A carbon credit is a licence to emit one tonne of greenhouse gases into the atmosphere.
These tradable credits are produced by firms in developed nations that pollute less than their quotas as defined under the Kyoto Protocol, or by companies in developing nations that voluntarily reduce emissions and sell the resulting 'credit' to buyers in developed countries, which may then pollute in excess of their quota.
The Clean Development Mechanism (CDM) is the programme encompassing the generation of Certified Emission Reduction credits.
The goal of the CDM is to encourage the transfer of wealth and technology from developed to developing countries while reducing global emissions.
Firms in Europe and Japan have quotas for the quantity of greenhouse gases they can emit set by the United Nations. They are allowed to meet a small portion of their quota through buying offset credits via the CDM.
In many cases it is cheaper for a European company to make a reduction in emissions in a developing country than at their own facilities.
They find potential projects in countries such as the mainland, Brazil, or India. A third party quantifies the emission reductions and calculates how many credits it will produce, and once the project is underway the owner and buyer or middleman share the profit from selling the credits. The buyer can then apply these credits to their emission quotas in their home country.