Asset tokenization as a tool against climate change

Introduction

Climate change mitigation efforts often face issues related to finance and investments. Because the effects of climate mitigation efforts are diffuse in space and time, it makes it hard to measure the effectiveness and profits of a specific effort. Additionally, the global character of climate change might lead to a reduced feeling of responsibility among individuals, companies and individual countries. With the consequences of climate change becoming increasingly evident, the world requires innovative solutions to tackle the monumental challenges of mitigating the increase in global temperature. One such solution that is gaining a lot of traction is asset tokenization. The tokenization of assets, made possible by blockchain technology, could offer solutions to the challenge of acquiring funding and investment for climate mitigation efforts. 

Traditional methods of financing climate change mitigation projects often face barriers of complexity, limited liquidity, and bureaucratic red tape. However, asset tokenization, driven by the principles of blockchain technology, has the power to reshape this landscape. By converting real-world assets—ranging from renewable energy projects and carbon offset initiatives to sustainable infrastructure—into digital tokens, we can unlock new avenues of investment, democratize access to green assets, and streamline the flow of capital towards projects with measurable environmental impact.

This article examines the benefits that asset tokenization can bring to the realm of climate change mitigation. We will first explore what asset tokenization is, and what its general applications, benefits and disadvantages are. After that, we will delve into the potential that the tokenization of assets has for climate change efforts by looking at some promising applications, and advantages and disadvantages related specifically to asset tokenization in climate change action.

About asset tokenization

What is asset tokenization?

Asset tokenization is the process that involves converting real-world assets into digital tokens that are stored on a blockchain or distributed ledger. These tokens represent ownership or rights to the underlying physical asset, such as real estate, artworks, commodities, or in the context of this article, assets related to climate change mitigation like renewable energy projects or carbon offset initiatives. Tokenization adds a layer of divisibility and liquidity to these traditionally illiquid assets, enabling them to be easily traded and invested in by a wider range of participants. The blockchain on which these assets are created and traded ensures that tokens cannot be sold double, and that no authority can erase ownership of a token, due to the immutability and security of the blockchain.

How does asset tokenization work?

In order to convert a tangible asset from the real world into digital tokens, you have to establish a smart contract on a blockchain network, such as Ethereum. This smart contract serves as a digital agreement outlining the details of the property and the associated tokens. Its role is to establish the guidelines dictating how ownership, trading, and overall token management will operate.

The process typically begins by identifying an asset with intrinsic value and creating a digital representation of it on a blockchain. This representation is what is referred to as a “token.” Each token is backed by a portion of the real asset, essentially giving the holder ownership or a stake in that asset. This process is transparent and secure due to the nature of blockchain technology, which ensures that transactions are recorded and verified across a distributed network of computers. 

Let’s look at a simple example to clarify how the process works. Imagine a real estate developer who owns a valuable commercial property in a prime location. They want to unlock liquidity and allow a broader range of investors to benefit from the property’s potential value appreciation and rental income. The owner creates digital tokens that represent fractions of the property, which are then offered for sale. People who buy the tokens become co-owner of the property, which entitles them to a share of the rental income, as well as potential capital appreciation. Token holders can trade their tokens further on secondary markets after the initial token offering. 

What assets can be tokenized?

The great thing about asset tokenization is that practically every asset can be turned into digital tokens. The most common examples of tokenized assets are real estate, art, company shares and collectibles, but asset tokenization is by no means limited to these sort of (digital) objects. Some more atypical examples of tokenized assets include intellectual property rights (e.g. patents), sports contracts, agricultural products, mining rights, race horses, trees, and film projects. With asset tokenization becoming increasingly popular, it is likely that more and more previously illiquid assets will find their way to decentralized platforms in the form of digital tokens.

Two types of tokens: fungible and non-fungible

Tokenized assets can come in the form of one of two types: fungible tokens and non-fungible tokens.

• Fungible tokens have two key characteristics: they are interchangeable and divisible. Interchangeable means that each unit of the tokenized asset holds the same value and validity. An example of a fungible token that is interchangeable is bitcoin; every single bitcoin is worth the same price at a given time. In addition to this, bitcoin is also divisible, meaning that it can be divided into as many decimal places as determined during development. 
• Non-fungible tokens, also known as NFT’s, are non-interchangeable and non-divisible. A NFT cannot be replaced with other tokens of the same type, because each token holds a unique value. They are also typically non-divisible, though there are some exceptions. Furthermore, NFT’s are unique; each token within a particular type is distinct, possessing its own specific information and unique attributes.

