Jayjit Biswas16 min read·Jan 8, 2024--
Blockchain technology holds significant promise in enhancing Environmental, Social, and Governance (ESG) criteria and carbon credit accounting due to its inherent features of transparency, security, and immutability.
1. Traceability and Transparency: Blockchain allows for a transparent and accessible record of transactions that is ailable to all participants. In the context of ESG, this means that corporations can more reliably record and report on their sustainability initiatives and goals. For example, a company could use blockchain to log its carbon emissions data securely. This would enable stakeholders to trace the company’s environmental impact accurately, and it could be used for sustainability reporting with greater confidence in the data’s integrity.
2. Carbon Credit Accounting: Carbon credits are a key market-based tool to incentivize the reduction of greenhouse gas emissions. The issuance, transfer, and retirement of these credits can be tracked on a blockchain, ensuring that each credit is accounted for and not double-counted, which is crucial for maintaining market integrity. By tokenizing carbon credits on a blockchain, they can easily be traded or exchanged without the risk of fraud or duplication.
3. Smart Contracts for ESG Compliance: Smart contracts are self-executing contracts with the terms of the agreement directly written into lines of code. They can automate ESG-related commitments and transactions. For example, a company looking to offset its emissions can enter into a smart contract which automatically purchases the necessary amount of carbon credits whenever their emissions exceed a certain threshold.
4. Supply Chain Management: For the ‘S’ (Social) and ‘E’ (Environmental) in ESG, blockchain facilitates the ethical sourcing of materials. It provides an auditable trail, ensuring that products are sustainably sourced and comply with labor laws, hence promoting corporate social responsibility.
5. Investor Due Diligence: Investors and regulators increasingly demand transparency and accountability in ESG performance. Blockchain technology’s ability to provide an unalterable and clear record of a company’s ESG-related actions helps in due diligence processes and in the assessment of ESG scores.
6. Security and Verification: The distributed nature of blockchain means that it is resilient against many kinds of fraud and cyber-attacks. This increases the security of ESG and carbon credit data, and also allows for easier third-party verification without giving control of the data to an external party.
Despite these potential benefits, there are also challenges to the implementation of blockchain for ESG and carbon credit accounting:
Technology Understanding and Adoption: Understanding and trusting blockchain technology is a hurdle for many companies and stakeholders. There’s a need for a greater level of education and skills development to harness its benefits.
Energy Consumption: Ironically, the high energy consumption of some blockchain networks, particularly those that rely on proof-of-work (PoW) consensus mechanisms, could itself be an environmental concern. It is vital to use more energy-efficient consensus algorithms like proof-of-stake (PoS).
Data Integrity: While blockchain ensures the integrity of data after it’s been recorded, it doesn’t guarantee the initial accuracy of the data entered onto the blockchain.
Regulatory Framework: As blockchain for ESG and carbon credit accounting is a relatively new concept, there may be a lack of regulatory frameworks governing its application, potentially leading to uncertainty for businesses.
Blockchain technology has the potential to enhance carbon credit accounting through its inherent features of transparency, security, and immutability. Here’s how:
1. Transparency: Blockchain creates a public ledger that is accessible to all participants in the network. This allows for the tracking of carbon credit transactions in real-time, ensuring that companies and individuals can be held accountable for their carbon emissions. Every transaction is recorded and is permanently ailable for verification, which helps prevent double counting of credits and promotes trust in the system.
2. Immutability: Once a transaction is recorded on a blockchain, it cannot be altered or deleted. This immutable record-keeping is crucial for carbon credit accounting since it ensures that once credits are used, they cannot be reused or retroactively changed. This permanence is vital for regulatory compliance and ensures the integrity of the system.
3. Decentralization: Traditional carbon credit accounting systems can be centralized, leading to a single point of failure or potential manipulation. Blockchain operates on a decentralized network, distributing the data across many nodes (computers), which makes it more resistant to tampering and fraud.
4. Smart Contracts: Blockchain platforms can use smart contracts, which are self-executing contracts with the terms of the agreement directly written into code. Smart contracts can automate the issuance, trading, and retiring of carbon credits based on predefined conditions. This can streamline the process, reduce human error, and ensure that compliance requirements are met automatically.
5. Cost Reduction: The use of blockchain can potentially reduce the transaction costs associated with carbon credit trading. By removing intermediaries and simplifying processes through automation, blockchain can make it more affordable for entities to participate in carbon credit markets.
