The carbon market is a globally recognized mechanism for tackling climate change, but its international rules and technical jargon can make it seem difficult to understand at first.
This article aims to clear that confusion by explaining the basics of the carbon market, how carbon credits work, the two types of markets, the benefits for companies, and what to expect in the coming years.
Let’s explore the full picture of how the carbon market works—and how you can better understand and make use of it.
The carbon market refers to a marketplace where reductions in greenhouse gas emissions, such as carbon dioxide (CO₂), are traded as financial instruments known as "carbon credits."
These carbon credits serve as certificates that verify the reduction or removal of greenhouse gases by companies or individuals and are widely used internationally.
For instance, credits generated through activities like forest conservation, afforestation, the adoption of renewable energy (such as solar and wind power), the dissemination of clean cooking stoves, or the installation of methane recovery equipment can be purchased by other companies to "offset" their own emissions.
This system allows companies that find it challenging to reduce emissions to efficiently and cost-effectively achieve their climate change mitigation or carbon neutrality goals. The carbon market is managed under clear rules set by governments and international organizations. While participation is mandatory for certain industries under emission trading schemes, many companies and individuals voluntarily engage in the carbon market to promote sustainable practices.
Notably, one unit of carbon credit typically corresponds to the reduction, removal, or avoidance of one ton of CO₂ or its equivalent in greenhouse gases.
The carbon market operates by allowing the buying and selling of "carbon credits" generated through the reduction, removal, or avoidance of greenhouse gas emissions. Countries and companies can purchase or trade these credits to offset their emissions or meet their reduction targets.
This system mainly consists of two mechanisms: the Cap-and-Trade system and the Baseline-and-Credit system.
The Cap-and-Trade is a system in which governments or international frameworks set an upper limit (a "cap") on greenhouse gas emissions. Within this cap, emission allowances (credits) are allocated to countries or companies. If an entity emits less than its allocated credits, it can sell the surplus credits in the market. On the other hand, if it exceeds its limit, it must purchase additional credits. Examples of Cap-and-Trade include the EU ETS (European Union Emissions Trading System) and CORSIA (Carbon Offsetting and Reduction Scheme for International Aviation).
In a Baseline-and-Credit, a baseline—the amount of emissions that would typically occur without the project—is established for each project. Credits are issued for the amount of emissions reduced, removed, or avoided below this baseline.
Unlike Cap-and-Trade systems, this system does not impose a fixed cap on total emissions, offering greater flexibility. Because of this, the Baseline-and-Credit制度 is widely applied in projects such as forest conservation, renewable energy implementation, and methane recovery, and is primarily used in the voluntary carbon market.
Carbon credits can be created through three main approaches:
A key principle of the carbon market is that the Earth shares a single atmosphere; therefore, emission reductions have a global impact regardless of where they occur. This understanding allows countries and companies to flexibly engage in emission reduction efforts through the carbon market. By facilitating cross-border collaboration, the carbon market accelerates the reduction of greenhouse gas emissions worldwide. It is essential to comprehend the differences between systems and the quality of credits to utilize the market effectively.
While both carbon credits and carbon offsets aim to reduce or neutralize greenhouse gas emissions, they differ in their issuance entities, purposes, and trading mechanisms. Think of carbon credits as "permits to emit" and carbon offsets as "balancing out emissions."
Note: The term "carbon credit" can broadly include credits based on emission reductions or removals from activities like forest conservation or renewable energy adoption (offset-type). However, in this article, we refer to "carbon credits" in the context of emission allowances allocated by governments (carbon allowances).
A carbon credit is a permit to emit a certain amount of greenhouse gases, typically issued by governments or international organizations. It is also referred to as a carbon allowance, and it allocates companies a fixed amount of CO₂ emissions they are allowed to produce.
If a company exceeds its emission allowance, it must purchase carbon credits to cover the excess. Conversely, if a company emits less than its allocated amount, it can sell its surplus carbon credits to other companies.
This kind of system is characterized by vertical transactions between regulatory authorities (such as governments and international institutions) and companies. Well-known examples include the EU ETS (European Union Emissions Trading System) and CORSIA (Carbon Offsetting and Reduction Scheme for International Aviation).
A carbon offset is a mechanism by which companies or individuals compensate for their own greenhouse gas emissions by purchasing the emission reduction efforts of others.
For example, if a company implements a project such as forest restoration or renewable energy installation and successfully reduces 1 ton of CO₂, that reduction can be converted into a carbon credit and sold on the market. Another company can then purchase this credit to offset its own emissions.
This process involves three key steps:Emission reduction→Certification and issuance of carbon credits→Selling those credits to other parties
Unlike systems managed by regulatory authorities, carbon offset transactions are primarily horizontal, taking place between companies, and are most commonly used in the voluntary carbon market.
| Carbon Credit | Carbon Offset | |
| Issuer | Government or international institutions | Private project developers |
| Transaction Type | Vertical transactions (Government ⇄ Company) | Horizontal transactions (Company ⇄ Company) |
| Market | Compliance market | Voluntary market |
| Purpose | Regulatory compliance | Emissions offsetting (corporate goals, branding, etc.) |
Carbon credits and carbon offsets are similar but fundamentally different concepts. While both contribute to climate change mitigation, they are used in different contexts and governed by different rules. By understanding the distinctions between these two mechanisms, businesses and individuals can develop more effective carbon reduction strategies.
