Marketplaces and exchanges are both crucial for facilitating the trade of environmental assets. Although the terms are often used interchangeably, marketplaces and exchanges provide different functionality and cater to different use cases. In this post, we define marketplaces and exchanges and walk through how they can support each other in environmental asset markets.
What are marketplaces?
A marketplace is a meeting point where buyers and sellers interact to trade goods and services. They can be physical spaces – like Istanbul’s Grand Bazaar or a local farmer's market – or digital platforms, such as eBay or Amazon. Marketplaces are usually used to trade illiquid assets that do not have enough quantity or volume to require high-frequency trading or consistent updates in pricing.
In the context of environmental asset trading, marketplaces allow project developers or intermediaries to list their available credits and organizations seeking credits to browse these assets and make purchases. They provide an easy-to-use interface for corporates (the primary end users of environmental assets) to interact with the market. Examples of environmental asset marketplaces include Salesforce’s Net Zero Marketplace, Patch, Cloverly, and ClimateTrade, while in the regenerative finance (ReFi) space Atem, Thallo, Senken, Carbonmark, Regen Market, and Nori are good examples. Most digital marketplaces aggregate sell-side orders, although some, such as Atem, focus on aggregating buy-side orders for sellers to execute against.
Marketplaces can generate listings through several methods, including inventory acquisition, user input, or interaction with liquid instruments. Inventory acquisition involves the marketplace sourcing and purchasing a desirable asset and listing it for sale. It is capital intensive but provides users with guaranteed execution and stable listings, as well as acting as a revenue stream for the marketplace as it likely sells the credits for higher than their acquisition cost. Inventory acquisition can also be used to corner the market and force participants to interact with the platform if they want to access certain credits.
Generating listings via user input moves the capital requirements from the marketplace to its users, as users add their own listings to the platform (e.g. project developers or brokers listing their available credits). This approach requires a strong ecosystem with high-quality assets to be effective.
The use of liquid instruments, such as pools, is a relatively nascent method for generating marketplace listings. It involves the marketplace listing the underlying assets available within the instrument and using the instrument to acquire the credits after an order is placed on the marketplace. This approach does not require marketplaces to take on personal inventory and provides them with reliable execution. However, they have less control over the projects available within the liquid instrument as the pool’s composition is up to the discretion of the market participants using that instrument. This means that marketplaces utilizing liquid instruments may have a wider range of assets available for trading at lower costs but will not be able to curate the listings as tightly.
To use liquid instruments for asset listings, the marketplace needs some level of certainty around the credits being traded within a liquid instrument and their availability. Contracts do not guarantee specific projects prior to trade execution and settlement, so cannot be used for this kind of activity by marketplaces. Pools, on the other hand, do provide a collection of known underlying assets and their corresponding quantities that can be redeemed at a user’s discretion. These unique features of pools allow them to be used by marketplaces to list assets without having to take on inventory for those listings. You can learn more about liquid instruments in environmental markets in our ‘Unlocking environmental asset liquidity’ blog.
What are exchanges?
An exchange is a type of trading venue where liquid instruments such as stocks, commodities, and derivatives are traded. Traditionally, exchanges run an order book or a list of buy and sell orders that are matched with a matching engine and settled via a clearing house or other mechanism; however, other exchange types such as Automated Market Makers (AMMs) have recently gained prominence.
Liquid instruments have a large number of orders and exchange infrastructure needs to be able to handle them, i.e. aggregate a high volume of market intent and produce a market price as a result. Traditional exchanges do this by running a matching engine against orders, with market makers filling in gaps in orders to increase the frequency of order matches.
The reliance of order book exchanges on market makers to fill orders with reasonable timing requires that the specifications of the order book exchange facilitate market-maker interaction. This means high-frequency matching and settlement. Other types of exchange, such as AMMs, get around this by producing prices algorithmically. They come with another set of tradeoffs and considerations that are beyond the scope of this piece.