Advantages of asset tokenization

Asset tokenization brings forth a wide range of advantages for multiple industries. Firstly, the tokenization of assets leads to greater accessibility to investments in traditionally liquid assets, which improves the democratization of these markets. By enabling fractional ownership (breaking up one asset into more than one token), more people are able to acquire part of that ownership, whereas traditionally, many large assets such as real estate could only be sold as a whole, which is a much more expensive investment. Fractional ownership therefore enhances accessibility and inclusivity on the financial market. 

A second advantage of tokenization is the greater transparency associated with blockchain technology. Because of the immutability of the blockchain technology that underlies a tokenized asset, owners cannot change the history of the asset in an attempt at making it more attractive. This provides investors with more transparency regarding the asset and its characteristics, allowing them to make more informed decisions, resulting in fairer prices. 

Thirdly, the tokenization of assets increased liquidity for many assets that were illiquid before, such as real estate. 

Furthermore, because smart contracts automate various processes, asset tokenization reduces the need for intermediaries such as lawyers, while also reducing the amount of paperwork. As a result of this, the sale and acquisition of assets costs less time and money. As an extension of this, transferring ownership of tokenized assets is much more simple too, since these tokens can easily be sent between buyers and sellers online.

Challenges for asset tokenization

While asset tokenization offers numerous benefits, it also comes with certain challenges and disadvantages. Currently, one of the biggest challenges is the regulatory uncertainty surrounding digital assets. Recently, the regulatory landscape has been evolving, with the OECD’s framework for tax-related activities in crypto assets, and the EU’s upcoming MiCAR regulation, but for now, uncertainty remains. It can be difficult to navigate compliance requirements and it is not clear what laws might apply to the tokenized assets market. Main challenges to overcome regarding regulation are related to the cross-jurisdictional character of decentralized markets, and how taxation would apply to this new class of assets. 

Cyber-security related issues are another challenge for asset tokenization. Mainly issues surrounding digital identity, data protection, and privacy can form obstacles on the way to broader adaptation of tokenized assets. Similar to this, the blockchain technology itself also faces potential issues, primarily related to scalability issues, network stability, and the level of interoperability between digital assets networks. 

Still, despite these challenges, many expect the tokenization of assets to transform the asset management market as we know it. With this in mind, let’s look at the potential that tokenization holds for efforts in reducing climate change. 

Asset tokenization in climate change mitigation

A complex problem

Climate change is a complex problem to tackle. Not only does it have many causes, all interacting in the intricate mechanism that is our climate system, the effects of climate change are also diffuse in space and time. Hence, the potential benefits of a climate change mitigation project are often hard to define precisely. These uncertainties and the diffuse character of the effects of mitigation efforts pose a challenge to raising enough funds for much needed climate change projects. The tokenization of assets offers new possibilities to tackle this challenge, holding the potential to contribute significantly to various areas of climate change mitigation, ranging from renewable energy projects and carbon offsetting initiatives, to sustainable agriculture and green infrastructure.  

In this section, we will highlight some ways in which tokenization of assets can assist in fighting climate change, as well as examining the associated benefits and challenges. Let’s start with some examples.

Tokenization of carbon credits

One of the most promising ways in which asset tokenization can be applied to the climate change problem is in the form of the tokenization of carbon credits. Carbon credits are tradable units that represent a reduction or removal of a certain amount of carbon dioxide (CO2) emissions. Companies or organizations can earn carbon credits through actions that reduce CO2 emissions. They can also be bought to offset an organization’s carbon footprint. 

The current voluntary market for carbon credits is quite vague, inefficient and not very inclusive. Instances of double-selling carbon credits have also been documented. The tokenization of carbon credits within a decentralized blockchain can establish transparency, while also providing security and limiting the risk of fraud. Additionally, it creates a more accessible place for individuals and organizations to trade carbon credits, both on the side of companies wanting to compensate their emissions, and on the side of reforestation and conservation efforts. 

Renewable energy assets

Another way in which the tokenization of assets can help in mitigating climate change is by providing an innovative way to sell renewable energy credits. Both larger companies and individuals generating renewable energy, for example from wind turbines or solar panels, can trade their excess energy on decentralized networks. By changing these assets into digital tokens, they become available to a wider public, stimulating engagement with and support for renewable energy projects. This democratization of participation not only stimulates a more diverse pool of funding but also propels the transition toward cleaner energy sources, which is highly needed to limit global warming.

