Sustainability Atlas
Crypto & Web3·14 min read··...

Explainer: DeFi & climate finance rails — what it is, why it matters, and how to evaluate options

A practical primer: key concepts, the decision checklist, and the core economics. Focus on incentive design, regulatory surface area, and measurable real-world outcomes.

The blockchain-based carbon credit tokenization market reached $325 million in 2024 and is projected to hit $567 million by 2031, yet the voluntary carbon market remains valued at just $2 billion annually—a mere fraction of its estimated $100 billion potential by 2030. This striking gap between current reality and projected scale represents both the promise and the challenge of decentralised finance (DeFi) as infrastructure for climate action. For UK-based sustainability practitioners, investors, and policymakers, understanding how DeFi climate finance rails operate—their incentive structures, regulatory implications, and measurable outcomes—has become essential as the Financial Conduct Authority prepares comprehensive cryptoasset regulations set to take effect in October 2027.

Why It Matters

The intersection of decentralised finance and climate action represents a fundamental reimagining of how environmental markets function. Traditional climate finance mechanisms suffer from well-documented inefficiencies: opaque intermediary chains that absorb 15-30% of transaction value, settlement times measured in weeks rather than seconds, and verification processes that often cannot trace carbon credits from issuance to retirement with certainty. DeFi protocols offer architectural solutions to each of these friction points through programmable transparency, atomic settlements, and immutable on-chain audit trails.

The UK context is particularly significant. The government has committed £11.6 billion in International Climate Finance from 2021-2026, with results through March 2024 showing 110 million people supported to adapt to climate change, 105 million tonnes of greenhouse gas emissions reduced or avoided, and £8.4 billion in public finance mobilised alongside £7.8 billion in private capital. However, questions persist about the efficiency of these capital flows and the integrity of associated carbon credits. Blockchain-based climate finance rails promise to address these concerns by creating verifiable, real-time tracking of climate investments from deployment through impact measurement.

Global DeFi Total Value Locked reached approximately $124 billion in early 2025, with Ethereum commanding 63% of the ecosystem at $78.1 billion. Layer 2 solutions have matured considerably, with Arbitrum holding $10.4 billion and Base emerging as a preferred network for climate-focused applications due to lower transaction costs and reduced energy consumption. The stablecoin market now processes approximately $8 trillion in annualised volume, providing the liquidity infrastructure necessary for climate finance applications. Perhaps most tellingly, 83% of financial institutions surveyed in 2025 reported exploring or actively deploying blockchain technology—a dramatic shift from the experimental posture of just two years prior.

Key Concepts

Decentralised Finance (DeFi) refers to financial services built on public blockchain networks that operate through smart contracts rather than traditional intermediaries. In the climate context, DeFi enables programmable carbon markets where credits can be traded, pooled, and retired through automated protocols. Unlike conventional finance, DeFi systems operate continuously, settle transactions in seconds, and maintain complete transparency of all operations through publicly auditable code.

Layer 2 Rollups are scaling solutions that process transactions off the main Ethereum blockchain while inheriting its security guarantees. For climate applications, L2 rollups like Polygon, Arbitrum, and Base reduce transaction costs by 90-99% compared to Ethereum mainnet, making it economically viable to tokenise smaller carbon projects and enable fractional ownership of environmental assets. The energy efficiency improvements of L2s also address concerns about blockchain's environmental footprint—a critical consideration for climate-focused applications.

Unit Economics in DeFi climate finance refers to the cost structure per transaction, per tonne of carbon, or per dollar of climate investment processed. Key metrics include gas costs (network fees), slippage (price impact of trades), protocol fees, and the cost of bridging assets between traditional and on-chain systems. Viable unit economics typically require gas costs below $0.10 per transaction and total friction below 2-3% of transaction value to compete with traditional carbon market infrastructure.

Smart Contracts are self-executing programs stored on blockchain networks that automatically enforce agreed terms when predefined conditions are met. For climate finance, smart contracts enable automated carbon credit retirement upon purchase, programmable vesting schedules for climate project funding, and real-time distribution of proceeds to project developers without manual intervention. The immutability of smart contracts provides counterparty assurance but also creates risks if code contains errors or fails to anticipate edge cases.

