How Commodities Markets Will Be Changed by Blockchain Technology

The financial markets have been especially enthusiastic about the potential blockchain technology can bring in terms of both profit-generating opportunities as well as transforming how these industries operate. One of the oldest forms of financial markets is the commodities market, which has existed in some form or another for hundreds of years. Ancient farmers, seeking to protect themselves from any volatile price swings in their crops, hedged themselves by creating fixed-price agreements that were traded on a central exchange — also known in today’s world as a future contract.

The point is the commodities markets have historically been a source of innovation, even though as an asset class commodities have fallen in favor among speculators for the more exciting financial instruments such as securities, derivatives, and bonds. Blockchain technology, which is already becoming commonplace among gold traders, can help change this.

While this technology won’t necessarily cause changes in the price of commodities themselves, the applications of this technology can help secure new ways of exchanging materials as well as open up new channels of trade among participants that wouldn’t otherwise exist. In addition, we could see an increase in liquidity and transparency in a market that is known for being quite the opposite at times.

The Gold Situation

As mentioned earlier, gold traders have jumped onto blockchain-powered applications to help them facilitate transactions. Gold has historically been the most liquid commodity traded, but as of last year, a purchaser can own physical gold as a digital asset in an electronic wallet that’s transferable to any other wallet on the platform. While there are many possible ways for investors to trade gold, whether it be futures and options, indices, or simple physical gold, blockchain technology has the ability to bring together the various market participants (from the miners, traders, refiners, investors, financial institutions, and even retail sellers).

The Chicago Mercantile Exchange, along with the Royal Mint, worked together to create the Royal Mint Gold blockchain, a token that represents physical ownership of gold. Another project, supported by Citigroup, Scotiabank, and other banks have completed a pilot for a blockchain-based gold trading platform developed by Euroclear. Nor is this the only gold-oriented blockchain solution coming onto the market either, but while players in the gold market remain the most open to blockchain, other commodities are slowly opening up to blockchain solutions for a variety of reasons.

Increased Security

Despite it being the 21st-century, the commodities markets have traditionally utilized less-sophisticated methods of data-entry. Before blockchain came onto the scene, transactions were recorded in an accounting ledger, with these entries getting compiled into spreadsheets and databases that would be stored on physical hard drives. This can be dangerous and physically-housed data isn’t secure. Information can include human clerical errors, get tampered with, or even deleted accidentally.

By using digitally distributed ledgers instead, physical servers and databases can be replaced with blocks that exist on multiple computers and networks in different locations. This acts as a safety mechanism, ensuring the information is both transparent for everyone to see as well as impossible to alter. Cryptographic proofs seal the order of transactions onto the blockchain, eliminating any disputes that might arise over the sequence of events. With no central authority in charge of authenticating arrangements, every participant in the chain is equal with the same access to transparency as everyone else.

Transparency in the Supply Management Process

Unlike other markets such as equities or bonds, commodities markets involve the actual trade of physical goods. Because of this, commodities markets have been able to avoid much of the regulatory scrutiny that befalls traditional financial markets since many of the areas where commodities are produced, stored, and shipped, are outside the country or impossible to regulate from start to finish.

This also means that from beginning to end, a typical commodities shipment involves not only mines, smelters, refiners, and end purchasers, but also an interconnected web of ships, trains, warehouses, and factories. What makes this more complex is that during the weeks or months a commodity is sitting on a barge, train, or factory, its ownership can change multiple times. What this means is that it can be a hassle for commodity owners to fully track where their shipments are at any period of time.

Blockchain can help drastically improve the transparency of this process, as shipment details could be recorded into a block along every stage in its journey similar to how shipping companies such as UPS track each individual parcel. Once a commodities contract has changed hands, a token can be transferred as well that contains all the shipment details. From there, the owner of a commodities contract can monitor in real time the location of a shipment.

Currently, physical commodities are subject to a variety of transnational procedures that are not only recorded on paper but can be almost impossible to access. Counterparties have to verify transaction data multiple times from initial execution until the transaction is settled. Even worse, this difficulty in verifying every aspect of a shipments journey opens the door to possible fraud and corruption. By resolving this problem through a distributed public ledger, market participants can enjoy an increase in confidence thanks to this newfound transparency.

Increased Liquidity

When all of these different improvements come together, the end result is a vastly streamlined system with a potential for significant savings. According to an Ernst and Young report, some commodities companies can have potential savings of 30–60% off their transaction expenses alone. When transactions become quicker, safer, and cheaper thanks to blockchain-powered applications, market liquidity is expected to surge.

On the other side of the spectrum, investing in commodities will become ever more accessible to retail investors. While products such as commodities-based index’s and other products are available for those interested in investing in the market, it’s harder for individuals to participate in the various futures markets or even outright purchase larger quantities of these physical commodities. As such, this market has been largely the domain of larger, commercial investors. However, small-time investors can purchase and trade commodities tokens that represent their physical equivalent.

Benefits blockchain will bring to commodities markets

Current Projects

While gold trading has been the hub of blockchain innovation within the commodities markets, there are some blockchain projects looking to bring this to the rest of the market. Open Mineral is one such project, a physical commodities trading platform that received over $2 million in funding during a recent investment round.

It’s digital platform, the Open Mineral Exchange, hopes to increase the efficiency of the market for raw precious metals and raw materials, bringing together buyers and sellers all along the supply chain and allowing them to transact directly without any middlemen. Not only will this streamline the otherwise paper-heavy transaction process, but also guarantee transactions remain secure.

Although currently focusing on zinc, lead, copper, gold, and silver markets, the other non-metal markets are just as poised for disruptions. Earlier this year, a soybean shipment from China to the US became the first blockchain-powered agricultural commodity transaction. According to Business Insider, the consortium of banks and trading companies that backed the deal claimed this blockchain application could reduce the time spent processing documents five-fold.

Final Thoughts

Blockchain brings much to the commodities trading table and promises to be an integral solution to many of the markets longstanding problems. From reducing the risk of human error, streamlining document-heavy transactions, to increasing market liquidity, these are only some of the numerable advancements the markets can enjoy in the future thanks to this decentralized technology.

Originally published at Kapitalized.