Stimulating reforestation projects

A third example of tokenization as a tool to combat climate change is the tokenization of trees. Because trees take up CO2 from the atmosphere, planting more trees and restoring and expanding forested areas can help in reducing the amount of this greenhouse gas, while also providing recreational, health-related, and biodiversity benefits (if done right). 

Through the process of tokenization, individual trees or entire forests can be represented as digital tokens on a blockchain. This enables people and organizations to invest in and own these tokens, essentially becoming stakeholders in the trees’ growth and carbon sequestration potential. The blockchain provides enhanced transparency to the funding of reforestation projects, because it can record tree planting, growth and impact, making it harder for potentially corrupt entities to make the funds designated for reforestation projects disappear. It also encourages sustainable land management practices, as token holders have a vested interest in the long-term health of their tokenized trees.

Sustainable agriculture

Agriculture, responsible for a large part of global greenhouse gas emissions, is another area in which asset tokenization can help when it comes to reducing the sector’s environmental impact. Through tokenization of agricultural assets and the added benefit of fractional ownership, farmers can raise funds to implement more sustainable practices. 

Additionally, on the customer’s side, blockchain technology creates transparency in the supply chain, allowing people to trace the origin and production methods of agricultural products before they choose whether or not to buy those. This can make it easier for customers to confidently choose the sustainable option.

The above-mentioned examples of fields in which asset tokenization might help with combating climate change are only a few of a wide array of implementations. As the technology continues to evolve and become more mainstream, we can anticipate even more innovative ways in which the tokenization of assets can be put to use in climate change action.

Benefits of asset tokenization for climate change

In addition to the general advantages of asset tokenization, such as greater inclusivity and fairer pricing, there are also benefits specifically for climate change action. The main benefit is increased funding: Tokenization expands the investor base, enabling a wider range of participants, including small investors, to fund climate projects, thus raising more capital for impactful initiatives. Not only does asset tokenization open up more funding opportunities for climate projects, it also increases the speed at which projects can be implemented by streamlining the fundraising process, automating parts of the process and eliminating administrative intermediaries. 

The cross-border character of blockchain technology and asset tokenization also benefits climate action, because many projects can span across borders or even across continents. 

A third advantage of asset tokenization for climate change is that it makes the process of measuring and reporting a project’s effects more efficient and transparent. Token holders can trace the environmental impact of their investments, which can increase trust. 

Finally, another major benefit is the fact that asset tokenization can stimulate the development of innovative technologies that can address climate change and its causes, hopefully creating new solutions and strategies for a sustainable future. 

Disadvantages

Aside from the challenges associated with asset tokenization as we mentioned earlier in this article, a challenge that is particularly relevant to climate change action are the concerns about the large energy requirements of many blockchains, especially those operating on a proof of work consensus mechanism. High energy consumption in which the energy originates from the burning of fossil fuels or biomass only adds to the problem of climate change. It is worth mentioning that there is an increasing amount of efforts and developments to reduce energy consumption of blockchains and to switch to more sustainable sources of energy.

Another noteworthy disadvantage of asset tokenization for climate change mitigation lies in its strong emphasis on the monetary aspects of obtaining financial benefits. While tokenization indeed streamlines funding and investment, it risks overshadowing the profound moral obligation we have toward future generations and the planet we share with other species. Climate change is not merely an economic equation; it’s a moral imperative to safeguard the well-being of our planet and its inhabitants. Overemphasizing financial gains may inadvertently reduce the urgency of the moral duty to protect the environment for the sake of current and future generations, as well as the delicate ecosystems with which we coexist. Striking a balance between financial incentives and moral responsibility is essential to ensure that tokenization aligns with the broader goal of preserving our planet’s ecological integrity. This is even more true since our unlimited economic growth is one of the main drivers behind climate change.

Conclusion

In conclusion, the challenges posed by climate change mitigation efforts are intricate and multifaceted, ranging from financial complexities to regulatory uncertainties and environmental concerns. Asset tokenization, powered by blockchain technology, emerges as a promising solution to address many of these challenges head-on. The benefits of asset tokenization, including increased accessibility, transparency, and liquidity, extend beyond the realms of finance. 

As we stand at the cusp of a climate crisis, the tokenization of assets is one of the many things that can offer help in mitigating global warming, if only we take the steps necessary towards the effort.