projects and provides novel opportunities for investors interested in environmental assets.
- Global Accessibility and Inclusion Blockchain’s borderless nature removes geographical constraints, enabling direct trading between stakeholders worldwide. Projects based in developing countries can list their carbon credits on global platforms, attracting international buyers without relying on intermediaries. This increased accessibility could unlock funding for underrepresented communities and amplify the socio-economic benefits of climate projects.
- Impact Investing Potential Tokenized carbon credits can be directly linked to measurable environmental outcomes. Investors are able to track the tangible impacts of their investments—such as acres reforested or megawatts of clean energy generated—thereby aligning financial returns with sustainability goals. This transparency may foster greater corporate engagement in offsetting and net-zero initiatives.
Key Challenges and Risks:
- Regulatory Uncertainty and Risks: The absence of harmonized regulatory frameworks across jurisdictions poses significant compliance risks. Carbon credit tokens may be classified as securities, commodities, or utility tokens depending on local laws, creating ambiguity for issuers and market participants. Regulatory fragmentation could hinder the development of a cohesive global marketplace.
- Technical Vulnerabilities:
- Smart Contract Flaws: Coding errors in smart contracts can cause unintended financial losses or operational failures. Once deployed, these contracts are difficult to amend, raising concerns about their resilience.
- Cybersecurity Threats: While blockchains offer enhanced security, they remain susceptible to hacking, phishing, and denial-of-service attacks.
- Interoperability Issues: The proliferation of different blockchain standards and platforms creates silos, preventing seamless integration and trading of carbon tokens across systems.
- Market Risks:
- Price Volatility: Speculative trading may introduce significant fluctuations in token prices, undermining their utility as reliable instruments for offsetting emissions.
- Greenwashing Concerns: Poor-quality projects may issue tokens with inflated claims of emissions reductions. Without stringent verification, such practices can erode market confidence.
- Environmental Trade-Offs: Blockchain’s energy consumption—particularly in systems using Proof-of-Work consensus—may conflict with the sustainability objectives of carbon markets. Although many platforms are transitioning to energy-efficient alternatives like Proof-of-Stake, the environmental footprint of blockchain remains a concern.
Ethical and Social Concerns: Tokenization may favor projects that are easily quantifiable, such as monoculture plantations, over complex yet ecologically superior initiatives like biodiversity restoration. This could distort investment flows and marginalize holistic environmental solutions.
III. A case study: What is Toucan Protocol?
Toucan Protocol is a project launched in late 2021 and is a blockchain-based solution to modernize and facilitate the voluntary carbon market. Founded in 2020 and launched on the Polygon network (an Ethereum-compatible blockchain) in October 2021, Toucan’s goal is to enhance scalability of climate change, through blockchain, by bringing carbon credits onto public ledger. The traditional carbon credit system often faced criticism regarding its organization or its inefficient and opaque price signal system. Toucan’s goal is therefore to inject transparency, liquidity and accessibility into this market.
In practice, Toucan is an infrastructure for tokenizing real-world carbon credit: it connects to existing carbon registries and converts certified credits into digital tokens that can be traded or used in DeFi applications. Toucan Protocol is thus positioning itself on the emerging ReFi movement (or Regenerative Finance), which applies crypto tools to fund climate solutions.
Toucan’s role in the tokenization of carbon credits became apparent soon after launch. In late 2021, the protocol partnered with KlimaDAO (a climate-focused crypto initiative that aims to spur uptake of tokenized carbon credits). This collaboration led to a rapid influx of credits being brought on-chain. More than 20 millions of carbon credits were being bridged into Toucan’s system, in just a few weeks, demonstrating the appetite for a more liquid and open carbon market. Toucan essentially provided the “rails” for converting traditional carbon offsets into digital assets: project developers or holders of carbon credits could retire them in an official registry and then receive tokenized carbon credits on Toucan’s platform. These tokens could then be traded globally, 24/7, by anyone with an internet connection. The end result is a two-tier token system that acts as an index, providing instant liquidity and price discovery for the carbon market.
How does it, concretely, work?
Toucan’s protocol is built around smart contract technology and runs primarily on Polygon, a scalable blockchain that is interoperable with Ethereum. At its core, Toucan’s system “bridges” real carbon credits onto the blockchain through a multi-step process:
– First, a carbon credit from a recognized registry (such as Verra’s Verified Carbon Unit, VCU) is permanently retired from the traditional registry. This retirement is crucial to avoid double counting: once a credit is tokenized via Toucan, it cannot also be sold or used elsewhere in the real world.
– After retirement, Toucan’s infrastructure issues a unique digital token representing that specific credit on-chain. Each retired credit yields an ERC-20 token often called a TCO2 token, which stands for a tokenized tone of CO2. The TCO2 token retains all the important metadata of the original credit (project ID, methodology, country, and vintage year). This means anyone can inspect the token’s details and verify the credit’s origin and attributes, a level of transparency difficult to achieve in legacy systems.
– Once carbon credits are represented as TCO2 tokens, they can be freely traded, transferred, or even retired on-chain to offset emissions in a public and traceable way.
NB: Adressing the issue of liquidity.