Benchmark KPIs for evaluating DeFi climate finance systems include: Total Carbon Locked (TCL) measuring the volume of verified credits held in protocols, Carbon Retirement Velocity tracking the rate at which credits are permanently removed from circulation, Protocol Revenue per Tonne indicating economic sustainability, and Additionality Verification Rate measuring what percentage of on-chain credits represent genuinely additional climate benefits versus relabelled existing credits.

What's Working and What Isn't

What's Working

Transparent Carbon Credit Provenance: Protocols like Toucan Protocol have successfully demonstrated that carbon credits from traditional registries (Verra, Gold Standard) can be bridged on-chain while maintaining verifiable links to their original issuance records. The Base Carbon Tonne (BCT) token represents a fungible pool of verified credits, while semi-fungible TCO2 tokens preserve project-specific metadata. This dual-layer approach enables both market liquidity and impact attribution—previously considered mutually exclusive in carbon markets.

Instant Settlement and Reduced Intermediation: Singapore's AirCarbon Exchange has proven that blockchain-based carbon trading can reduce settlement times from T+3 (three business days) to near-instantaneous, while cutting intermediation costs by an estimated 30-50%. For climate project developers in the UK and Europe, this means faster access to capital and reduced transaction friction when accessing international carbon markets.

Programmable Climate Commitments: KlimaDAO's treasury mechanism demonstrates how protocol-level incentives can systematically remove carbon credits from circulation. With approximately 20 million carbon credits locked in its treasury, the protocol creates demand pressure that theoretically increases carbon prices market-wide. The model shows how DeFi tokenomics can be designed to align individual profit motives with collective climate outcomes—a form of automated carbon sequestration through economic mechanism design.

What Isn't Working

Verification Standards and Double-Counting Risks: The current ecosystem struggles with verification integrity. When carbon credits are bridged from traditional registries to blockchain networks, the risk of the same credit being counted in multiple systems (once in the original registry, once on-chain) remains inadequately addressed. While some protocols require retirement in the original registry before on-chain minting, enforcement is inconsistent, and the lack of standardised cross-registry communication protocols creates systematic risks.

Regulatory Uncertainty Constraining Institutional Adoption: The UK's Financial Conduct Authority has explicitly exempted crypto firms from climate-related disclosure requirements in its forthcoming regulatory framework, citing "challenges in sourcing data and limited demand." While this reduces compliance burden for DeFi protocols, it also signals that tokenised carbon credits may not receive the same legitimacy as traditional environmental assets in institutional portfolios. The full cryptoasset authorisation regime doesn't take effect until October 2027, leaving a multi-year period of uncertainty that inhibits large-scale institutional commitment.

Fragmented Liquidity and Interoperability Gaps: Despite the promise of unified global carbon markets, the reality is fragmented liquidity across multiple chains, protocols, and token standards. A carbon credit tokenised on Polygon cannot be easily traded against one on Ethereum mainnet without bridging—a process that introduces additional costs, complexity, and smart contract risks. The absence of universally accepted token standards (analogous to ERC-20 for fungible tokens) specifically designed for environmental assets creates persistent friction.

Key Players

Established Leaders

Toucan Protocol operates the foundational infrastructure for bridging traditional carbon credits on-chain, having pioneered the BCT and NCT (Nature Carbon Tonne) token standards. Their architecture enables composability with broader DeFi ecosystems while maintaining links to original registry records.

KlimaDAO functions as a decentralised reserve currency protocol backed by carbon assets, with a treasury mechanism designed to remove credits from circulation while rewarding long-term token holders. The protocol has become a significant demand driver in on-chain carbon markets.

Flowcarbon provides enterprise-grade infrastructure for carbon credit tokenisation, with GCO2 tokens enabling trading, staking, and clearing functions. Founded with backing from notable technology investors, Flowcarbon bridges traditional corporate sustainability requirements with DeFi capabilities.

Carbonmark offers an API-first marketplace enabling developers to integrate carbon credit purchasing and retirement directly into applications. Their infrastructure supports real-time retirement and fractional ownership, lowering barriers for consumer-facing climate features.