Well-known exchanges include the New York Stock Exchange, the Nasdaq, and the Chicago Mercantile Exchange. In the context of the Voluntary Carbon Market (VCM), the main exchanges are XPANSIV’s CBL Market and AirCarbon Exchange. In the ReFi space, Neutral will act as an exchange for the next generation of liquid instruments. These exchanges create liquid instruments (e.g. N-GEO on CBL Market) and provide the necessary infrastructure to trade such instruments. The intended outcome of liquid instruments on exchange infrastructure is to produce reliable pricing and provide a venue where intermediaries can execute large trades easily.
Marketplaces and exchanges in environmental markets
The liquidity of an asset and its target audience will determine whether a marketplace, exchange, or both are best suited for the assets and audience. In the context of environmental asset markets, marketplaces are necessary for corporates and other offsetting entities, as they require an easy-to-use platform and care more about the project they are acquiring and its characteristics than the details of the liquid instrument through which it is traded. Marketplaces can accommodate a diverse set of assets (both liquid and illiquid) and be targeted at specialist buyers without the need for a liquid instrument. On the other hand, exchanges must cater to financially sophisticated clients that provide intermediation services and pay close attention to the characteristics of the liquid instruments they trade and the infrastructure they are traded on.
In terms of the evolution of most markets, assets in illiquid markets are traded on marketplaces and over-the-counter until market size increases and liquid instruments become prevalent. Environmental asset markets are following a similar market evolution.
This transition to liquid instruments in environmental markets has been slow due to difficulties with creating effective instruments. Carbon credits, renewable energy certificates, and carbon forwards theoretically represent similar outcomes (e.g. a tonne of CO2 sequestered) but have specific characteristics of interest (e.g. methodology, location, and execution against that methodology) that make them semi-fungible in nature. Instruments to date have treated these assets as homogenous commodities and have failed to capture a large portion of trading activity. Instruments that have stringent acceptance criteria and discriminatory logic for aggregating a wide range of assets are under development and should usher in a new evolution in environmental asset markets.
As these markets transition to liquid instruments and are being traded on exchanges, we should see more accurate pricing emerge. Exchanges generate more accurate pricing because prices are generated from the aggregation, matching, and execution of a large number of orders, i.e. from broader market consensus, in contrast to prices generated at the discretion of a few market actors. Marketplaces can then use the prices generated on exchanges as benchmarks to inform the pricing of their own listings.
Price discovery from exchanges can either directly or indirectly influence asset pricing on marketplaces. If marketplaces are listing assets not tied to liquid instruments then the liquid instruments can be used as benchmarks to inform pricing, similar to how they inform over-the-counter markets. Their use as a benchmark will depend on the effectiveness of their design. If a marketplace uses liquid instruments to list projects, then the pricing of the liquid instrument and its underlying assets directly inform prices for listings.
As the prevalence and effectiveness of liquid instruments increases, marketplaces will need to consider how to integrate these instruments into their platforms. In the absence of such integration marketplaces have to rely on their own balance sheets or user input. Using liquid instruments allows marketplaces to take advantage of available assets without having to include them on their balance sheet or rely on third parties. Ironically, as the technological sophistication of this market increases and access is democratized, marketplaces will have to compete on the non-technical aspects of their business. In the future, the tech seems likely to take a back seat compared to the quality of their white-glove service or their ability to help their clients navigate and understand the credits they’re interacting with.
As the market matures, the interoperability of marketplaces and exchanges will grow and both will provide key market functions. As a blockchain-enabled exchange, Neutral is building out the infrastructure to trade liquid instruments and working with partners to design the next generation of instruments. We are seeking to supercharge marketplaces in all of their variations by creating a more interconnected and efficient environmental asset liquidity and execution layer. Marketplaces have played and will continue to play a key role in the VCM as they help offsetting entities navigate the wide range of available credits. We’re excited to help accelerate their growth and to give traders the tools to navigate these markets more effectively.