At a time when reforestation is seen as an effective method to reverse the impending climate change, different countries are developing novel policy initiatives to combat the inevitability of carbon emission due to deforestation. The same is manifested in the major initiatives in recent years, such as the development of a carbon market to offset the emissions with a proportionate development of carbon sink. For instance, Paraguay, which has lost huge swaths of Gran Chaco (second largest forest in Latin America) recently, brought a law on the carbon market that adjusts the loss of forest in one area with reforestation in the other area.
RECOGNISING CARBON MARKET
The carbon market and such regulatory laws are not new. In fact, it was one of the mechanisms proposed in the Kyoto Protocol 1997 to reduce global warming. More recently, in COP 21, the Paris Agreement paved the way for the global acceptance and transaction of the carbon credit system. Carbon market refers to the trade of carbon credits by an individual or a company, often a company, in return for its greenhouse gas emissions. Technically speaking, a carbon credit represents a tradable certificate or permit that reflects a reduction in greenhouse gas emissions. When an entity exceeds its set targets for reducing carbon emissions, it earns carbon credits as a reward. These credits serve as a tangible acknowledgement of the entity's efforts in mitigating climate change, which can further be traded to entities which have exceeded their emissions. Scientifically, one carbon credit equals one ton of CO2 or other greenhouse gases.
That being the case, the Government of India recently passed the Energy Conservation (Amendment) Bill, 2022, establishing a carbon credit market in India in order to fulfill its obligations set out in the Nationally Determined Contributions (NDCs) under the Paris Agreement. To be sure, the key benefits of such carbon credit systems could be various, such as economic gains by selling carbon credits on the advancement of the country's rich biodiversity, coverage in a wide variety of sectors, from agriculture to livestock, industrial processes to waste management, and energy to technology developers.
However, it appears that while the mechanism of carbon credit is to offset the harm, it has often proved ineffective in curbing the loopholes of ‘additionality’ and double-counting. With these fallacies in carbon market, carbon credits can be issued for superficial reduction in emissions and can be used more than once, respectively. At the heart of such inadequacies, lies the lack of efficient verifiability, transferability and transparency of these instruments. Therefore, acknowledging these gaps forces us to rethink the technological approach to the transactions in the carbon credit system. That said, this piece focuses on one of the safest and pioneering technologies to integrate diverse projects across the globe into a cohesive system — blockchain technology (hereinafter “BCT”).
MECHANISM OF BCT VIS-À-VIS CARBON MARKET
Before delving into the utility of blockchain in carbon trading contracts, it is of assistance to understand the mechanism of the BCT. As understood in the popular sense, blockchain is a digital data architecture functioning as a shared, distributed database that maintains a continually growing record of transactions in a sequential order. It encompasses digital transactions, data entries, and executables and aggregates them into blocks, where each block is time-stamped and cryptographically linked to the preceding block. Thus, it creates a chain of records that establishes the sequence of events, known as the 'blockchain'.
In contrast to the conventional databases, it operates on a consensus mechanism, which guarantees that: firstly, the network remains distributed and free from the control of any single entity; secondly, the validator nodes are incentivised to act with integrity; and thirdly, once verified, blocks are immutable and resistant to tampering. These methods ensure that compared to the traditional databases, the use of blockchain networks in carbon trading can be more reliable and secure.
On a detailed perusal, the use of blockchain architecture for estimating carbon emissions can follow two primary approaches: Open Blockchain and Permissioned Blockchain.
Open Blockchain: In an open blockchain system, any interested party can join and verify the blockchain architecture. In light of this, independent authenticators can play a pivotal role in calculating emissions and carbon credits, thus becoming crucial in the credit system verification process. However, at the same time, this process may counter a significant challenge for manufacturers due to the high computational power required to maintain a large-scale distributed ledger and the possible corruption of independent authenticators.
Permissioned Blockchain: In contrast to the open one, a permissioned blockchain system restricts participation to controlled members who can join and verify the blockchain. In a permissioned blockchain environment, participants are governed by smart contracts, with emission calculations pre-determined by a regulatory authority. Unlike open blockchains, which utilise independent authenticators, permissioned blockchains rely on the autonomy and design of smart contracts to ensure compliance and accuracy.
ENABLING SMART CONTRACTS ON CARBON CREDITS
In substance, smart contracts are computer codes that automatically execute the conditions of a contract based on blockchains. These contracts, introduced by Nick Szabo at the end of the 20th century, offer several significant advantages in carbon trading market, such as paperless records, transparency, real-time execution, and transaction irreversibility upon the fulfilment of conditions.
It is also interesting to note their ability to bypass the traditional claims process in cases of default by another party, as transactions are already recorded in a distributed ledger, eliminating the need for cross-verification. Programmatically executed transactions (PETs), or smart contracts, can replace fiduciary relationships with automated code. For instance, just like the example of vending machine introduced by Szabo, if a company fails to control emissions within a stipulated time, a smart contract ensures the deduction of carbon credits or any liquidated damages automatically without the need for manual intervention or negotiation.
