This is one of several posts on new areas we are exploring for USV’s Climate Fund.
Natural resources such as fertile land and healthy oceans are the ultimate foundations of the economy and civilization, and their protection and regrowth are critical to resolving the climate crisis. However, since their benefits are difficult to quantify and hence price, their value is not reflected in today’s markets.
Blockchain-based crypto networks provide fundamentally new features to global assets and financial markets, and it follows that there is untapped potential in representing natural resources as tokenized assets.
The Challenge of Valuing Natural Assets
Until recently, forests in the United States were mainly valued for their timber because timber is simple to measure and has obvious uses in furniture and construction. Forests’ function of carbon sequestration, by contrast, was insufficiently incentivized by a limited market. This means that at the margin, whether to log or maintain a forest was driven by timber economics and not by climate considerations. Similar logic applies to forests around the world (in some cases, the priced use case is clearing forests for agriculture).
Companies like Silviaterra, a USV portfolio company, are starting to change this by mapping and measuring forests with high precision. Doing so allows landowners to verify that their trees are there and thriving, which provides the basis for selling the carbon sequestration function of their trees into a market (Silviaterra also operates such a market with its Natural Capital Asset Exchange).
For all-natural assets, measurement solutions like Silviaterra will be needed. However, measurement isn’t the only issue that needs to be addressed in order to prevent a Tragedy of the Commons situation. In addition, rules governing participation and incentives are required.
Elinor Ostrom, a Nobel Prize winner, studied how societies collaborate to share resources such as grazing lands, forests, and irrigation water. She argued that, contrary to common opinion, private property is not the only way to govern shared wealth.
Her studies in farming villages around the world led to the following eight main principles for managing common resources:
- Define clear group boundaries.
- Match rules governing the use of common goods to local needs and conditions.
- Ensure that those affected by the rules can participate in modifying the rules.
- Make sure the rule-making rights of community members are respected by outside authorities.
- Develop a system, carried out by community members, for monitoring members’ behavior.
- Use graduated sanctions for rule violators.
- Provide accessible, low-cost means for dispute resolution.
- Build responsibility for governing the common resource in nested tiers from the lowest level up to the entire interconnected system
Ostrom’s principles describe a blueprint for sustainable coordination. Her rules, governance, and aligned incentives mirror blockchain principles that became mainstream after she passed away in 2012.
While Ostrom’s research focused on local common resources, blockchain and smart contract technology might be able to help scale her concepts to global shared resources. Tokenizing assets could aid in global cooperation and the accurate pricing of natural resources.
Why on-chain assets?
Turning natural assets into crypto assets on decentralized blockchains has the potential to give natural assets the following important properties:
Transparent uniqueness: easy registration of new units is essential to ensuring uniqueness and avoiding the buying and selling of duplicate assets. As companies and governments commit large sums of money to become carbon neutral by investing in natural assets in faraway lands, it is crucial that these assets aren’t “double spent.”
Instant access to global markets: natural assets are global, and allowing people to participate in a global market for natural assets is essential for unlocking their value. Borderless, permissionless transactions verified on-chain will enable participants to participate in natural asset markets anywhere in the world.
Use as collateral: once sufficient natural assets are tokenized, they can also form the basis of a new type of digital collateral. Tokenized assets can be collateralized for use in lending, insurance, stable coins, and other on-chain financial products. Instead of pegging stable coins to existing currencies such as the US dollar, a new stable coin could be backed primarily (or maybe entirely) by natural assets. This is somewhat akin to the idea of a carbon currency in Kim Stanley Robinson’s new book Ministry for the Future.
Open third-party verification of asset quality (oracles): It is important that the quality of natural assets be verified. Not all natural assets are created equal, and their quality changes over time. Adding identifiers like source and age on-chain can help determine the quality of the asset as it is traded globally. With tokenized assets, any third party can add verification and quality data. These parties, in turn, can build reputation or gain skin in the game through mechanisms such as staking.
Tokenized natural resources have the potential to become one of the largest crypto asset classes due to the sheer scale of the world’s natural assets. Blockchain technology, when combined with the social power of legitimacy and trusted oracles for climate data, will help realize Ostrum’s vision of governing commons at scale. By aligning financial incentives, this will unlock the true value of natural assets and aid in the resolution of the climate crisis.
If you are working on a project in this space, please reach out to me at [email protected].