Carbon Knowledge Hub

Brief Introduction to Carbon Markets

As a brief overview, carbon markets first emerged from the Kyoto Protocol era, most notably the Clean Development Mechanism (CDM). The CDM has been widely regarded as a failure, but alongside it, a Voluntary Carbon Market (VCM) emerged, a market that coordinates the generation and sale of carbon offsets to companies that buy them voluntarily as part of ESG strategies, climate commitments, and marketing programs, claiming that these credits “offset” their emissions.

Carbon offsets are commonly defined as the reduction, avoidance, or removal of a unit of greenhouse gas (GHG) emissions by one entity that is purchased by another entity to counterbalance a unit of greenhouse gas emissions by that other entity. Offset projects can include forest conservation, tree planting, clean cooking interventions, or renewable energy projects intended to replace fossil fuel use. These projects generate credits, each typically equivalent to one metric tonne of carbon dioxide equivalent.

Projects that generate credits on the basis of reforestation or preserving carbon in vegetation or soil are often referred to as nature-based offsets. Project developers design and implement projects. Certification bodies, also known as standards bodies, approve projects after validation bodies examine the underlying process and science against established rules. Carbon registries issue the credits and track their use or retirement, while carbon ratings agencies increasingly evaluate the quality of credits and rate them for clients and buyers.

Emitters, typically large multinational firms or wealthy states, can purchase credits to reduce their “net” carbon footprint, at least on paper. Many of these credits are traded on the international VCM, while others are bought and sold on legally binding compliance markets such as the European Union’s or China’s Emissions Trading Systems (ETS). As Article 6 of the Paris Agreement continues to be developed, carbon credits are also moving more directly into formal international climate governance.

While carbon markets have historically been controversial as mechanisms for supposedly cost-effective emissions reduction, they increasingly resemble financial markets as their proponents seek to expand them into larger pools of finance. This has created a widening split between debates that focus on whether carbon markets actually reduce emissions or support sustainable development, and debates that focus on how to regulate, standardize, support, and grow the market.

Carbon Credits / Carbon Offsets

At its most basic level, a carbon offset is the reduction, avoidance, or removal of a unit of greenhouse gas emissions by one entity that is purchased by another entity to counterbalance a unit of greenhouse gas emissions by that other entity. On a more technical level, offsets are often associated with the VCM, whereas carbon credits may refer to units representing greenhouse gas emissions that are traded within an ETS or another compliance market. For the purposes of this knowledge hub, these terms are used interchangeably unless a more precise distinction is needed. ‘Carbon credits’ are typically used to refer to all kinds of mtCO2e units traded on various types of markets.

Carbon credits can be generated from a wide range of activities, from nature-based offsets to renewable energy, to carbon capture and sequestration technologies. Their tradability, or fungibility, depends on the premise that each represents the same thing: one metric tonne of carbon dioxide or its equivalent in another greenhouse gas.

The fact that these units are produced from a wide variety of project types means that the purchase of different credits can carry very different risks, and where the financing ultimately goes can be vastly different across projects that are treated as formally comparable. This can be true even for projects that are considered the same from the standpoint of standards bodies and methodologies.

With all this in mind, exactly what a carbon credit is remains an active subject of debate. Questions continue around whether carbon credits should be treated as commodities, securities, or some other kind of legal asset. Governments have had to take positions on these issues as they develop legislation, and the answers may have major implications for carbon rights, ownership structures, and national regulatory frameworks. These questions are becoming even more important as Article 6 becomes operationalized.

Advice for communities: As carbon markets have matured, carbon credits have increasingly acted as tradable financial instruments whose appeal often grows from the ability to capture revenue from supposedly emissions-reducing projects. Even if a community decides to move forward with a developer, communities should follow strong contract negotiation guidance, protect land tenure and livelihoods, and where possible seek independent legal support to ensure accountability for project developers and their financial backers.

Compliance Markets

Compliance carbon markets are established and run by governments, usually as systems for trading emissions allowances or carbon-related units within a national or regional jurisdiction.

The most common form of compliance system is an Emissions Trading System, or ETS, which bakes the cost of greenhouse gas emissions into business decision-making by controlling the quantity of emissions businesses under the system can produce, while the price of those emissions fluctuates with the supply and demand of allowances. This makes ETS systems different from carbon taxes, which control the price directly rather than the quantity. Although carbon taxes differ from compliance carbon markets, they are sometimes discussed as part of broader compliance policy systems.