Verra remains the dominant traditional carbon credit registry globally, and their engagement with blockchain initiatives—while cautious—signals acknowledgment that on-chain infrastructure may become standard market infrastructure. Verra's decisions about which tokenisation protocols to recognise effectively determine market legitimacy.

Emerging Startups

Thallo positions itself as an interoperability layer connecting carbon credit issuers, buyers, and standards bodies through a multi-registry bridge architecture. Their regulated approach targets institutional clients requiring compliance-friendly infrastructure.

Nori focuses specifically on soil carbon sequestration, issuing NRT tokens on Polygon for regenerative agriculture projects. Their partnership with Bayer demonstrates how protocol-specific focus can attract strategic corporate relationships.

Puro.earth specialises in engineered carbon removal credits (biochar, mineralisation) rather than nature-based solutions, with clients including Microsoft and Shopify. Their digitally native credits avoid some complexity of bridging from traditional registries.

EcoRegistry provides distributed ledger technology for full lifecycle credit tracking from issuance to retirement, functioning as a registry rather than marketplace. Their infrastructure focuses on solving the verification challenges that plague bridged credits.

Metlabs operates with explicit European regulatory focus, building tokenisation infrastructure compliant with MiCA (Markets in Crypto-Assets), GDPR, and major carbon standards. Their use of ERC-3643 security token standards positions them for institutional adoption as regulations clarify.

Key Investors & Funders

Andreessen Horowitz (a16z) has made significant investments in climate-focused blockchain infrastructure through its crypto fund, signalling Silicon Valley venture capital's interest in the intersection of Web3 and sustainability.

Breakthrough Energy Ventures (founded by Bill Gates) has invested across the climate technology spectrum, including in companies exploring blockchain applications for carbon markets and climate finance infrastructure.

J.P. Morgan's Kinexys (formerly Onyx) has launched carbon registry tokenisation testing with S&P Global, EcoRegistry, and ICR, representing major financial institution commitment to blockchain-based environmental asset infrastructure.

The World Bank has developed the Climate Warehouse prototype enabling standards bodies to mint native digital credits, lending multilateral legitimacy to blockchain-based climate finance approaches.

The UK Infrastructure Bank has committed to catalysing private investment in climate solutions, with increasing attention to digital infrastructure that could include blockchain-based climate finance rails.

Examples

Carbonplace Banking Consortium Settlement Pilot: A consortium of major banks including UBS piloted Carbonplace as a shared settlement layer for cross-registry carbon credit transactions in 2022-2024. The pilot demonstrated that traditional financial institutions could participate in blockchain-based carbon markets while maintaining existing compliance frameworks. Settlement times reduced from days to hours, and the consortium model addressed single-platform concentration risks that concern institutional risk managers.

J.P. Morgan Kinexys Digital Assets Carbon Tokenisation: In late 2024, J.P. Morgan's Kinexys platform launched testing for carbon registry tokenisation in partnership with S&P Global, EcoRegistry, and the International Carbon Registry. The initiative represents the first major US bank directly engaging with on-chain carbon credit infrastructure, with implications for UK institutions operating in global markets. The testing includes both spot trading and structured products using tokenised environmental assets.

Mastercard Blockchain Carbon Offset Transparency Initiative: Mastercard's pilot programme launched in October 2023 explored blockchain technology for improving transparency in the carbon offset market. The initiative focused on tracking offset purchases through payment networks, creating verifiable chains from corporate buyers to specific climate projects. While not fully DeFi-native, the pilot demonstrated how traditional financial rails and blockchain infrastructure could interoperate for climate applications.

Action Checklist

  • Assess current carbon credit holdings for tokenisation eligibility by verifying registry compatibility (Verra, Gold Standard, ACR, CAR) with major bridging protocols
  • Establish wallet infrastructure using institutional-grade custody solutions compliant with anticipated FCA requirements before the September 2026 authorisation gateway opens
  • Conduct unit economics analysis comparing on-chain carbon transactions against current broker relationships, accounting for gas costs, slippage, and bridging fees
  • Evaluate smart contract audit reports for any protocol under consideration, prioritising those with multiple independent audits and active bug bounty programmes
  • Map regulatory surface area by tracking FCA consultation papers (CP25/40, CP25/41, CP25/42) and preparing compliance frameworks for October 2027 implementation
  • Develop double-counting prevention procedures ensuring credits are properly retired in original registries before or simultaneously with on-chain minting
  • Identify L2 networks appropriate for use case—Polygon for maximum ecosystem compatibility, Base for cost efficiency, Arbitrum for DeFi composability
  • Establish benchmark KPIs including Total Carbon Locked, Retirement Velocity, and Cost per Tonne Transacted for ongoing performance monitoring
  • Build internal expertise through pilot transactions using testnet environments before committing material capital to mainnet operations
  • Engage legal counsel specialising in both carbon markets and cryptoasset regulation to navigate the intersection of environmental and financial compliance

