A carbon credit is a trading unit that represents one metric ton of reduced, avoided or removed greenhouse gas emissions. Credits are used by companies or individuals to offset their own GHG emissions. Each credit has an exclusive claim on the corresponding GHG emission reduction or sequestration, and is only valid until it is “retired.” When a credit is retired, it becomes ineligible for trade. This process is typically triggered by a project reaching its intended life span or the achievement of the claimed GHG emission reduction or sequestration.

The carbon credit exchange was shut down in 2010 following a sustained period of flat trade volumes and negligible penalties for noncompliance with emissions reduction targets. The CCX’s failure was widely attributed to flaws in the market design and its system for linking corporate emissions reduction commitments with market activity. These weaknesses were evident throughout the CCX’s existence, but they became especially pronounced as global companies began to make voluntary commitments to invest in carbon reduction projects.

Many governments and states run cap-and-trade programs to encourage corporations to reduce their greenhouse gas emissions. In these markets, regulators set a limit on total emissions — the cap — and issue credits to businesses that reduce their output below the cap level. Firms that exceed their emissions reduction target can bank or sell excess credits to stay within the cap. In the United States, California’s program is the most prominent example. Other caps are in place in the European Union, the United Kingdom, Australia and New Zealand, while several other countries and states are considering carbon trading systems of their own.

There are two main types of carbon credit markets: voluntary and regulated. Voluntary carbon markets operate outside of a government-backed program, and are open to any business or individual that wants to buy or sell emissions reductions. These markets are often criticized for being unregulated and opaque. They are also more difficult to navigate than regulated markets, as there are numerous brokers, rating agencies, standards and projects all acting in the same space. The overlapping roles of these actors creates significant barriers to entry for businesses that are not already familiar with the space.

In the voluntary market, a company looking to offset its GHG emissions can work with a broker that specializes in sourcing carbon credits from various sources. The broker will then sell the credits to an end buyer, which can be either a corporation or an individual. Brokers charge a commission for their services, and the price of carbon will fluctuate depending on supply and demand.

The remaining part of the carbon credit marketplace is made up of projects that are developed to produce a specific quantity of carbon credits. These projects are grouped into four categories by their method of carbon capture: avoidance, forestry, reforestation and geological storage (underground). Credits produced by reforestation and forestry projects tend to trade at a premium to those from industrial projects, due to the fact that these types of projects often provide additional co-benefits.