There are two major ways of governing an ETS: cap-and-trade systems and baseline systems. Cap-and-trade systems are the most common. In these systems, companies must purchase or hold allowances for their emissions, and the number of allowances issued by the government acts as a cap on total emissions. The cap is generally supposed to decline over time.

The baseline model, by contrast, requires companies to meet a given emissions target. If a company performs better than the target, it may generate a tradable credit. China has the largest ETS in the world in terms of emissions coverage, while the European Union ETS remains the largest by market value. Other major systems include South Korea, California, and the United Kingdom.

These systems are generally not linked to one another, meaning units in one jurisdiction typically cannot be applied in another. Compared with voluntary markets, there is stronger reason to believe that carbon pricing under ETS systems can support emissions reductions, though outcomes depend heavily on system design and political implementation.

Voluntary Carbon Market

The Voluntary Carbon Market (VCM) refers to the set of arrangements through which private actors buy, sell, and retire carbon credits outside legally binding public compliance systems. It is one of the most visible and contested spaces in contemporary climate governance because it sits at the intersection of private climate claims, international finance, project development, and ongoing policy experimentation, though it is also relatively small in overall market value.

The voluntary market is where many corporate net-zero claims, ESG strategies, and offset-based climate narratives are made operational. It is also the part of the broader carbon market landscape that has faced some of the most intense criticism around additionality, over-crediting, permanence, baseline inflation, and harms to communities living in or around project lands.

Article 6

Article 6 allows countries to cooperate in meeting their Nationally Determined Contributions (NDCs), including through international carbon markets. Its rulebook was adopted at COP26 in Glasgow in 2021 and refined at later COPs. It creates three pathways.

Article 6.2: Cooperative Approaches - Countries may agree bilaterally to transfer mitigation outcomes, known as Internationally Transferred Mitigation Outcomes (ITMOs). As of October 2026, 108 bilateral arrangements had been formalized across 55 host countries. The first completed ITMO transfer was between Thailand and Switzerland.

Article 6.4: The Paris Agreement Crediting Mechanism (PACM) - Article 6.4 sets up a centralized, UN-supervised crediting mechanism. It is run by a Supervisory Body and replaces the Kyoto-era CDM. It was earlier often called the “Sustainable Development Mechanism.” The mechanism issues A6.4 Emission Reductions (A6.4ERs). A share of proceeds goes to adaptation in developing countries, and activities must meet social and environmental safeguards, though we, alongside others, consider these safeguards fairly weak. Some CDM activities may transition to the new mechanism under updated rules. Article 6.4 does require an independent appeal and grievance process. ICVCM requires grievance processes that are clear, transparent and impartial. The CDM has had no grievance mechanism in its more than 15 years of operation.

Article 6.8: Non-market approaches - Creates opportunities for cooperation, including but not limited to finance, in support of holistic Non-Market based Approaches (NMAs) for implementing NDCs, offering a much broader scope than 6.2 or 6.4.15 It does so by establishing a centralized UNFCCC website where countries can submit mitigation projects and specify where support is required, serving a sort of ‘match-making’ function between collective land or forest owners and sources of finance.

Additionality

One of the foundational concepts behind carbon markets, ‘additionality’ means that a project is not legally required, not already common practice, and not financially viable without carbon credit revenue. In simple terms, whether a project is ‘additional’ asks whether the intervention would have happened anyway irrespective of the revenue from selling carbon credits.

In the case of many renewable energy projects that use carbon credits, the case for additionality has often been weak, especially as renewable energy has become more cost-effective and governments have implemented other forms of policy support and financial incentive.

In recent years, it has become increasingly clear that testing for additionality is not simply a binary matter of “additional” or “not additional.” In practice, market actors often view additionality as a spectrum, and carbon markets have developed a growing number of additionality tests in response. Accreditation of carbon offsets still generally results in a binary certification outcome, but ratings agencies have stepped in to capture more of this spectrum of quality and risk as part of wider initiatives to enhance integrity.

Permanence

Permanence concerns the risk that carbon that has been counted as stored or sequestered is later released through natural or human-caused disturbances, undermining the claim of equivalence between carbon emitted and carbon removed or avoided that is central to each carbon credit’s value and supposed purpose.

Scientific and policy debates emphasize that permanence is a persistent limitation for nature-based mitigation. Emissions can remain in the atmosphere for hundreds of years, sometimes upwards of 1,000. Nature-based carbon cycling operates on much shorter timescales and cannot be guaranteed for hundreds of years, particularly not based on the needs and incentives of market actors.

