Originally published at The Data-Driven Investor on June 17, 2020: https://www.datadriveninvestor.com/2020/06/17/blockchain-reduces-risk-and-costs-in-trading-commodities/
This article is the second in a series on exogenous and endogenous assets tracked on the blockchain. For a definition of these topics, as well as a general discussion about distributed ledger technologies (DLTs), we recommend starting with the first article in the series, Beyond Bitcoin: Assets Off The Chain.
We'll cover the current implementations of DLTs in the commodities sector, including trade and supply chain management. We will discuss some of the companies that are cornering blockchain-based services in the commodities space.
The commodities space is enormous, and so is the potential for disruption.
The primary assets that exogenous distributed ledgers track are commodities, also known as producer goods or raw goods. These goods touch each point of our everyday lives ranging from the coffee or tea we drink to the tables on which we set our cups. Therefore, global commodity trade financing comprises some 80-90% of global economic activity: it is a cornerstone of our modern lifestyles.
Such colossal amounts of commercial activity entail many different counterparties at each step of the process. These parties often have proprietary methods for ensuring quality, quantity, and other factors of their shipped or received commodities. These siloed assurance models entail inflated costs, long timetables, and sometimes unexpected delays for all parties involved, inflating the cost of doing business in commodity trading and trade financing. Exogenous distributed ledgers are utilized in several ways to break down these silos of assurance and reduce bid-to-delivery times, counterparty risk, and overall cost in commodity trading and trade finance.
Below is an infographic provided by Datex that breaks down the level of interest by 3PLs (third-party logistics providers) and shippers in blockchain applications for different areas of the supply chain.
The 2018 study by Datex exhibits how more than 60% of 3PLs and shippers surveyed do not yet understand blockchain enough to make a statement about its usefulness at this time. Blockchain solutions remain a novel idea for the industry as a whole. Perceived trust in blockchain applications is growing among the surveyed groups, with about 14% of both 3PLs and shippers waiting to see the initial results from early adopters. 3PLs perceive the benefits of blockchain but cannot yet quantify the impact it would have on their business. Interestingly, only 3-6% of those surveyed think blockchain applications will transform the way business is already done.
The areas of interest in blockchain applications are highest for improving traceability and transparency in the industry. About 30% of those surveyed have no interest in blockchain activities.
An overview of companies transforming the commodities space
Some of the most significant participants in the commodity trading industry, such as BP, Chevron, ING, and more, are employing blockchain in the form of Vakt. This commodity trading platform promises to deliver up to 40% cost savings for clients.
Vakt seeks to bridge the existing silos in the commodity trading industry by utilizing a trustless blockchain architecture to connect parties that desire specific commodities and sees the process through from the first contact to contract fulfillment. Vakt takes up the responsibility of managing the exogenous distributed ledger by allowing only specified parties at specific points of the transaction to enrich the ledger with relevant information such as arrival, departure, and audit data.
Watch this video for a rundown on how Vakt works.
Establishing reputable credit for all parties is a critical part of commodity trading that is known as trade finance. Komgo, another company backed by commodity industry titans and global banks such as Citi, Shell, and ING, streamlines the process of credit assurance. With over one hundred corporate entities and one thousand unique users, Komgo has not only processed some contracts on behalf of industry partner Vakt but is poised to continue rapid development in the trade finance industry during the coming years. The thirteen global banks that comprise Komgo make it one of the largest liquidity pools for global commodity financing.
Energy is perhaps the essential commodity to the global economy, powering everything from toothbrushes to the ships that deliver the products themselves to markets around the world. Energy firm giant EY has issued a report that estimates 30-60% savings are achievable amongst various energy industry participants by leveraging blockchain technology. Oil, an otherwise stable market, demonstrates just how volatile specific commodity markets can become when otherwise inelastic sectors experience high sigma events. The recent Black Swan event of COVID-19 led to WTI Crude futures contracts posting negative, highlighting the need for a more robust and real-time pricing mechanism for this critical commodity. IBM offers a consortium of services surrounding blockchain technology that seeks to optimize the process of oil and gas transactions in the global commodity marketplace.
The quality and quantity of the commodities shipped across the world's oceans often change very little, if at all, during transportation. Despite this fact, both shipping and receiving parties must take meticulous stock of outgoing and incoming cargo, corroborating with one another to ensure that there are no discrepancies between participating parties. This auditing process takes time and money, negatively impacting all participants' bottom lines and often results in these costs impacting the recipient in the form of higher-priced producer goods and the end-user in the form of higher-priced consumer goods. The application of exogenous digital ledger asset tracking and management is helping to undercut these long settlement times in various ways. ZIM, a global shipping company, has reduced the wait time for offloading commodities that arrive at international ports from days or weeks to as little as two hours by introducing paperless Bill-of-Landing forms that assure the received goods.
Additionally, global logistics firm Maersk is using blockchain-enabled tracking tools to assist in governing a fleet of over 235 vessels. While the pandemic mentioned above has slowed worldwide shipping, it has done little to slow the optimizations afforded to the industry via exogenous blockchain applications. Agrocorp, Cargill, and Rabobank have managed to ship agriculture products across the world during this global health crisis in just five days. While the world seems poised to enter a commodity bear market, the potential applications for exogenous blockchain tools in both commodity trading and trade finance seem to be only increasing.
Downsides to implementing distributed ledger systems in the commodity industry
Despite diverse applications and optimistic attitudes about exogenous distributed asset management, there are several potential downsides to these current and potential applications. A highly calibrated trade finance environment will likely result in decreased arbitrage opportunities for commodity traders and financial institutions alike. This shrinking arbitrage may seem of little consequence. In a complicated and globalized economic system, this negative impact on underlying liquidity in global finance may further isolate national economies from one another in unexpected ways. A significant increase in IT investment is needed to ensure that the emerging blockchain platforms that aim to serve the global commodity and trade finance industries are robust and secure. Without such investment, these otherwise beneficial entities will only help to create a more brittle, siloed interface with clearer vectors of attack for malicious actors.
Transparency may seem to be an objective good, but in the highly competitive marketplaces of global commodity trading and trade finance, proprietary information is an invaluable asset. Participation in an open ledger divulges information about bids, asks, and other price-sensitive data. While this benefits the participants, it can also serve as a double-edged sword that gives competitors a window through which to peer into immediately relevant financial information. Regulatory uncertainty is also an ever-looming force with which industry titans and minor players alike must grapple.
The most successful commodity and trade finance platforms that utilize exogenous distributed asset management platforms will include regulatory bodies at each step of the process. This inclusion of government entities will ensure compliance and help to shape the emerging industry as a whole.
Closing thoughts on tracking commodities with blockchain technology
We have explored several platforms backed by major industry players utilizing exogenous distributed systems, mostly in the form of blockchain, to track and manage their commodity and financial flows. Uncertainty still plagues these diverse industries in how to apply this emerging technology. Despite this lack of clarity, the race has begun; the world's largest commodity firms, global banks, and financial institutions have started to stake their claim in the fertile new land of distributed systems.
In our next installment in this series, we will explore how the recent technology of exogenous distributed systems interfaces with more tangible, fertile land in the form of agriculture and land management. We'll also encounter many smaller companies that are making outsized changes in terms of distributed system applications.