In macro, one very important aspect is velocity of money. Calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock, it shows the number of times $1 is used to create $1 of GDP.
All the money printing aside, in the real economy, higher velocity = good as the same dollar changes hands more frequently and there is more activity, meaning more GDP. Low velocity is generally bad because there is less economic activity and GDP shrinks.
This post aims to analyze Klima DAO’s dynamics from a macro perspective using velocity of money.
Why is this metric important for $Klima? Because it aims to establish itself as a carbon-backed on-chain currency.
The main properties of currencies are:
- Unit of Account (Achieved): $Klima = 1 carbon credit (= 1 ton CO2e)
- Medium of Exchange (Getting there): $Klima needs to have utility and be actively tradable
- Store of Value (Mostly achieved): $Klima needs to act like an asset and have intrinsic value
Velocity affects both the MoE and SoV properties in different ways. In order to assess the potential of $Klima as utility and saving instrument, we need to start with the market.
Carbon market expansion
Let’s define the carbon GDP as the total market size of the voluntary market today. Specifically, the goal is for the on-chain carbon GDP to one day absorb most or all of the global voluntary carbon market by offering a better and more efficient marketplace, tools and UX for participants.
In order to achieve the 1.5 degree Celsius goal, humans will need to decrease the current emissions by at least 35 gigatons CO2e by 2050 (25 gigatons by 2030). I’ve used the chart below by McKinsey to showcase this before:
What does this mean exactly? If you could wave a magic wand and invent a giant CO2 sucking machine, large enough to capture 25 Gtn in 2030, would that work?
Yes, that would work. However, this is not an aggregated number, it is per year. In 2031, we would need to capture another 25 Gtn (or more) if the current emissions stay unchanged. You can view this giant machine as a “proxy” for all carbon removal tech that can be done — direct air capture, new trees, soil capture, methane capture, etc.
We need removals, which are better than avoided emissions. To illustrate, if we were to avoid the same 25 Gtn, it would mean that we are preventing new emissions from happening, but we would remain at the current level.
Hence, removals. This is why they are so much more expensive than avoidance credits. The issue is that removals are still a very small part of the already small overall voluntary market.
Are avoided emissions / removals sufficient?
No, we also need to reduce existing emissions organically. These are all the things you hear every day like replace gasoline cars with electric, replace your lightbulbs with LED, switch to renewable energy, make buildings more energy efficient etc.
The hope is that with the decarbonization efforts across industries, the current 40+ Gtn emission levels will decrease. However, we can’t really expect miracles (even the “business as usual” line on the chart even shows that not much is expected to change even by 2050). There will be a level of emissions (hopefully lower) that sustains normal life for the global population.
To reduce the rest, we need carbon offsets (the inorganic way of doing it).
As an order of priority, first avoided emissions (readily available), then removals (as they scale, desperately needed) and all the while decarbonization.
The market are avoided emissions / removals.
Let’s assume that the market size in 2030 is 25 Gtn per year. In other words, 25 billion carbon credits. If prices increase to $50/tn on average, this becomes a $1.25 trillion (potential) market. Some outlets estimate prices at between $40–$120 so it could even double.
Currently, we are at 0.2Gtn (200 million tons). I am using the retired number of credits in 2021 as we don’t need carbon credits to just change hands, we need it to be “used” (as in destroyed after it has been captured). At avg. prices of $5, this is a $1 billion market in 2021.
We have a potential 115x increase in volume and 1,250x in $ size.
The 115x is the supply of credits. We need this to happen, we can’t stay at the current low levels. I have previously written about 50x growth by 2030, but this may prove conservative.
However, when you increase the supply of something by 115x, its price tends to go down, unless demand outweighs supply. We have three challenges:
1/ Demand needs to at least match supply growth.
2/ Demand actually needs to significantly outpace supply in order for prices to increase 5x-10x.
3/ Carbon credits need to be commoditized in order to be widely traded.
Point 3 is being addressed by bridges like Toucan, Flow and Moss via their carbon pools.
In this market, supply tends to follow demand, often with some lag. The primary carbon GDP factors (volume AND price growth) are both demand driven.
If demand only grows by 5x (instead of 115x), then we will only get some supply growth and likely limited price increase.
Why do we need prices to increase, wouldn’t that hurt everyone?
1/ We actually need high prices so that companies have an incentive to decarbonize organically (the “feel the pain” argument).