Some have suggested this can be addressed through institutional design, including monitoring, liability rules, and buffer pools. Even so, these mechanisms often function more like insurance than a guarantee. Their effectiveness depends on how accurately risks such as fire, disease, drought, or future land-use change are modeled and governed. In the context of Article 6 and international carbon markets, permanence becomes a cross-border credibility issue. If credits are to support claims of real, verified, and additional mitigation outcomes, permanence has to be monitored, tracked, and made auditable over time.

Standards Bodies

Standards Bodies, also called Certification Bodies, establish the methodologies and rules through which projects are evaluated and credits are issued. Their role is to ensure that projects satisfy core market requirements such as additionality, avoidance of overestimation, treatment of permanence, exclusive claim to reductions, legal compliance, and in some cases demonstration of social or environmental co-benefits.

The major standards bodies emerged in the wake of the failures associated with earlier Kyoto-era mechanisms. Important names in this space include Verra, Gold Standard, American Carbon Registry, and Climate Action Reserve, though there are a handful of others.

Verra is the largest Certification Body, a major actor in the VCM, and a highly influential institution in Article 6 development. Verra manages the Verified Carbon Standard (VCS). Through its program rules, standards, and methodology requirements, Verra governs project development, credit issuance, methodological design, and accreditation expectations for auditors.

Verra’s framework includes detailed rules for project crediting periods, monitoring expectations, and approaches to uncertainty and conservativeness. These requirements are especially important in sectors such as forestry and other AFOLU project types, where questions of permanence, monitoring, and overestimation are especially difficult.

Nature-Based Offsets

Nature-based offsets typically involve land-sector activities such as avoided deforestation, afforestation, reforestation, restoration, improved forest management, or soil carbon sequestration that claim emissions reductions or removals.

Nature-based offsets are often promoted as providing climate mitigation alongside ecological and social co-benefits. At the same time, they face recurring constraints around governance, additionality uncertainty, and permanence risk. Permanence risk is especially serious because land-based carbon sequestration generally does not lock away carbon on the kinds of time scales associated with fossil fuel emissions, and therefore cannot straightforwardly “offset” fossil fuel combustion.

In addition, nature-based projects often run into land tenure issues involving communities living in or around project areas. These tensions can compound technical questions about whether a project represents real emissions reductions by introducing further legal, ethical, and reputational risks where community rights are weakly protected or violated.

Proponents argue that nature-based projects can channel climate finance toward rural communities in the Global South and incentivize more sustainable land-use practices. Critics counter that these goals would often be better pursued through non-market approaches or, at minimum, through much stronger safeguards and benefit-sharing mechanisms than are currently common.

REDD+

REDD+ is the UNFCCC framework for reducing emissions from deforestation and forest degradation, while also addressing conservation, sustainable management of forests, and enhancement of forest carbon stocks. It was developed through UN climate negotiations and tied to safeguards and implementation guidance meant to shape how forest-based mitigation is pursued.

REDD+ safeguards include expectations around transparent and effective governance, respect for Indigenous peoples and local communities, full and effective participation, and consistency with conservation of natural forests and biodiversity. Subsequent UNFCCC decisions also elaborated the need for safeguard information systems and reporting on how safeguards are addressed and respected.

Critiques and Implications

A major issue lies in the mismatch between REDD+ as a broad policy framework and the way REDD+ projects have been used to generate credits in voluntary markets. Many such projects rely on baseline scenarios about what would have happened in the absence of the project, and these baselines are notoriously difficult to verify in advance.

Another major problem is that these baseline scenarios can become unrealistic over time as conditions change, increasing the risk of over-crediting. In this sense, the presence of safeguards at the policy level does not guarantee that individual projects are accurately measuring carbon outcomes.

When REDD+ credits are used in international transfers or national-level claims, stricter standards become even more important. Questions of verification, additionality, tracking, and host-country alignment become central to whether such credits can be treated as credible mitigation outcomes.

Nationally Determined Contributions (NDCs)

NDCs outline countries’ strategies to reduce emissions and adapt to climate-related effects under the Paris Agreement. Countries are expected to update their NDCs every five years, with each update intended to increase ambition over time.

Each party to the Paris Agreement is expected to set out its NDC as an actionable plan and to implement monitoring procedures that allow progress to be tracked. When certain NDC targets depend on external financing, these are often referred to as conditional targets. When goals can be attained without external financial support, they are considered unconditional targets.

As countries develop programs for authorizing Article 6 transfers, many are prioritizing harder-to-abate sectors within conditional targets while reserving easier or cheaper mitigation opportunities for unconditional programs. In this way, countries seek to participate in Article 6 without undermining their own NDCs, especially where Article 6 transfers require corresponding adjustments.