What are carbon credits and how do they work?

Carbon credits represent a measurable and verifiable reduction, avoidance, or removal of one metric ton of carbon dioxide equivalent from the atmosphere . Carbon markets turn CO2 emissions into a commodity by giving it a price , creating a financial mechanism that channels investment toward climate solutions while allowing businesses and individuals to compensate for emissions they cannot yet eliminate.

Key Points

Each carbon credit represents one metric ton of greenhouse gas emissions that has either been avoided or removed from the atmosphere

• Carbon credits operate in two distinct markets: compliance markets mandated by government regulations, and voluntary markets driven by corporate sustainability goals

Projects must follow stringent assessment methodologies developed by recognized carbon standards organizations such as the Gold Standard or the Verified Carbon Standard

The two main types of carbon credits are avoidance credits and removal credits, each playing a crucial role in combating climate change

New guidance from global coalitions and frameworks such as the Science Based Targets initiative is clarifying how high-integrity carbon credits can complement sustained emissions reductions

Understanding Carbon Credits

Carbon credits have emerged as one of the most widely used tools to support the transition to lower emissions, enabling climate action through market-based mechanisms rather than regulation alone . The concept traces its roots to international climate agreements. The Kyoto Protocol of 1997 and the Paris Agreement of 2015 were international accords that laid out international CO2 emissions goals, with the latter ratified by all but six countries, giving rise to national emissions targets and the regulations to back them .

The process begins with project developers designing projects with the aim of avoiding or removing carbon dioxide emissions, and each ton of carbon dioxide equivalent avoided or removed by the project activity is represented by a carbon credit, which is issued to the project developer . These projects include afforestation, biochar, blue carbon removal and renewable energy production, and are rigorously assessed and verified to ensure they result in real and measurable emissions reductions or removals, with credits issued in proportion to the amount of carbon dioxide equivalent they prevent or remove from the atmosphere .

Carbon credits fall into two broad categories depending on the market in which they are used: compliance credits are used within regulated systems where governments set emission caps and companies that exceed their allowed emissions must purchase credits to remain compliant, forming the backbone of national and regional emissions trading schemes . Voluntary credits are purchased by companies or individuals seeking to reduce their climate footprint beyond legal requirements, and the voluntary carbon market supports a wide range of projects from renewable energy to nature-based solutions .

How It Works

1. Project Development and Design: Project developers design projects with the aim of avoiding or removing carbon dioxide emissions, choosing to follow a stringent assessment methodology developed by a recognized carbon standards organization such as the Gold Standard or the Verified Carbon Standard, which assess the real-world emissions reductions or removals and measure impact in tons of carbon dioxide or carbon dioxide equivalent .

2. Verification and Certification: Projects are generated by verified climate action projects that adhere to rigorous international standards, such as Verra's Verified Carbon Standard or the Gold Standard . Standards bodies such as Verra, Gold Standard, American Carbon Registry and Climate Action Reserve are crucial for ensuring the integrity of the voluntary carbon market, establishing rigorous methodologies and standards that outline the eligibility criteria, rules, and carbon accounting frameworks for carbon projects . Key criteria for a high-quality credit include that emission reductions must genuinely occur and be proven (real), and the project's emission reductions would not have happened without the finance generated from carbon credits (additional) .

3. Credit Issuance: Carbon credits are issued by carbon standards, which are organizations that set the criteria projects must meet to earn credits, with each carbon standard having its own methodologies and requirements . Once validated and verified, projects receive tradable credits that can enter either compliance or voluntary markets.

4. Trading and Retirement: Voluntary carbon credits trade in decentralized markets through various channels, with project developers able to sell credits directly to an end buyer, work with brokers, or list them on specialized platforms, and unlike compliance markets, the voluntary carbon market operates without centralized regulation, allowing for flexible transactions . When a buyer uses a credit to compensate for their emissions, the credit is permanently retired and cannot be resold.

Why It Matters

A major benefit of voluntary carbon projects is that they don't rely on government support but instead rely on climate finance from businesses and individuals who purchase carbon credits to take responsibility for their footprint by contributing to global greenhouse gas reduction, providing a way for businesses and individuals to drive carbon reduction and sustainability independent of the politics of the moment .

As climate ambition accelerates globally, the carbon market enters 2026 with renewed momentum, with integrity standards rising, supply evolving, and new policies formalizing the role of carbon credits in corporate net-zero strategies . Beyond their climate impact, these projects often deliver additional co-benefits, like empowering communities, protecting biodiversity or improving public health . The market continues to mature, with increasing emphasis on quality, transparency, and measurable climate impact.

Related Terms

• Cap-and-Trade: A regulatory system where companies must either reduce their emissions or purchase allowances from others, operating under a cap-and-trade system .

• Additionality: The principle that a project's emission reductions would not have happened without the finance generated from carbon credits .

• Carbon Offset: A reduction in emissions made to compensate for emissions occurring elsewhere, typically through the purchase and retirement of carbon credits.

• Verification Body: Third-party organizations that establish rigorous methodologies and standards for climate projects .

Frequently Asked Questions

What's the difference between carbon avoidance and carbon removal credits?

Avoidance credits prevent future emissions from entering the atmosphere, while removal credits actively extract existing carbon dioxide, with avoidance focusing on prevention and removal focusing on extraction and storage . Carbon avoidance is an action that prevents a carbon-emitting activity from happening, carbon reduction is an action that decreases the amount of greenhouse gas emissions compared to prior practices, and carbon removal is the process of removing carbon dioxide from the atmosphere and locking it away for decades, centuries, or millennia .

How do compliance and voluntary carbon markets differ?

Compliance carbon markets are regulatory systems that command specific industries to cap or reduce their GHG emissions, operating under a cap-and-trade system where companies must either reduce their emissions or purchase allowances from others . Voluntary carbon markets allow businesses and individuals to offset their emissions by purchasing carbon credits voluntarily, usually as part of corporate social responsibility initiatives or to achieve sustainability goals . The voluntary carbon market uses a project-based system in which there is no finite supply of allowances, and within the VCM more carbon credits can be created through the development of environmental projects .

What makes a carbon credit high-quality?

A high-quality carbon credit represents a genuine, verifiable, and permanent climate benefit, with key criteria including that emission reductions must genuinely occur and be proven (real), and the project's emission reductions would not have happened without the finance generated from carbon credits (additional) . Projects must also demonstrate permanence, accurate quantification, and avoid double-counting of emissions reductions.

Last updated: June 18, 2026. For the latest energy news and analysis, visit stakeandpaper.com.