6. Tokenization: Carbon credits can be tokenized on a blockchain, turning them into digital assets that can be easily traded. Tokenization ensures each credit is unique and can be traced back to its origin, facilitating more liquid markets and potentially expanding access to a broader range of buyers and sellers.
7. Integration With IoT: Blockchain can work in tandem with IoT (Internet of Things) devices to provide real-time data about emissions. These IoT devices can monitor and verify carbon offset projects’ performance, and this data can be automatically uploaded to the blockchain, providing an accurate and current data record.
8. Cross-border Transactions: Carbon credit trading often takes place on a global scale. Blockchain supports cross-border payments and transactions without the need for an intermediary or currency conversions, which can be beneficial in the international carbon markets.
By using blockchain for carbon credit accounting, organizations can benefit from increased confidence in the accuracy of carbon reporting, potentially leading to more robust and effective carbon markets. The system’s improved transparency and reliability can help to drive more informed decision-making and investments in sustainable practices and technologies.
Blockchain technology offers a transparent, secure, and efficient way to track carbon credit transactions. Here’s a more detailed explanation of the process:
1. Issuance of Carbon Credits: A carbon credit represents the right to emit a certain amount of carbon dioxide or the equivalent amount of a different greenhouse gas. When a project that reduces, oids, or sequesters emissions is verified by a standard body (like the Verified Carbon Standard or the Gold Standard), it can generate carbon credits. These credits are then serialized to ensure each one is unique and can be tracked.
2. Blockchain as a Ledger: Each carbon credit is represented as a digital token on the blockchain. A blockchain is a decentralized, distributed ledger that records all transactions across a network of computers. It’s like a digital “book” where every page (block) is a list of transactions. Once a page is completed (new block is created), it’s added to the “book” (chain) in a linear, chronological order.
3. Tokenizing Credits: The carbon credits are tokenized, meaning each credit is turned into a digital token that can be easily traded on the blockchain. These tokens follow certain standards, like ERC-20 or ERC-721 on the Ethereum blockchain, which define how they can be traded, transferred, and stored within the network.
4. Smart Contracts: Blockchain platforms use smart contracts, which are self-executing contracts with the terms of the agreement directly written into lines of code. They automate the execution of transactions when predetermined conditions are met, such as the transfer of tokens between parties without the need for an intermediary.
5. Trading: When carbon credits are bought and sold, the transaction is recorded on the blockchain. Each transaction will include information like the buyer’s and seller’s public addresses, the number of carbon credits, the unique serial numbers of the credits, and the timestamp.
6. Transparency and Security: The blockchain records every transaction and makes it viewable to anyone with access to the network, ensuring complete transparency. The records are immutable, meaning once a transaction is entered, it cannot be altered or deleted, which helps prevent fraud and ensures the integrity of the data.
7. Retirement of Credits: Once carbon credits are used (retired) to offset emissions, this transaction is also recorded on the blockchain. Retiring credits ensures they are not resold or claimed by another entity. The information about the retirement includes which emissions were offset and any additional relevant compliance data.
8. Verification and Audibility: Hing carbon credit transactions on a blockchain enables easier and more reliable auditing. Auditors can view the complete history of a credit’s issuance, trades, and retirement without sifting through paperwork or relying on third-party reports.
9. Provenance Tracking: Blockchain can track the origin and the journey of carbon credits, documenting each step. This traceability ensures that credits are not double-counted or falsely claimed and that they originate from legitimate and verified carbon offset projects.
10. Elimination of Intermediaries: With blockchain, the need for middlemen is reduced, which can diminish the risk of manipulation and errors often introduced by human intervention.
11. Standardization: Blockchain platforms can enforce standards for carbon credit issuance, tracking, and retirement, which brings uniformity to the market and helps in preventing the submission of fraudulent or substandard credits.
When it comes to recording carbon credit accounting, both centralized (traditional) and blockchain-based methods he their own sets of advantages and disadvantages. Here are the key differences, along with the pros and cons of each approach:
Centralised (Traditional) Accounting:
Pros and Cons :
Control and Management: Centralised systems are managed by a specific organization or consortium that maintains complete control over the issuance, trading, and retirement of carbon credits. There’s usually one central authority that enforces rules and regulations.Centralized systems are managed by a specific organization or consortium that maintains complete control over the issuance, trading, and retirement of carbon credits. There’s usually one central authority that enforces rules and regulations.
