Could You Earn 28,000% While Saving The Planet?

Could You Earn 28,000% While Saving The Planet?
Reda Farran, CFA

about 2 years ago8 mins

  • Klima is a crypto project looking to push up both the cost of polluting and the reward of green projects, as well as create a better way of trading carbon offsets.

  • It offers investors an attractive yield, funded by the project's profits that it earns from the price difference between the KLIMA it mints and the BCTs deposited by users.

  • The project’s key risks are that the staking yield won’t be sustainable in the long run, the price of KLIMA could drop, and the project could end up being illegitimate.

Klima is a crypto project looking to push up both the cost of polluting and the reward of green projects, as well as create a better way of trading carbon offsets.

It offers investors an attractive yield, funded by the project's profits that it earns from the price difference between the KLIMA it mints and the BCTs deposited by users.

The project’s key risks are that the staking yield won’t be sustainable in the long run, the price of KLIMA could drop, and the project could end up being illegitimate.

Crypto has a bad environmental reputation, with bitcoin mining generating about 96 million tonnes of CO2 emissions each year. But Klima – a decentralized autonomous organization, or DAO – is a crypto project that’s actually trying to galvanize climate action by creating a “black hole” for carbon offsets. And here’s the kicker: it’s offering investors a 28,000% annual percentage yield in the process. Here’s how it works.

What exactly are carbon offsets?

Carbon offsets represent a tonne of CO2 that has been permanently avoided or removed from the atmosphere. Examples of projects that generate carbon offsets include renewable energy (which avoids the CO2 that would’ve been emitted from conventional power plants) or planting large swathes of trees (which removes CO2 from the atmosphere).

These carbon offsets are then sold to entities (governments, companies, etc) that need them. For example, some entities are forced to buy carbon offsets to comply with legally binding caps on the total amount of CO2 they’re allowed to emit per year (what’s known as the compliance market for offsets). Other entities buy offsets to voluntarily mitigate their greenhouse gas emissions and meet carbon-neutral, net-zero, or other established emission reduction goals (known as the voluntary market for offsets).

Where does Klima come in?

Klima is a decentralized autonomous organization: a crypto community that’s owned and managed by its members. It’s the first “official” fork of Olympus DAO, and its aim is to suck up carbon offsets from the real world to reduce their supply and push up their price. This forces companies and governments into more action against climate change in two main ways.

First, it disincentivizes polluters. If the price of carbon offsets is very low, a polluting firm will carry on doing what it’s doing and simply greenwash the practice by purchasing cheap carbon offsets. But if those offsets are expensive, it’ll force the firm to switch to greener alternatives and actually cut its emissions instead of simply offsetting them.

Second, it incentivizes carbon offset projects by increasing their financial rewards. Put differently, these projects’ revenues will increase if they can sell the carbon offsets generated at higher prices. That incentivizes more green projects like renewable energy, forestation, and so on.

It’s not just the little problem of climate change Klima’s trying to solve, but the way carbon offsets are traded too. There’s currently no centralized, global market for trading them. Instead, offsets are traded via carbon brokers and middlemen in an illiquid, opaque, fragmented, and inefficient market. Klima’s solution to this problem is its native KLIMA token, each of which represents one tonne of carbon offsets. If the project succeeds, KLIMA tokens can be a better way of trading carbon offsets than the status quo.

How does the KLIMA token represent carbon offsets?

Carbon offsets from the real world are verified and converted into crypto tokens called Base Carbon Tonnes (BCTs) using the Toucan Carbon Bridge. This bridge basically takes a verified carbon offset from a real-world registry, retires it from existence, and creates one BCT in its place. That brings carbon offsets “on chain”, moving from the real world to the blockchain. There always has to be at least one BCT sitting in Klima’s treasury for every KLIMA token out there. To summarize: one KLIMA is backed by one BCT, which is the equivalent of one tonne of carbon offsets.

Note that the price of BCT moves roughly in sync with the price of voluntary carbon offsets from the real world, which, according to one firm, could rise more than tenfold by 2050.

How does Klima acquire BCTs?

Klima’s treasury acquires BCTs through a mechanism called bonding, which allows users to deposit BCT into the treasury in exchange for discounted and newly minted KLIMA tokens. As of the time of writing, one KLIMA is worth $140 and one BCT is worth $6. So if someone wanted to acquire KLIMA through bonding, they’d deposit $140/$6 = 23.3 BCTs to receive one KLIMA. But in reality, users might only have to pay, say, 23 BCTs, because bonding allows them to buy KLIMA at a discount.