The execution of such contracts is rudimentary at the moment. It fails to determine subjective legal criteria just as the smart contracts in carbon market cannot account for the subjective reasons behind emissions, delays, and the non-applicability of alternatives. However, besides that, smart contracts offer a robust framework for managing carbon credits, ensuring meticulous record-keeping and seamless data storage. They facilitate efficient credit ownership transfers across blockchain networks and make the verification of project data self-executing, enhancing the accuracy and reliability of the process. Its settlement features will automate compensation processes and bolster the transparency of fund management, ensuring a more efficient and accountable system for carbon credit transactions.
In one such recent development in carbon removal, Nasdaq has partnered with Puro.earth, a leading registry platform for engineered carbon removal, to register CO2 Removal Certificates (CORCs). The registry introduces the avenues of smart contracts in digitising the carbon markets to ensure full traceability and transparency by tracking the issuance, retirement, and transfer of assets.
ADMISSIBILITY OF SMART CONTRACTS AND THEIR LEGAL IMPLICATIONS
At the outset, it is important to have a glance over their legality and effect on the traditional frameworks. Smart contracts, being digital agreements, automatically enforce their terms based on predefined conditions, promising enhanced efficiency and reduced transaction costs. However, their integration into traditional legal frameworks also poses significant challenges, necessitating judicial scrutiny and adaptation. With a limited legal literature on smart contracts in India, the following part of the article delves into the foreign based precedents, establishing the enforceability of smart contracts in the United States and the United Kingdom with its scope in India.
In the United States, the courts have proactively addressed the complexities of smart contracts. A notable instance can be seen in the case of CFTC v. My Big Coin Pay, Inc, where the Commodity Futures Trading Commission (hereinafter “CFTC”) brought action against My Big Coin Pay, Inc. for fraudulent activities involving cryptocurrency. The US District Court for the District of Massachusetts held that cryptocurrencies are commodities under the Commodity Exchange Act, thereby extending regulatory oversight to encompass digital assets often used in smart contracts. On its face, this ruling underscores the adaptability of the U.S. regulatory framework to carbon credits by affirming that they can fall within existing regulatory purviews if they involve digital assets classified as commodities.
Another relevant legal development is the recognition of smart contracts under the Uniform Electronic Transactions Act (UETA) and the Electronic Signatures in Global and National Commerce Act (E-SIGN Act). These Acts plainly provide that electronic records and signatures have the same legal standing as their paper counterparts, thereby supporting the enforceability of smart contracts that meet traditional contract law elements such as offer, acceptance, and consideration. This legislative framework can set a precedent for the recognition and enforcement of digital agreements on carbon credits in the United States.
Of equal relevance is the legal landscape in the United Kingdom, which has also evolved to integrate smart contracts. The Smart Contract Working Group Report (hereinafter “UKJT”) by the UK Jurisdiction Taskforce was a notable development which affirmed that smart contracts could satisfy the requirements of English contract law, provided they exhibit an intention to create legal relations and fulfill contractual obligations. UKJT, thereby furthers the potential usage of pre-determined contracts on BCT in carbon market trading. Therefore, as long as smart contracts in carbon trading meet the conventional criteria of a contract, they are as binding as traditional agreements.
Significantly, the case of AA v. Persons Unknown represents a shift in the judicial approach to crypto-assets, which often underpin smart contracts. The High Court of England and Wales dealt with a ransomware attack involving crypto-assets and classified these assets as property, thus extending legal protections and remedies. This classification of crypto-assets becomes crucial, as it provides a legal foundation for recognising and enforcing rights related to digital assets such as smart contracts based on carbon credits.
In India, the judicial system has begun to address the implications of smart contracts, focusing on their compliance with existing laws. Firstly, to ensure the admissibility of electronic communication in Indian Contract Law, Trimex International FZE Limited, Dubai v. Vedanta Aluminium Limited, is instrumental. The Supreme Court of India held that electronic communications could constitute binding agreements if they demonstrate mutual consent and specific terms. On a similar note as AA v. Pearsons, SC suggested that smart contracts, which are characterized by clear, predefined terms, can be enforceable under Indian law. More importantly, in Shapoorji Pallonji & Co. Ltd. v. State of Maharashtra, the Bombay High Court highlighted the necessity for electronic transactions to comply with statutory requirements to ensure authenticity and non-repudiation. While BCT ensures the authenticity of carbon credits, this case allows the enforceability of smart contracts in carbon trading, provided that they meet the same rigorous standards as traditional contracts.
Comparatively speaking, in all three jurisdictions, courts have acknowledged the enforceability of digital agreements, provided they meet fundamental contractual elements such as offer, acceptance, and consideration. This recognition is critical for the broader acceptance and implementation of smart contracts in carbon markets and others. It ensures that the broad spectrum of technological leaps, such as BCT carbon credits, does not bypass the legal standards required for enforceability.
In conclusion, smart contracts can play a potential role in tracking the verity, transferability and ownership of carbon credits along with other potential data stack. Even with less specificity to smart contracts, the judicial systems have shown a progressive approach in recognising and adapting to technological advancements.
And, as the legal landscape continues to evolve, future judicial developments will elucidate the enforceability and regulatory compliance of smart contracts and their usage in carbon markets.
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