Familiarity: Traditional systems are well-understood, and there is a substantial existing infrastructure and expertise that can be leveraged.
Database: They use traditional databases that are maintained and updated by designated administrators. These databases are usually not accessible to the public, or access is very limited.
Trust: Participants must trust the central authority’s ability to manage the system fairly and accurately, which can expose the system to risks like fraud or mismanagement.
Transparency: While centralised systems can produce reports and audits, the visibility of transactions is often restricted to certain stakeholders, limiting overall transparency. Transactions and audits in centralised systems may be less transparent, which can reduce trust among stakeholders.
Security and Risk: Centralised systems he a single point of failure; if the central system is compromised, the entire network can be at risk. They are also more vulnerable to hacking and fraudulent activities because control is concentrated.
Adjustability: They can be more quickly and easily adjusted by the central authority to changes in regulations or market conditions.
Cost and Speed: Depending on the system, intermediaries may be required, which can increase costs and transaction times.
Ambiguity in Regulatory Compliance and Uniform International Reporting System: Centralised systems can be more easily adapted to meet the regulatory requirements of different jurisdictions. Moreover at present centralised reporting meets the various aspects of different IFRS Accounting standards for carbon credit accounting.
Example: A government-run registry for carbon credits would be centralized. This authority would manage the issuance, transfer, and retirement of credits, maintaining data integrity through oversight and regulation.
As more companies enter into commitments to reduce their carbon emissions or invest in renewable energy, questions about how to account for carbon offsets and credits are becoming more pressing. The complexity and variety of arrangements in rapidly developing voluntary markets is giving rise to questions about how IFRS Accounting Standards apply, often involving more than one standard. Here, we level set on these offsets and credits, and provide some of the key accounting considerations for voluntary markets relevant under IFRS Accounting Standards; plus a comparison to US GAAP.
The accounting for carbon offsets and credits is both an emerging issue and one that has been on the radar of global standard-setters for decades. Mandatory emissions trading schemes are not new, but for companies making net-zero or other emissions commitments, voluntary offsets and credits are often a key driver of their strategy. Where these schemes were historically established to help companies comply with governmental emissions mandates, they are now also a catalyst of growth and innovation, incentivizing companies to develop and implement the latest renewable technology. These schemes vary greatly and their number is growing. This has caused the related accounting issues to reemerge as a high priority.
Although several standard-setting projects he been attempted, there are currently no accounting requirements under IFRS Accounting Standards (or US GAAP) specific to carbon offsets or credits. International Accounting Standards Board (IASB®) attempts over the years were either not finalized or withdrawn. And unlike the Financial Accounting Standards Board (FASB) in the US, the IASB currently has no active project on its agenda. Thus diversity in practice exists as companies seek to apply current accounting guidance to arrangements that are often complex and innovative.
Offsets vs credits vs allowancesBefore considering the proper accounting, it is important to understand the nature of the item being accounted for. Terms are often conflated or undefined — e.g. carbon offsets, renewable energy credits or certificates (RECs), emissions permits or allowances, certified emissions reductions (CERs), environmental credits — and the respective ESG reporting proposals of the International Sustainability Standards Board (ISSB), SEC and the European Financial Reporting Advisory Group (EFRAG) were not aligned. It remains to be seen whether there will be alignment in the final standards.
Historically, the most recognizable term in discussing greenhouse gas (GHG) emissions under IFRS Accounting Standards has been ‘emissions allowances’ in the context of emissions trading schemes (ETSs). One example is a cap and trade scheme in which a company receives allowances that in effect allow it to emit a certain amount of CO2; established markets exist in which companies can sell surplus allowances and/or purchase additional allowances to make up for a deficit. The world’s largest cap and trade scheme is in the EU and covers just over a third of the EU’s GHG emissions. ETSs operate in the US at the state level (e.g. the California Cap-and-Trade Program).
In the context of reducing GHG emissions, the ISSB proposed using the general term ‘carbon offset’, which it defined as: “An emissions unit issued by a carbon crediting programme that represents an emission reduction or removal of a greenhouse gas emission. Carbon offsets are uniquely serialised, issued, tracked and cancelled by means of an electronic registry.”
