Carbon trading is an activity of buying and selling carbon credits, in which typically the buyer produces carbon emissions that exceed the specified limit, or have their personal target to become a net zero or carbon neutral individual or company. A carbon credit is a representation of the 'right' for a company to emit a certain amount of carbon or other greenhouse gas emissions in its industrial processes. One unit of carbon credit is equivalent to a reduction in emissions of 1 tonne of carbon dioxide (CO2).
The carbon credits sold generally come from green projects, such as conserving or restoring forest area, conducting sustainable agriculture practices and generating electricity from renewable energy. Verification agencies, such as Verra, Plan Vivo, Gold Standard, will calculate the carbon sequestration capacity of forest land in certain projects and issue carbon credits in the form of certificates.
Broadly speaking, carbon emissions are currently traded voluntarily (voluntary carbon market) and mandatory (mandatory carbon market). When viewed from the trading mechanism, the carbon market can be divided into two types, namely The Emissions Trading Scheme (ETS) and Carbon Credit trading scheme.
The ETS is also known as the cap-and-trade system. This scheme is generally applied to the carbon market which is mandatory because the amount of carbon emissions traded is limited by the government. In this scheme, the traded emissions are for emissions that will be produced in the future. Participants in this market mechanism consist of organizations, companies, and even countries.
Meanwhile the carbon credit trading scheme does not require quotas (allowances) at the beginning of the period, because what is used as a commodity (referred to as carbon credits) is the result of certification of carbon emission reductions due to the implementation of projects that reduce carbon emissions. One unit of carbon credit is usually equivalent to a reduction in emissions of one tonne of CO2. In the carbon credit scheme, the credit value is obtained at the end of a period (ex-post) which can be sold and used by participants to meet emission reduction targets or make participants' positions become carbon neutral or zero emissions.
Source: ICDX Group