FAQ

Q: Are tokenised carbon credits recognised by UK regulators for corporate emissions reporting? A: Currently, tokenised carbon credits exist in a regulatory grey zone. The UK Emissions Trading Scheme does not recognise blockchain-based credits for compliance purposes, and voluntary corporate reporting frameworks (CDP, SBTi) do not specifically address tokenised credits. However, if the underlying credit originates from a recognised registry (Verra, Gold Standard) and proper retirement procedures are followed, the environmental claim remains valid regardless of the on-chain wrapper. The key risk is procedural—ensuring that retirement in the original registry occurs to prevent double-counting, and maintaining documentation that satisfies both blockchain records and traditional audit requirements.

Q: How do DeFi climate finance protocols address the energy consumption concerns associated with blockchain technology? A: The transition from proof-of-work to proof-of-stake consensus mechanisms has reduced Ethereum's energy consumption by approximately 99.95% since the September 2022 Merge. Layer 2 rollups further reduce per-transaction energy costs by bundling hundreds of transactions into single on-chain commitments. Most climate-focused protocols now operate on Polygon, Arbitrum, or Base—all proof-of-stake networks with minimal environmental footprints. Additionally, several protocols (including KlimaDAO) programmatically retire carbon credits to offset any remaining protocol emissions, creating net-negative carbon footprint claims that, while debatable in methodology, demonstrate sector awareness of the concern.

Q: What happens to tokenised carbon credits if a DeFi protocol fails or is exploited? A: This represents a genuine systemic risk. If a bridging protocol is exploited, tokenised credits could theoretically be duplicated or destroyed without corresponding changes in original registries—creating either double-counting or stranded assets. Mitigation strategies include: using protocols with comprehensive smart contract audits and insurance coverage, preferring protocols that maintain real-time synchronisation with original registries rather than one-way bridges, and diversifying across multiple protocols rather than concentrating holdings. The immutability of blockchain records means that ownership history remains verifiable even if protocol frontends become unavailable, but recovering actual carbon credit value may require legal proceedings against registry operators.

Q: How should organisations evaluate the additionality of on-chain carbon credits versus traditional credits? A: Additionality assessment should follow the same rigorous criteria regardless of transaction medium. The critical question is whether the climate project would have occurred without carbon credit revenue—a determination made during project registration, not during tokenisation. When evaluating on-chain credits, organisations should verify: (1) the credit originates from a registered project in a recognised registry, (2) the vintage (year of emission reduction) meets organisational requirements, (3) the project methodology is appropriate for the claimed emission reduction type, and (4) proper retirement procedures will ensure the credit cannot be resold. Tokenisation itself neither adds nor subtracts additionality—it merely changes the transaction and custody infrastructure through which credits move.

Q: What is the realistic timeline for DeFi climate finance to achieve mainstream institutional adoption in the UK? A: The regulatory timeline provides clear milestones. The FCA's consultation period closes in February 2026, with final rules expected throughout 2026 and the authorisation gateway opening in September 2026. Full regulatory implementation occurs October 2027. Realistically, mainstream institutional adoption—meaning pension funds, insurance companies, and large asset managers routinely using DeFi rails for climate investments—is likely a 2028-2030 phenomenon. Current activity remains dominated by crypto-native organisations and climate-focused funds with specific mandates for innovation. The gap between regulatory clarity and institutional adoption typically spans 18-24 months as compliance frameworks, custody solutions, and internal approval processes develop.

Sources

Topics

DeFifinancecomplianceL2 rollupsunit economicsbenchmark KPIssmart contracts

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