Examples of emissions reductions include using wind, solar and geothermal energy sources as alternatives to natural gas or coal power plants.Examples of GHG removals include planting forests to absorb GHG emissions and sequestering carbon in underground storage.Reflecting the lack of consistency in practice, as part of its redeliberations the ISSB has decided to use ‘carbon credits’ as the general term, noting feedback that ‘offset’ better described “the application of a carbon credit to an entity’s net emissions.”5 Therefore, the remainder of this article refers to the acquisition or sale of carbon credits.
Accounting for carbon creditsIn the absence of specific guidance on the accounting for carbon credits, and because of the complexity and variety of arrangements beginning to emerge, a critical initial step is to understand the company’s facts and circumstances, and the specific terms and conditions of the credits. There is no one-size-fits-all accounting answer, and a contractual reference to a carbon credit can mean a variety of things — from a separable asset that can be traded to a ‘green’ credential or attribute.
Before analyzing specific fact patterns, a general question often asked is whether carbon credits even meet the definition of a separate asset. An asset is a present economic resource (i.e. a right that has the potential to produce economic benefits) controlled by the company as a result of past events.6
In some cases, it will be obvious that a carbon credit is a separate asset — e.g. a company enters into a transaction to acquire a carbon credit that can be traded on an exchange. In other cases, the answer may be different because the carbon credits are part of a larger transaction or they are immediately retired such that the economic benefits he been consumed, for example.
The possibility of future accounting guidanceUnder IFRS Accounting Standards, the IASB has a project on pollutant pricing mechanisms (e.g. emission trading schemes) on its newly created reserve list. Although identified as a high priority, the IASB concluded there were higher priority projects in the pipeline and the project will only be added to the work plan if capacity becomes ailable before its next five-year agenda consultation in 2026.
In May 2022, the FASB added to its active agenda a project on accounting for environmental credit programs. The Board acknowledged that the current proliferation of markets that trade environmental credits has made the need to provide accounting guidance to program participants a priority. The objective of the Board’s new project is to address the recognition, measurement, presentation and disclosure requirements for participants in compliance and voluntary programs that create environmental credits. The project also includes financial reporting requirements for nongovernmental entities that create environmental credits. We anticipate the Board will continue discussions on this project in coming months.
Key Takeaways:There is a growing voluntary market for carbon credits, with arrangements becoming more complex. At the same time, there is no specific accounting guidance and no consistent terminology that helps identify the nature of a carbon credit in a given situation. Therefore, it is critical to understand the substance of an arrangement as a precursor to determining the appropriate accounting.
Blockchain-Based Accounting:Pros and Cons
Control and Management: Blockchain operates on a decentralized network where no single entity has full control. Instead, it relies on consensus mechanisms among different parties to validate transactions.
Database: The blockchain serves as an immutable ledger that records all transactions chronologically. This ledger is distributed across a network of computers, ensuring that data is not stored in a single location.
Trust: Trust is distributed across the network. With blockchain, the need for trust in a central authority is reduced, as trust is placed in the system’s algorithms and cryptography.
Transparency: All transactions are visible to anyone with access to the blockchain, providing full transparency and the ability to audit transactions in real time. All transactions are publicly verifiable, which can enhance trust and participation from stakeholders.
Security and Risk: The decentralised nature of blockchain reduces the risk of a single point of failure. However, it can be exposed to other risks like 51% attacks or smart contract vulnerabilities. The decentralised nature of blockchain and cryptographic principles make it resistant to tampering.
Adjustability: Modifying a blockchain system can be more complex, as changes often require consensus from the network participants, which can take time and effort to achieve.
Efficiency: By removing intermediaries with smart contracts, blockchain systems can reduce transaction times and costs.
Traceability: Each carbon credit can be traced back to its origin, making the entire life cycle transparent and reducing fraud.
Complexity: Blockchain systems can be complex to set up and require participants to he a certain level of technical understanding.
Scalability: Some blockchain platforms struggle with scalability, leading to potential performance issues as the system grows.
Regulatory Uncertainty: Blockchain is a newer technology, and regulatory frameworks are still under development across many jurisdictions.
Example: A blockchain platform like IBM’s Blockchain Platform or Verra’s registry system that allows for the tokenization of carbon credits. Each credit is recorded on the blockchain from issuance to retirement, offering an immutable and transparent ledger.
