World’s Biggest Commodities Pricing Firm Using Smart Contracts Without Blockchain
S&P Global Platts successfully deployed smart contracts on a centralized ledger instead of DLT to reduce energy, latency and cost.
Can smart contracts be used without blockchain? That was the question asked by a Quora user. Of the answers given by netizens, about half said yes, and the other half said no.
So which is it?
Well, the world’s biggest commodities pricing firm, S&P Global Platts, has said “yes”. They claimed that their smart contract system is up and running in a centralized ledger, instead of a distributed ledger — which is usually the case when people think of smart contracts and blockchain.
To understand the debate, we must first define the key terminologies involved. Bear with me if you already know a thing or two about blockchain.
What exactly are smart contracts?
Many people equate smart contracts with blockchain. Yet others think of cryptocurrencies, blockchain, distributed ledger technology (DLT) and smart contracts as being the same thing.
They are not the same.
Blockchain is the idea that ‘blocks of information’ can be encrypted with a very difficult to break algorithm and then stored in a digital ledger. This ledger increases in length as each new piece of information is added onto it (hence the name).
These blocks of information can be an accounting record of transactions and who owns what, in which case the blockchain forms the basis of a cryptocurrency.
If the information is a piece of software that stores the terms of a contractual agreement and the circumstances under which to execute it, then it is a smart contract.
In order to enforce greater security to prevent hacking and fraud, a blockchain is usually stored using a DLT system. This means that the exact same blockchain is replicated and stored across many different computers within a network (each computer is a ‘node’).
This makes it much harder to ‘cheat’ this autonomous system of keeping records because for anything to be changed, at least 51% of the nodes must agree on the transaction being permissible, before allowing it and then adding this new information to all of the copies.
For example, in the case of cryptocurrencies, if I decide to transfer 10 bitcoins to my friend Alex, then at least 51% of the many thousands of computers hooked up to the bitcoin network on the Internet must agree that I have 10 bitcoins in my digital wallet in the first place, before the transaction can take place.
In the case of smart contracts, a buyer of a product may use a smart contract to govern the entire transaction to say something like this: when independent sources verify the quality of the goods, I’ll pay a deposit of 20%. When the goods are shipped, I pay another 20%. When it arrives in good condition at my warehouse, I’ll send the balance.
If all these rules are coded into a computer program, and automatically executed when trusted sources of information updates it at each stage, then it can be a type of smart contract.
So why can’t this be done on traditional technology? Simple rules to program on any computer aren’t they?
Well, remember the advantages of encryption used in blockchain and storing replicas of it across many different nodes? These two levels of protection prevents information stored on a blockchain from being easily hacked and replaced with fraudulent records.
The people who argue that smart contracts cannot be used without blockchain is really saying that, for it to be useful, both levels of protection must be implemented.
But Platts disagreed, and this is why...
Cost versus protection
Within the world of commodities trading, Platts is what we call a ‘price reporting agency’, or PRA in short.
In commodity markets, prices are typically negotiated privately between buyers and sellers. So there is no transparency to anyone outside of the negotiations. How then do the parties involved know they are getting a fair price compared to other similar deals?
That’s where PRAs like Platts comes into the picture. They gather information on commodities transactions from all over the world and publish it as a price index. These indexes become the reference point for contract pricing for both current transactions, as well as the financial derivatives used by big buyers and sellers to hedge their future transactions.
It is a big business.
In 2018, Platts made US$815 million in revenue and US$383 million in operating profits.
Traditionally, the way Platts gathered their pricing information is by having their staff call up buyers and sellers, and literally asking them… one by one.
Not very efficient but it is still the case in this digital era for many of the commodities markets.
In more recent times, Platts has sort to digitalize some of these workload by having the bigger players in the market submit their transactions through an online platform.
However, this poses an honesty problem. How does Platts know the transactions that were submitted really did take place, and that the prices were genuine? There is vested interest from sellers to report higher prices and buyers to do the opposite, in order to influence the price index in their favor for future transactions.
Again PRAs like Platts traditionally do this verification by testing the price in the actual market with third parties and asking for supporting documents like shipping and financing paperwork from credible sources.
In November 4, 2019, Platts announced the launch of Trade Vision, an online platform for participants of the natural gas market to voluntarily submit price information to Platts through the internet.
While the initial announcement did not go into details of the technology involved, the company subsequently revealed that the system was built using smart contracts stored on a centralized ledger (instead of DLT).
This is due to the cost of having both two layers of security — encryption and multiple nodes. In order to process the encryption algorithm, and then verify the transaction across many many nodes, a lot of computing power and time may be required. By retaining the encryption but using only one central server to store the digital ledger, they sacrificed a security feature for the sake of practicality and efficiency.
“Blockchain has huge advantages for security and encryption… But speed, cost and energy intensity mean it is currently difficult to scale for many players in the commodity markets. Smart contracts that offer a similar level of security are already a reality, albeit with centralized ledgers using the similar reconciliation and physical documentation of trade but without the need for simultaneous record keeping, thereby reducing the energy, latency and cost.”
— “Five commodity themes for 2020”, S&P Global Platts
Platts President Martin Fraenkel said their implementation was a great success. “Already nearly half of our data is being submitted through Trade Vision after just a few weeks.”
In my previous article “Blockchain is Broken”, I have discussed the challenges of applying blockchain to most industries outside of cryptocurrencies. I also explored its future potential for powering self-evolving AI in another.
Blockchain and DLT are, without doubt, an ingenious technology in my mind. But its current commercial use cases remain largely experimental in most traditional industries.
Perhaps the experience of Platts teaches us that the key may be to leverage parts of it, instead of trying to fit the whole concept into every potential use case.
It is still too early to declare a pattern, but at the very least the question we’ve started off with seems credibly answered: Yes, smart contracts can be used without blockchain. Or more accurately, without distributed ledger technology.