One challenge is that each TCO2 corresponds to a specific project and vintage, making the market fragmented and threatening liquidity. Toucan’s answer to this is the creation of Carbon Pools, which are liquidity pools that bundle different TCO2 tokens meeting a certain set of criteria. For example, Toucan’s first carbon pool was the Base Carbon Tonne (BCT), a fungible token that represents a generic basket of carbon credits. Users can deposit eligible TCO2 tokens into the BCT pool, and in return mint an equivalent number of BCT tokens. Each BCT token is backed by a 1:1 rule, by an underlying tone of carbon from the pool. As all pool tokens are interchangeable, it creates a strong liquidity on the market, (the BCT pool had a simple quality criterion: it accepted credits from various projects as long as the credit’s vintage was within the past 10 years). Toucan later introduced another pool called NCT (Nature Carbon Tonne) with stricter criteria (only nature-based credits of newer vintages) to improve quality standards. It is through smart contracts that the mint and burn system is ensured.
Using Polygon blockchain enables transactions with low fees and fast confirmation times, which is important for practical use at scale. All token transactions and credit metadata live on a public ledger, enabling independent verification and audits by anyone. Toucan also introduced an Open Climate Registry, a public database that aggregates information on all tokenized credits, to ensure transparency and prevent data silos across different standards. In summary, Toucan Protocol works by combining the rigor of carbon accounting with the flexibility of blockchain tokens, thereby bringing the voluntary carbon market on-chain in a secure and transparent manner.
A few metrics to understand Toucan’s Impact.
Since its launch, Toucan Protocol has achieved notable scale in the tokenized carbon market, with data indicating its dominant market share and growing ecosystem:
– Between October 2021 and may 2022, 22 million Verra-issued credits have been bridged on-chain, which represents around 4% of all issued credits.
– These tokenized credits came from more than 50 different carbon projects from all around the world.
– On the demand side, thousands of crypto users and several specialized organizations participated in Toucan’s carbon market. KlimaDAO, which is the original partner of Toucan Protocol, accumulated a treasury of more than 17.5 million tons of carbon (as of 2023 data).
– Toucan’s cumulative trading volume exceeded $4 billion in the first year.
What is the Issue with Toucan Protocol?
Toucan Protocol’s indeed offers several pros for the carbon credit market, such as:
– Transparency and traceability,
– Mechanism to avoid double counting,
– Mechanism to ensure liquidity on the market,
– Integration with decentralized Finance,
– Speed and efficiency with a 24/7 open market offering low transactions fees and quick confirmations,
– Scalability for ReFi though an innovative market option.
However, despite its innovations and security mechanism, Toucan Protocol has faced significant limitations and critiques that highlight the challenges of marrying carbon markets with blockchain. The biggest issue being the zombie credits. A zombie credit is a carbon credit from a project that has essentially abandoned its activities, but whose credits are still active on the market. This issue shows the difficulty to assess quality of carbon credit and its effectiveness.
A very striking paragraph to illustrate this point:
“As we pointed out in our original article, 99.9% of BCT’s tokenized credits come from projects that are so old they are ineligible for the international aviation industry’s CORSIA program, and nearly 85% would be ineligible for trading under Article 6 of the United Nations’ Paris Agreement. While we don’t think that CORSIA or the Article 6 rules set a sufficiently high bar for quality, the inadequacy of the BCT credit pool in relation to these much-discussed standards is striking.”
→ A Response to KlimaDAO’s Analysis of Base Carbon Tonne Tokens – CarbonPlan. https://carbonplan.org/blog/klimadao-bct-response.
Such findings suggest that tokenization in itself doesn’t guarantee quality, security or transparency, it only provides a bridge. Toucan did respond by creating pools with tighter criteria (as we saw above with the NCT) and by engaging with initiatives to improve digital credit integrity, but the stigma of poor-quality credits is still sticking to the project.
Another issue has been the difficulty to partner with regulation. Toucan’s rapid success also led to push back from traditional carbon authorities. In May 2022, Verra (the largest credit registry and primary bridge of Toucan) publicly banned the practice of tokenizing its retired credits. The main concern of the entity was the threat of creating a “digital twin” of retired credits (a token continuing to circulate even after the credit was officially used) and that this could create confusion about what retirement means. This highlights a major limitation: the protocol depends on cooperation (or at least tolerance) from credit issuers and regulators. If registries like Verra or Gold Standard disallow third-party tokenization, Toucan’s model cannot work (or needs to be adapted).
Other limitations:
– Market Volatility and Speculation: Introducing carbon credits into the crypto market exposed them to the extreme volatility often seen in digital assets. The speculative frenzy (driven in part by KlimaDAO’s high rewards for bonding carbon tokens) led to a rapid spike in demand for cheap credits, followed by an oversupply once those credits were tokenized. This volatility is problematic for the carbon market: it can distort the price signals for genuine climate action and make it hard for project developers to plan. Moreover, there’s a risk that financial speculators, not end-offset buyers, dominate the market, which might decouple token prices from the actual value of climate impact (just as the traditional carbon credit market experience after its launch).
– Complexity and User Experience: Another practical limitation is the technical complexity of participating in Toucan’s system. For a traditional carbon market participant, the process of using Toucan (setting up blockchain wallets, understanding token mechanics, and handling security of digital assets) can seem complicated, especially when compared to the ease of use offered by traditional players or brokers.
Conclusion: is Toucan Protocol worth it?
Toucan Protocol’s case study shows the progress of DeFi and ReFi and its lessons. It clearly demonstrated that tokenizing carbon credits can increase market transparency and participation, and it created new channels for climate finance via the crypto world. At the same time, it exposed issues around credit quality control, regulatory alignment, and market dynamics that need to be addressed for the approach to fully deliver on its promise. As of 2025, Toucan remains at the forefront of the carbon credit tokenization movement – evolving through partnerships (like the biochar CHAR pool) and collaborating with standards bodies to address the different concerns that we mentioned above.