Enabling Climate Finance at Scale—Investing in Neutral Labs

Enabling Climate Finance at Scale—Investing in Neutral Labs

Oct 11, 2023 6:52 PM
Posted by

Jahed Momand & Matthew Stotts

Scaling investment in solutions to climate change requires price-efficient spot markets, plentiful and deeply liquid derivatives to allow market participants to hedge their risk, and trustworthy, integrated marketplaces across web2 and web3 ecosystems to enable asset access and variety. In addition to this, carbon markets specifically suffer from fraud and abuse due to double counting and limited participation from a small number of big players leading to most transactions being over-the-counter (OTC). Commodity trading firms complain about market fragmentation in assets and asset standards. Project developers cannot get a market price for assets they want to bring to market, making it difficult to fund new projects. Buyers, corporate and otherwise, are weary of greenwashing.

Neutral Labs seeks to address market fragmentation, price discovery, hedging, and liquidity for green assets by building the first cross-chain, blockchain-agnostic order book and matching engine. They will offer spot and derivative instruments with physical settlement which will enable buyers of credits to lock in price for their offsetting schedule, and for sellers to lock in prices to fund their projects. Neutral will provide a superior user experience (UX) by abstracting the complexities of on-chain interaction, and enabling traders and buyers to focus on the assets and not on custody, security, and bridging. In addition, they will enable pooling with semi-fungibility, capturing the unique specificity of carbon credit data and methodology without sacrificing liquidity.

The two most popular climate-related assets that will be traded on the Neutral platform are carbon and renewable energy credits. Carbon markets can be split into two segments: compliance (cap and trade programs) and voluntary (elective offsetting by corporates). Total value of compliance is $850 billion in 2021 (up from around ~$270 billion in 2020 – a ~2.5x increase in one year). The growth in compliance markets is astonishing (~$600 billion in value added in one year) and is expected to grow significantly into 2030 as emission caps become more aggressive and emission prices are set to nearly double through 2025 with projections that it will be a multi-trillion dollar market.

Voluntary markets (VCMs) are a nascent segment of carbon markets with a value of $2 billion (up from $500 million in 2020 – a ~4x increase). Despite the macro downtown this year, the VCM’s 2021 value was passed in August of this year (2022) with expected growth of 50-80% YoY in 2022 as demand rebounded in Q3 and Q4 of this year. Projections place VCMs at anywhere between $35-50 billion by 2030. Given historical growth, momentum behind climate commitments, and increasingly aggressive caps, many are expecting that carbon markets (compliance + voluntary) will balloon into a multi-trillion dollar asset class by the end of the decade with the largest commodity firms bulking up their carbon trading teams (including Vitol Group, Trafigura, Glencore).

Neutral’s success in riding this trend and growth, will come from enabling the pricing of public goods such as carbon sequestration and renewable energy production, as well as providing mechanisms to fund these incredibly important activities. A market that is currently largely OTC can greatly benefit from open price-discovery—project developers can understand the market price of a project delivering carbon for a specific year by methodology, and corporates can lock in price to meet their net zero goals, enabling the entry of massive amounts of liquidity directed at climate action. Neutral is focused on enabling finance in climate action at scale.

Equity investors have substantial carbon risk in their portfolios due to climate risks and scenarios, therefore there is a huge potential market for carbon derivatives to hedge underlying risk in markets such as the energy sector. You do not have to own carbon credits to be exposed to carbon price fluctuations—they’re already in your portfolio and there are limited abilities to hedge. Neutral will bring the ability to hedge to the portfolios of the world’s biggest institutional investors and traders, opening a potential $100bn+ market opportunity.

What is Neutral?

Spot Exchange

Neutral’s order book exchange is designed specifically to provide a reliably price feed for on-chain natural assets, so that lending markets and derivatives can be built on top to power trading activity. By building this as a high frequency order book executed off-chain, it will enable direct interaction between buyers and sellers such that Neutral will corner the market on more reliable pricing—not just in web3, but for carbon and RECs as an asset class, wherever they appear.

By conducting trading off-chain, they will allow for extremely fast time-to-finality (TTF) with a superior UX to anything that is currently provided on-chain. The spot exchange will be a price generating exchange (in contrast to price-taking marketplaces) and can be used to trade partner's pools to improve pricing and on-chain operations, providing a reliable price feed for money markets and derivative instruments.

Why did we invest?

Neutral has the technology chops and go-to-market expertise that we love to see in teams we back.

Demand-side Distribution Strategy

There are two primary segments of customers on the buy side of the platform: carbon traders and financial institutions looking to hold and hedge natural asset positions. This is an early stage venture so the demand-side go-to-market is in the territory of “do things that don’t scale”. This means that the team is conducting one-to-one user research and designing growth experiments to target these two customer segments (financial institutions and carbon traders) with their existing relationships, get in front of them and sell them on the platform, or gather intelligence on what can be improved to meet their needs. Cold-calling, industry conferences, prototype feedback, and more will be done from the perspective of customer development to ensure that institutional requirements are met.

Supply-side Partners

An order book strategy to build price transparency requires supply. Neutral has preemptively addressed this by signing exclusive partnerships for on-chain supply providers, including Flow Carbon, Toucan Protocol, Senken, Jasmine Energy, and Atem.Earth. This will give them access to nearly 200 million credits (renewable energy and carbon) at launch, giving Neutral twice the inventory of all credits traded on CME Group and making them immediately competitive with the most valuable private market comparables in our market research.

What will come next is engaging with real world supply partners vs. exclusively on-chain, web3 native supply. Ultimately, we see their success being agnostic of the underlying technology—if they can aggregate supply by aggregating demand, they can get the most transparent, accurate price, and settle faster than anyone else in the market. The protocol being built on a web3 basis is secondary.

Of course, at the end of the day we back founders, and we love this team. CEO and co-founder Farouq Ghandour has worked with some of the largest tech companies such as Microsoft, Amazon, and Meta to build out product strategies, as well as hands-on experience building DeFi products. He has a B.S. in Physics and Economics from Yale, is on-leave from the MPhil program in Economics at the University of Cambridge.

CTO and co-founder Piotr Kosinski has 15+ years of experience as a software engineer and has led engineering teams from 10 to 100+, at Advanced Blockchain as well as Energy Web. Piotr has built out energy trading systems for Nordic countries, order book exchanges for renewable energy credits, and DeFi protocols (he was one of the early contributors to the ETH ecosystem). He has an M.S. in microelectronics from Gdansk University.

The team Neutral have assembled is strong across the board, with engineers and designers that have experience optimizing order books for large energy trading firms, building out derivative protocols, and providing security to leading players in blockchain.

Nothing contained herein constitutes investment, legal, tax or other advice nor is to be relied upon in making an investment or other decision. This article contains the opinions of the author, and such opinions are subject to change without notice. Furthermore, it may also include data and opinions derived from third party sources. Cerulean Ventures does not accept liability for the accuracy or completeness of any such information or opinions which can be subject to change without notice.