2/ Many of the carbon removal technologies are either too early or don’t exist yet. The ones that do are prototypes and require very high purchase prices (50x-200x higher than average prices) in order to sustain.
The high prices are typically paid by a very limited number of large corporations like Microsoft, Stripe, Swiss Re etc. It’s like “VC” funding until the tech scales, supply increases leading to a gradual price decrease.
A good analogy are the renewable price subsidies in many countries over the last 10 years which were many times higher than traditional power generation. These were needed so that the tech and production capacity could be built out. Ultimately, prices decreased enough and many renewables can operate at market prices.
Knowing the carbon GDP size we need, back to the role of Klima.
Who would win in a fight — a horse sized duck, or 100 duck sized horses?
In other words, would you rather have 100mn tons with velocity of 1 or 10mn with velocity of 10. In macro, the dollars that are not being spent creating GDP are used for savings.
1/ Accumulates carbon in the treasury that won’t move around (long term savings), leading to an expansion of the carbon monetary base.
2/ Makes markets in carbon assets via the Liquidity Pools (short term spending).
The above features allow $Klima to be used both as a Store of Value (asset) and Unit of Exchange (currency). Both are necessary for the long-term goals.
The trade off between spending and saving is captured by velocity.
Velocity of tokenized carbon
A few definitions:
- tCarbon = BCT, MCO2 and any other tokenized carbon credit representing 1 ton CO2e.
- tCarbon “uses”: trading, bonding, lending, borrowing, burning, permanent locking (one-way embedding into things like NFTs, similar to burning).
- Carbon Velocity = number of times 1 tCarbon is used (“spent”) in the carbon GDP, eg. BCT trading volume / total BCT owned or in existence.
Here is BCT’s velocity vs Total Treasury Carbon (the total monetary base, your M2 equivalent)
And here is BCT’s vs LP carbon assets (the tradable monetary base = your M1 equivalent)
For a broad (but not ideal) reference, the USD velocity has been ca 1.8x until 2010 when the monetary base expansion started and is currently just >1x.
For BCT, this has been only 3 months so quite early to draw any conclusions, other that it has remained relatively stable over the past month.
Higher velocity = more transactions are occurring between participants in the on-chain carbon economy.
To have a large impact, Klima needs both a strongly expanding market (= high velocity) AND to lock away supply in order to increase prices (= low velocity).
If there is more demand for $Klima, it would mean more demand for BCT and its price should increase. More BCT demand would bring with it more supply, pushing its price down, but by bonding in treasury and subsequent burning, the BCT supply would decrease, leading to a price increase. It is a fluid system.
Generally, it seems possible for Klima to act as the central bank of the carbon economy.
Let’s dig deeper.
Expanding the market
With the market being very small right now, Klima DAO has a direct benefit in enabling and incentivizing more usage of $Klima because:
1/ It wants to establish $Klima as the main carbon-backed currency within the carbon GDP.
2/ It aims to sit at the center of the marketplace so more usage = more trading = more fees for the DAO = more opportunities to make direct investments = more potential cashflow.
3/ The more widely Klima is held, the broader the market activity for the underlying tCarbon.
All of this would increase velocity = higher carbon GDP.
On the other hand, Klima’s stated goal is to lock as much carbon as possible in its treasury and never release it so that prices can increase.
Generally, more carbon in treasury = higher monetary base = lower velocity (assuming unchanged usage). Since a price increase is a major goal, it comes down to demand and increased usage. Klima is converting the BCT supply into a slowly dripping (rebases) asset, locked in the treasury.
Is there anything that can be done with these locked assets? Klimates often ask these questions.
1/ What is Klima going to do with all the carbon in the treasury? Can the DAO make money out of it?
2/ The DAO needs to keep the carbon locked forever. Is there a risk that the DAO releases assets and breaks its pledge?
These are somewhat contradictory, but maybe there is a trade off which somehow fulfills both conditions?
Let’s start with the first point: can the DAO monetize the treasury assets?
There are currently ca 15mn tons in the treasury, out of which >8mn are locked and the rest are “owned” via the two LPs.
The LPs have always been monetized via accruing fees.
For treasury carbon, since anyone can go and take BCT out of the LPs and use it, I won’t count it as being locked, hence let’s first look at the 8mn.