The carbon credit market is generally divided into two categories: the Compliance Market and the Voluntary Market. The Compliance Market is based on regulations and schemes established by governments or international authorities, while the Voluntary Market is driven by private sector initiatives, where entities voluntarily buy and sell carbon credits. Let’s take a closer look at the structure and characteristics of each market.
The Compliance Market is a carbon credit market regulated by legal frameworks established by governments or international organizations. Under this system, companies are allocated a carbon allowance, which permits them to emit a certain amount of CO₂. If their emissions exceed the allowance, they must purchase carbon credits to cover the excess.
The Compliance Market mainly targets large-scale emitters such as power plants, manufacturing industries, and airlines.
In these systems, companies use carbon credits to meet their legal obligations within the limits of their allocated emissions.
The Voluntary Carbon Market is a marketplace where companies, organizations, and individuals voluntarily purchase and trade carbon credits, even though they are not legally obligated to do so. It is commonly used as a means to support carbon neutrality, align with ESG investment goals, and enhance brand value.
These standards may also be recognised in certain compliance markets. Under these standards, emission reductions or removals achieved by projects are verified and issued as carbon credits, which can then be traded in the market.
In recent years, there has been a growing emphasis on nature-based solutions and alignment with Science-Based Targets (SBTs), prompting more companies to participate in the Voluntary Carbon Market.
Businesses, organizations, and individuals are increasingly using carbon credits as part of their climate action, net-zero goals, CSR efforts, and brand strategies.
| Carbon Credit | Carbon Offset | |
| Legal Obligation | Yes | No |
| Participants | Government or international institutions | Private companies and individuals |
| Purpose of Use | Regulatory compliance | Carbon offsetting, corporate strategies |
| Applicable Sectors | Power generation, manufacturing, aviation, etc. | Wide range of industries and individuals |
| Project Flexibility | Limited (regulated methods) | High (diverse mitigation approaches allowed) |
The carbon credit market is generally divided into two categories: the Compliance Market, which is used to fulfill legal obligations, and the Voluntary Carbon Market, which supports voluntary climate action by companies and individuals. Both markets have their own roles and value, and it is essential for organizations to choose the appropriate approach based on their climate strategy and relationships with stakeholders.
The carbon market offers more than just a way to reduce greenhouse gas emissions—it also has positive impacts on the economy, employment, and financial flows.
By introducing the concept of "putting a price on carbon emissions," the carbon market creates a system that links environmental responsibility with economic incentives, making it an effective tool for climate action. In this section, we’ll explore five key benefits of the carbon market, including: Encouraging behavioral change by pricing emissions, Reducing the cost of decarbonization. Promoting international consistency and credibility, Creating new business opportunities, Enabling cross-border cooperation between countries, companies, and regions.
In the carbon market, carbon credits are bought and sold based on the amount of greenhouse gas emissions. Under this system, companies or projects that reduce emissions can generate revenue by selling credits, while those that emit more must pay for the excess.
By providing financial rewards for emission reductions and imposing costs for excessive emissions, the carbon market makes decarbonization a practical and economically viable option for both companies and governments. This approach is a form of carbon pricing—assigning a monetary value to environmental impact that was previously treated as a free externality. It helps align economic behavior with climate responsibility, encouraging action through market-based incentives.
The carbon market helps reduce the cost of decarbonization.
While addressing emissions at the source is essential, doing so often requires massive investment and decades of technological development. For many companies and countries, these financial and time-related burdens are significant barriers to progress.
By participating in the carbon market, these burdens can be shared through the purchase of carbon credits generated by emission reduction projects carried out elsewhere.
For example, companies can purchase credits from renewable energy projects in developing countries, or offset emissions by supporting forest conservation and methane capture initiatives.
This allows businesses to complement their internal reduction efforts with cost-effective external solutions.
The World Bank has stated:
“Carbon markets help reduce the costs of transitioning to a decarbonized economy and mobilize much-needed finance.”
In short, by internationally sharing the cost of emissions reduction, the carbon market makes decarbonization more feasible and accessible—especially for small and medium-sized enterprises (SMEs) and emerging economies.
Source：World Wide Bank｜The World Bank Engagement Roadmap for Carbon MarketsWorld Wide Bank
By participating in the carbon market, companies and organizations can demonstrate their commitment to climate action in alignment with international frameworks, gaining greater trust and recognition from society and investors alike.
In particular, the international carbon market under Article 6 of the Paris Agreement enables countries to collaborate across borders, allowing the transfer of emission reductions between nations with differing capacities and financial resources.
For example, a company in a developed country can provide financing for a renewable energy project in a developing country, and apply the resulting emission reductions (carbon credits) toward its own climate targets.