Now recall that one KLIMA is backed by one BCT, but the protocol just received 23 BCTs for one KLIMA. So what the protocol can now do is mint up to 22 extra KLIMA tokens and distribute them as rewards to users staking existing KLIMA. These are users who essentially lock up their KLIMA to get more in return. So here’s the key thing: the Klima protocol is mainly earning a profit from the price difference between KLIMA and BCTs, and it distributes 90% of this profit to stakers. Even if no one bonds BCTs in the treasury, Klima can purchase one BCT for $6, deposit it in its treasury, mint a new KLIMA token, sell it in the open market for $140, and make $136 in profit.

Why does KLIMA trade at a premium to BCT?

KLIMA isn’t pegged to BCTs, or anything else for that matter: its price is purely determined by supply and demand. The staking mechanism reduces supply because it incentivizes people to lock up their KLIMA for the long term to benefit from favorable compounding (more on this in a second). In fact, more than 99% of KLIMA’s total circulating supply is currently staked. As for demand, that comes from rising interest in the protocol as more users see it as a unique way to help the fight against climate change, as well as to create a new carbon trading market.

So what about the 28,000% return?

Users staking KLIMA are currently rewarded with more KLIMA at an approximate rate of 0.47% every 7.3 hours. Due to the effect of compounding, this is equal to 1.6% more KLIMA every day, 11.4% every week, 60% every month, and 27,677% every year. Just remember, this is an increase in the number of KLIMA tokens, not necessarily the value of a staker’s investment. For example, if you stake KLIMA for a month but the price of the token drops by 40% during that time, you’ll actually end up with a 4% loss (60% more tokens that are all worth 40% less).

Ultimately, your investment results from staking come from the number of KLIMA you end up with and the price of each. That’s why if you’re staking the token, the most important metric to monitor is the token’s total market capitalization. After all, the total supply of tokens is increasing every day as the treasury mints new KLIMA and distributes them to stakers. That dilutes the value of each KLIMA, lowering its price. But if the price of KLIMA stays constant or doesn’t drop by a percentage that offsets the increase in supply, the total market capitalization of the token increases, and that benefit accrues to stakers.

What are the risks of buying KLIMA?

1. The staking yield is not sustainable in the long run

As you can see from the below graph, the annual percentage yield (APY) of KLIMA has already gone down over time.

Staking’s APY has gone from around 74,000% two months ago to around 28,000% today. Source: https://dune.xyz/Cujowolf/Klima-DAO
Staking’s APY has gone from around 74,000% two months ago to around 28,000% today. Source: https://dune.xyz/Cujowolf/Klima-DAO

There are two main reasons why. First, mathematics: as KLIMA rewards get distributed across an expanding base of KLIMA, the reward rate (in percentage terms) goes down because the denominator is increasing. Second, economics: newly minted KLIMA expands the supply of tokens and lowers their price. That reduces the price difference between KLIMA and BCTs which, in turn, reduces the protocol’s profits that it distributes to stakers.

If the protocol was to completely stop generating any profit today (if, for example, BCT bonding dries up), there would be enough BCTs in the treasury to continue to mint and issue new KLIMA for 122 days at the current APY. You can see all these stats (and more) on the project’s Dune dashboard.

2. The price of KLIMA could drop

Recall that 99% of all KLIMA is currently staked, which greatly reduces the token’s supply and supports its price. But if some users – especially the early ones who have accumulated a lot of KLIMA – unstake their tokens and sell, the token’s price will start to drop. That could cause other stakers to panic sell, leading to a vicious cycle of price drops and more selling. There’s an interesting element of game theory here that you actually can read more about in Klima’s documentation.

Just note that KLIMA’s price floor is, in theory, the price of a BCT since there always has to be at least one BCT sitting in Klima’s treasury for every KLIMA token out there. If KLIMA’s price dips below one BCT’s, the protocol will actually sell BCTs from its treasury and use the proceeds to buy back and burn KLIMA until the two’s prices are equal.

3. The project could end up being illegitimate

We don’t know who Klima’s founders are, and the project hasn’t been officially audited. So while Klima and all its documentation appear legitimate, there’s always a non-zero probability that the project ends up being illegitimate and/or gets rug-pulled – a malicious maneuver in the crypto industry where developers abandon a project and run away with investors’ funds. As always, do your own research before investing and only play with small amounts of money that you’d be fine to lose completely.

Finimize

BECOME A SMARTER INVESTOR

All the daily investing news and insights you need in one subscription.

Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

/3 Your free quarterly content is about to expire. Uncover the biggest trends and opportunities. Subscribe now for 50%. Cancel anytime.

Finimize
© Finimize Ltd. 2023. 10328011. 280 Bishopsgate, London, EC2M 4AG