1/ Direct use
Since it’s carbon and not $, it is not very easy for the DAO to directly invest in stuff in the traditional way. Bear in mind that in all these cases, it has to uphold the vision to lock carbon away in order to increase prices.
- Klima could become a direct offtaker of carbon credits or develop its own projects in time. Will need $ for that.
- A native crypto use around tCarbon as a defi lego block (this space is very creative with coming up with ways to monetize assets). A simple example could be lending markets, the DAO could use its BCT to get $ income.
- Theoretically, the DAO can barter swap BCT for some other asset with corporations that need BCT for burning against some cashflow generating asset that can help out the treasury. This is a long shot.
- The DAO could simply burn BCT/MCO2 in order to reduce the supply, but this can potentially be done later when the APY is stable and it doesn’t need as much in the treasury for rebases.
Note: one special case is that if 1 Klima falls below 1 BCT, the DAO is supposed to intervene, sell BCT to buy Klima and burn it, thus maintaining the 1:1 backing ratio. This is just how the protocol is supposed to work, all related questions aside.
2/ Indirect use
The ongoing “use” of the BCT/MCO2 is to “realize” those by printing Klima against them and give it out as rebase rewards. This means that the locked up carbon is in a way “released” via the Klima token into the hands of the users.
Now that people have $Klima in their hands, the question becomes what utility the token has (as Medium of Exchange).
- Keep accumulating Klima via the rebases => decreases velocity
- Sell Klima from rebases for BCT/MCO2 and burn / permanently lock => flat / increasing velocity as reduces BCT/MCO2 supply
- Sell Klima from rebases for USDC to cash out => increases velocity as supply stays flat
The optimal seems option 2. This is the idea behind Klima Infinity where organizations or individuals would calculate their footprint, buy the equivalent amount of Klima to cover it (or voluntarily 2x, 3x) and then use the rebase rewards to buy BCT/MCO2 and burn it.
Why is this the best option?
1/ It would create a lot of demand for staked $Klima which is good for its price
- A higher relative $Klima price vs. carbon is needed to accommodate higher priced carbon credits.
- A higher price provides more $ from rebase rewards.
- A higher price can act as a potential hedge against an increased price of carbon.
2/ Create trading volume (the fees are an income for the DAO).
3/ Burn the tCarbon (reducing supply).
As a result, this would create a balanced velocity and benefit all parties, users will offset at reasonable prices, hold a diversified asset, carbon projects will get funding, the DAO will make money and the market will grow.
Lastly, the treasury has a deliberately low (or even zero) velocity as it needs to accumulate the supply and use it as backup for the carbon currency $Klima.
The DAO has the bonding discount capacity tool at hand in order to incentivize either low or high velocity as needed to pursue its goals in a sustainable way.
Klima needs tooling in order to enable both demand and supply
Klima lives on the blockchain. In order for the on-chain market to overtake the off-chain legacy market over time, it needs new tools, many of which are being actively developed. See some of them below:
- Tokenization bridges to get carbon credits on-chain.
- Commoditization of carbon via pools so that liquidity increases around the asset while leaving enough flexibility for differentiated price discovery based on quality, credit types etc.
- New tech-enabled MRV (Measurement, Reporting and Verification) methods
- New tech-enabled monitoring (especially post-issuance)
- Integrated footprint calculators, including crypto-native calculators
- Easy 3-rd party custody
- Fiat on/off-ramps
- Integrated corporate ESG analytics products with decarbonization and offsetting features
#1 priority: Demand
Remember, the success of the market and Klima will be driven primarily by increased demand. I can’t stress enough how crucial this is.
Klima is setting the foundation for the expansion of the market via the integrations it offers and functionality for bonding, buying and burning. These features will hopefully act as scaling levers and enable the future demand. The timing for the market looks right and there a plenty of tailwinds which I have discussed at length before.
However, Klima as a utility has still not achieved true product-market-fit. All the traction so far resulted from the early investors, pre- and post-launch, not actual users who buy and burn for offsetting their footprint.
The jury is still out on this.
Similar to how Stripe is aiming to expand the GDP of the internet, Klima DAO can play a major role in expanding the GDP of the voluntary carbon market.
By being a combination of an asset and a carbon-backed currency, it has made a lot of progress in 2/3 properties of currencies (SoV and UoA). A lot of work is currently being done to also get the wraps around #3 (MoE) and should that work out as expected, all the fundamentals will be in place for future growth.