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Carbon markets are systems that allow the trading of environmental benefits in the form of carbon credits. To understand how they work, we need to start with the basic „currency“ of this market.
Definition: Carbon credit
A carbon credit is a verified unit that represents the reduction, removal, or prevention of greenhouse gas emissions. The basic environmental equation applies here: 1 ton of CO2e = 1 carbon credit Note: The abbreviation "e" stands for equivalent. It states that other greenhouse gases (such as methane) are also included in the calculation, converted to the effect of carbon dioxide.
These units do not arise randomly, but are the result of targeted activity. In practice, we distinguish two approaches to their generation:
- Projects: Specifically, locally limited activities (e.g. construction of a wind farm).
- Jurisdictional programs: Large-scale programs at the level of entire states or regions (e.g. a national program for the protection of primary forests).
The main activities that generate credits include:
- Forest protection (REDD+): Preventing deforestation and supporting natural landscape regeneration.
- Clean energy: Replacing fossil fuels with renewable sources (sun, wind).
- Methane capture: Reducing emissions from landfills or agriculture (as methane is a much more potent greenhouse gas than CO2).
- Energy efficiency: Technological improvements that reduce energy consumption in industry.
As the need to reduce emissions grows, there is a demand for a place where these proven results can be safely traded.
Typology of markets: Mandatory, Regulated and Voluntary
The world of carbon trading is not uniform. It is divided by who sets the rules and what motivates participants to buy. Understanding demand is key – it is the „engine“ that drives investment in climate projects.
Carbon Market Comparison
| Criterion | Mandatory markets (Compliance) | Regulated / Cooperative (Regulated) | Voluntary markets (Voluntary) |
| Main motivator | Legal obligation. Entities must meet emission caps set by the state. | International cooperation. Countries are meeting their nationally determined targets (NDCs). | A voluntary promise. Companies want to achieve climate neutrality. |
| Who sets the rules? | Governments and international bodies (laws, guidelines). | UN frameworks and bilateral agreements (Article 6 of the Paris Agreement). | Independent standards (e.g. Verra, Gold Standard, Plan Vivo). |
| Range | Domestic or regional (e.g. within the EU). | International (transfers between countries). | Global, driven by market demand. |
| Unit type | Allowances or recognized offsets. | ITMOs (Article 6.2) or credits under Article 6.4. | Carbon credits from private standards. |
| Examples | EU ETS (EU), K-ETS (Korea), RGGI (USA). | Bilateral agreements (e.g. Switzerland – Peru). | Purchases of companies for „Net-Zero“ portfolios. |
Although these worlds are separate, they are increasingly interconnected – for example, some mandatory systems allow companies to use a limited amount of voluntary credits to meet their goals.
Rules of the game and sanctions: What happens if you don't comply?
The credibility of the market depends on the enforceability of promises. The difference in consequences reflects the legal strength of the individual systems.
- Mandatory markets: They operate on the principle of state power. If a company does not surrender enough allowances, it faces high financial fines (in the EU it is tens of euros for each missing ton) and legal sanctions that can even lead to restrictions on activities.
- Regulated markets (Article 6): If a state fails to comply with the rules (e.g. reports incorrect data), it risks international sanctions under agreements and loss of access to future climate finance.
- Voluntary markets: There are no state fines here, but the risks are devastating. The main penalty is reputational risk (allegations of greenwashing) and loss of investor confidence. Standardization bodies may suspend projects and follow suit if local community rights are violated litigation.
These mechanisms force participants to invest only in projects with high integrity.
How the systems work: Cap-and-Trade vs. Carbon Tax
In mandatory systems, states use two main tools. Their common goal is to send a price signal that favors cleaner technologies.
| Tool | Operation | Practical examples |
| Cap-and-Trade | The state will determine ceiling total emissions. It issues allowances that are traded. If a company reduces its emissions, it can sell them; if it exceeds them, it must buy them. | EU ETS (energy, industry), New Zealand ETS (including forestry), RGGI (USA). |
| Carbon tax | The state determines fixed price for each ton of CO2e emitted. It is a simple and predictable system that generates revenue for the state budget or environmental funds. | Carbon taxes in Colombia, Mexico or South Africa. |
Both approaches make pollution more expensive, thereby incentivizing companies to innovate.
Benefits and Risks: Why Does Quality Matter?
Carbon markets have the potential to mobilize billions of dollars to protect the planet. But to be successful, they must meet strict quality criteria. That's where they come in. verification bodies a rating agencies, which check whether the declared benefits are real.
Main benefits
- Mobilizing investments: Directing private capital where public resources are lacking.
- Biodiversity protection: Preserving ecosystems that naturally store carbon.
- Social integrity (UNDP priority): Truly high-quality credits must bring fair benefits to local communities and indigenous peoples and protect their human rights.
Critical risks
- Double counting: When the same emission reduction is counted by the country where the project took place and the company that purchased the credit.
- Greenwashing: Using credits as "indulgences" without actually reducing the company's own emissions.
- Non-permanence: The risk that stored carbon will be released back (e.g. in a forest fire).
- Lack of additionality: The credits are issued for a project that would have been implemented anyway (e.g. by law or due to high profitability), so it does not provide "extra" climate assistance.
High integrity – both environmental and social – is essential for the credibility of markets. Only if credits are of high quality can they serve as a real tool to achieve the goals of the Paris Agreement. JRi&CO2AI
source: UNDP Carbon Market Toolkit: Foundations and Mechanisms