In conclusion, blockchain-based accounting offers a revolutionary approach to carbon credit accounting by enhancing transparency and reducing fraud. However, challenges like complexity and regulatory uncertainty remain. Centralized systems provide a more familiar structure with easier regulatory compliance but often at the cost of transparency and potential efficiency losses. Stakeholders must consider their specific needs, ailable infrastructure, regulatory requirements, and the scale of operations when choosing between centralised and blockchain-based accounting for carbon credits.
In essence, the key differences lie in the degree of transparency, trust, control, and security. Blockchain-based systems for carbon credit accounting arguably provide a more transparent and secure approach to managing carbon credit transactions compared to centralized systems, which centralize control and may he limited transparency. However, the choice of system depends on the context, regulatory requirements, and the objectives of the parties involved.
The way forward for blockchain-based solutions in accounting for ESG (Environmental, Social, and Governance) and carbon credits includes:
Standardisation: Establishing global standards for how carbon credits and ESG metrics are recorded on the blockchain will ensure consistency and comparability.
Integration: Ensuring blockchain platforms can interface with existing accounting systems and ESG reporting frameworks to provide a seamless experience.
Verification: Leveraging third-party verification within the blockchain ecosystem to validate the authenticity of ESG data and the origin of carbon credits.
Regulatory Support: Encouraging governments and international bodies to recognise and regulate blockchain-based ESG and carbon credit systems to foster trust and stability.
Education and Adoption: Promoting education about blockchain applications in ESG reporting to increase adoption among businesses and stakeholders.
Technology Innovation: Continuously improving blockchain technology for better scalability, privacy, and reduced energy consumption, which is critical for ESG considerations.
Transparency and Accessibility: Making blockchain platforms user-friendly and the data easily accessible to increase transparency and stakeholder engagement.
Collaboration: Encouraging collaboration between tech providers, businesses, environmental organisations, and regulators to align efforts and goals.
Adopting these approaches will likely lead to greater trust, efficiency, and participation in ESG initiatives and the carbon credit market, fostering a more sustainable global economy.
Overall Blockchain has incremental benefits in Carbon Accounting can be used to track ESG metrics by leveraging its ability to create a secure, transparent, and unchangeable record of data. Here’s how it can work:
Data Recording: ESG-related data, such as energy consumption, emissions data, waste management, labor practices, and corporate governance actions, are recorded on the blockchain.
Smart Contracts: These are used to automatically execute actions when certain ESG-related criteria are met. For example, they can issue certifications or release funds for projects that meet predefined sustainability goals.
Provenance Tracking: Blockchain can track the origin and lifecycle of products to ensure they meet environmental and social standards, beneficial for supply chain transparency and responsible sourcing.
Real-time Reporting: Blockchain enables real-time ESG reporting and monitoring, providing stakeholders with up-to-date information about a company’s sustainability performance.
Transparency and Trust: The data on a blockchain is transparent and can be independently verified, which increases trust among investors, regulators, and the public.
Stakeholder Engagement: Shared data on a blockchain platform allows for multiple stakeholders, including investors, customers, and community members, to access and analyse ESG metrics.
Reducing Fraud and Error: Blockchain’s immutability means that once an ESG metric is recorded, it cannot be altered or removed, reducing the risk of fraudulent reporting.
Conclusion:
In conclusion, blockchain technology has the potential to significantly enhance ESG initiatives and transform carbon credit accounting, making these processes more reliable, efficient, and transparent. However, careful consideration of challenges, broader ecosystem readiness, and refinement of the technology and surrounding regulations are essential for realizing this potential. The utilization of blockchain for ESG metrics is a developing field, and integrating it with existing reporting systems and standards is crucial for widespread adoption.
Blockchain’s ability to provide an immutable, transparent record of carbon credit transactions helps to build trust in the system and ensures that double counting (claiming the same credit more than once) is minimized. This can enhance the effectiveness of carbon markets and help in the fight against climate change by ensuring that carbon offsetting is accurately and reliably accounted for.
When integrating these characteristics, blockchain technology greatly enhances the integrity and efficiency of carbon credit markets, making it easier for participants to track, trade, and ensure the quality of carbon credits.
Disclaimer : The views expressed herein is fully of the author who is founder of Elite Web3 Forum and can be reached through his socials
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