This form of offsetting is increasingly viewed not just as compensation, but as a demonstration of shared international climate responsibility.
Additionally, various carbon credit schemes help link corporate action with national and global goals:
Leveraging the carbon market allows companies to implement net-zero strategies that are globally credible—enhancing their standing in ESG investing, international procurement, and broader sustainability efforts.
The carbon market creates new business opportunities by assigning economic value to emissions reductions. This allows businesses and project developers to turn decarbonization efforts into revenue-generating activities through the issuance and sale of carbon credits.
A wide range of projects are eligible for generating carbon credits, including: Renewable energy installations, Forest conservation, Clean cookstove distribution, Carbon removal technologies.
These projects not only help reduce emissions, but also open up revenue streams in the carbon market. Moreover, the development and operation of such projects stimulate employment in both technical and operational roles, including:Project design, construction, maintenance, education, and operations, Monitoring, reporting, and verification (MRV), Certification and auditing experts.
As a result, carbon markets contribute to the growth of “green jobs”, particularly in emerging economies and rural areas, where they offer a practical model for combining decarbonization with economic development.
The carbon market places value not on where emissions are reduced, but on the fact that they are reduced.
This approach enables flexible cooperation across national, corporate, and regional boundaries, fostering collaborative climate action.
This concept is clearly institutionalized in the international carbon market under Article 6 of the Paris Agreement, which allows for the transfer of emission reductions between countries.
For example, a company in a developed country can support a renewable energy or forest conservation project in a developing country, receive carbon credits based on the verified emission reductions, and use those credits to meet its own net-zero goals or contribute to the host country’s Nationally Determined Contributions (NDCs).
This model of international cooperation creates a cycle of mutual benefit:
In this way, the carbon market provides a practical and equitable framework for addressing climate change as a global challenge.
The carbon market is expected to continue expanding globally in the coming years.
The trend of assigning a price to carbon emissions—known as carbon pricing—is accelerating across the world, and the overall market size is increasing year by year.
According to the World Bank’s 2024 report “State and Trends of Carbon Pricing”, global revenue from carbon pricing reached a record high of USD 104 billion (approximately ¥15 trillion) in 2023.
These revenues are being used to fund climate action and nature-based projects around the world. The expansion of these systems indicates strong future growth for both the compliance and voluntary carbon markets.
Source：World Bank Group｜Global Carbon Pricing Revenues Top a ReWorld Bank Group
Private-sector analyses also point to a highly promising future for the carbon market.
Source：
As the market expands, the importance of high-quality carbon credits will only grow.
Credits must be backed by credible emission reductions, sustainability, and robust monitoring and verification systems.
Meeting these quality standards will promote investment, strengthen policy frameworks, and enhance market transparency, paving the way for healthy long-term growth.
Moreover, carbon credit-generating projects should deliver positive social and environmental outcomes.
It is critical that these projects avoid social and environmental risks while contributing to community well-being and nature conservation.
This approach will be essential to maintaining trust and credibility in the future carbon market.
The carbon market is rapidly expanding worldwide as a system that assigns economic value to greenhouse gas emission reductions.
Two main mechanisms are widely used: the Cap-and-Trade system, in which a cap is set on emissions and credits are traded within that limit, and the Baseline-and-Credit system, where projects generate credits by reducing emissions below a defined baseline.
Carbon credit transactions fall into two categories: compliance-based trading between governments and private entities, and voluntary offset trading between companies. The market itself is divided into compliance markets, which are regulated by law, and voluntary markets, driven by self-initiated climate action.
The carbon market brings benefits not only for the environment but also for the economy. For businesses, it offers tools for cost reduction, ESG alignment, and brand enhancement. For project developers and communities in emerging economies, it creates opportunities for revenue generation, job creation, and technology transfer.
Going forward, ensuring the quality of credits and sound system design will be essential.
Understanding the structure and functioning of the carbon market—and engaging as a credible, responsible actor—will become a source of competitive advantage in the era of decarbonization.
Disclaimer
This commentary is for informational purposes only and should not be considered financial, investment, or regulatory advice.. No assurances or guarantees are made regarding its accuracy or completeness. Views expressed are our own and subject to change
A market regulated by legal frameworks established by governments or international organizations. It mainly targets large-scale emitters such as power plants, manufacturers, and airlines, and is characterized by highly credible credits backed by strict MRV (monitoring, reporting, and verification) processes.
A market where companies, organizations, and individuals with no legal obligation voluntarily buy and sell carbon credits. It is used to support carbon neutrality, ESG alignment, and brand value enhancement.
A system in which governments or international frameworks set an upper limit (cap) on emissions and allocate emission allowances within that limit. Entities that emit less than their allowance can sell the surplus, while those that exceed it must purchase additional allowances. Representative examples are the EU ETS and CORSIA.
A system that sets a baseline, the expected level of emissions without the project, and issues credits for the amount of emissions reduced, removed, or avoided below that baseline. Because there is no cap on total emissions, it offers greater flexibility and is primarily used in the voluntary carbon market.
