How Blockchain Overcomes Friction in Commodities Trading

Omer Ibrahim, Managing Director of LiquidX, was a featured speaker on the “Blockchain and the Future of Commodities Trading” panel discussion at the Global Blockchain Business Council’s Blockchain Central – Davos Conference 2022. The panel, moderated by Jeff Bandman of Global Digital Finance, also included Jeanine Hightower-Sellitto of Atomyze, Amanda Martinez of Artemis Climate Partners, and Andrew Pisano of Xpansiv.

Commodities are defined by statute, so classifications vary by jurisdiction. As such the panel took a broad approach to the discussing commodities, which could include physical goods such as agricultural products or natural resources, or intangibles including currencies or contracts for future delivery. Here is a summary of the questions they tackled.

What are present frictions with commodity trading?

With the wide variety of commodities across the globe, marketplace friction can be dependent on the asset in question. In general, physical assets are burdened with antiquated trading technology, logistical burdens for investors to access these markets, and credit and performance risks. Adding to the complexity is the fact that consumers are now being more demanding about where and how a commodity is produced.

Blockchain creates efficiency in tracking digital ownership of physical materials, which instead could be traced by digital certificate – a digital title mapped to a specific piece of inventory. In addition, this digital “twin” captures the information related to the commodities’ production and/or transportation, giving producers the means to differentiate their products, such as through Renewable Energy Certificates (REC.) As one panelist remarked, RECs are allowing for “uncommoditized commodities.”

How does blockchain make commodity trading easier?

The traceability allowed by blockchain provides much-needed transparency to commodities transactions, helping to mitigate fraud which in the past has caused banks to pull back from the industry. Blockchain solutions, including InBlock from LiquidX, serve as a central asset registry, connecting the inventory to the invoice throughout the entire payment lifecycle and allowing funders to view changes, see disputes, and other information relevant to the transaction.

What are other benefits from applying blockchain to commodities trading?

Blockchain has the potential to drive value across industries. As one panelist remarked, distributed data doesn’t just go into a single database; it can provide transparency through the life of a commodity from a mine to the manufactured product. As corporations are more and more pressed to hit ESG (environmental, social, governance) targets, there is “little verification today if something is really green,” according to one panelist. By tracking and tracking inputs and activities in real time, ESG factors become more auditable, delivering added information to investors.

Growing consumer demand for sustainable products could also boost adoption of blockchain, due to its authentication capabilities. A recent McKinsey banking industry report stated that the pandemic has increased focus on sustainability, estimating that producers could expect a 15-30% price premium for sustainably produced products and services.

Another benefit is wider participation in commodities trading. Historically, commodity markets were only open to those that could manage huge credit lines. Blockchain has the potential to democratize the market, allowing new participants through more transparent pricing, lower transaction processing costs, and increased demand for “better sourced” products.

What’s the path to adoption?

Current commodities traders and funders are looking for ways to reduce large back-office costs. The panelists expect this group to lead the charge until larger penetration can be made into smaller supply chains. Smaller traders could benefit from blockchain’s ability to connect all counterparties such as funders and suppliers without interoperability issues.

In addition, larger companies that need to meet ESG reporting targets will demand better reporting from their smaller suppliers, which could further expand blockchain as the big firms chip away at the less accurate parts of their operations.

What are the hurdles?

The complicated nature of commodity trading – often cross-border, and commonly underpinned by complicated financial arrangements – has made adoption slow. Some of the “moving parts” can be addressed with blockchain solutions such as digital letters of credit. What used to take two or three days can now be accomplished in hours. However, the panel acknowledged that until every aspect has been addressed, full digitization from the origination of the commodity through the transaction lifecycle is a goal for the future.

Another complication is international law. Since digital contracts not accepted in all jurisdictions, blockchain in cross-border commodity trade will take time.

Finally, the panel weighed in on the larger question of where to start. Could tokenization of the underlying assets in a commodities trade be retrofitted to existing assets such as gold bars, or is it necessary to start with completely new assets?

The question remains open, however there was agreement that data quality is crucial, and self-reported data is not feasible because of validation issues. All parties must have comfort that data is monitored, verified, and auditable. The growing consumer preference to demand transparency, combined with evolving tech capabilities that are available to all participants, will drive accessibility and visibility in commodities markets.

Visit the GBBC blog for a short summary of all the sessions from Blockchain Central – Davos.

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