What Are Commodities?
Commodities are in general raw materials or good that are grown or mined. The commodities market is where they can be bought and sold, such as precious metals, gold, coffee beans, oil, grains, energy etc. People have been using physical commodities all around the world throughout history as forms of representing and storing wealth. Today, with large corporates, commodities are traded on the stock exchange, with trades in the millions of dollars worth changing hands constantly.
How can Blockchain Technology Benefit the Commodities Market?
Blockchain-based platforms and cryptocurrencies promise to improve the way the commodity-trading industry operates, addressing issues of trust, their inefficiencies and the complexity of transactions, which typically involve multiple parties. Blockchain technology allows a transparent record of complicated transactions, track goods, and reduce fraud, which seems to make it a natural fit for the commodity business.
The technology works as an encrypted and immutable database that does not need to be controlled by a central party and can be made accessible to all participants. Blockchain platforms can track commodities, record contractual agreements, and serve as a trusted register for trade documentation. Furthermore, Blockchain can digitize information, automatically execute contracts, and be used to standardize procedures, participants can manage and settle transactions reliably (on permissioned platforms settlement can be achieved in close to real time).
Market variables Blockchain aims to improve on efficiencies and more systematic processes
Market variables such as pricing complexity, particularly how much diversity currently exists in pricing mechanisms; transaction volumes, including variations in consignment size; the requirement for a foolproof certification of origin; and the seriousness of efforts to reach a more efficient market infrastructure, including how developed the current infrastructure is and how beneficial improved efficiencies and more systematic processes would be.
Blockchain solutions can improve how business functions in all commodity markets, but it will impact each one in different ways.
Power and Gas
Distributed power generation and localized microgrids, which can function independently of the traditional centralized electricity grid, are growing in popularity. And, Blockchain is being used to develop peer-to-peer (P2P) online platforms, enabling localized producers and buyers to trade energy.
Oil, Iron Ore, and Diamonds
The use of blockchain solutions would significantly improve transparency in the supply chain, verifying the ownership and origin of goods and enabling secure, reliable tracking. It would also create a more efficient and liquid market, moving commodity trading away from bilateral deals struck directly between two parties to transactions based on electronic platforms that match buyers and sellers.
High frequency trading, a particular subset of algorithmic trading, has also prompted exchanges to develop algorithm-testing facilities to prevent predatory behavior. This would expedite the shift to a state of market hyperliquidity characterized by speed, highly standardized and accessible information, trading platforms, and narrow spreads.
Companies that are persuaded of blockchain’s benefits will need to ensure that they have sufficient skilled technicians in case the technology takes off. They should also carefully consider which potential solutions will best support their business, which are most likely to succeed, and which can be scaled up, in order to target investment.
Pros & Cons of Tokenizing Commodities
Pricing and Arbitrage
With transactions recorded on a shared ledger, participants could compare the price of their consignment against other consignments and thereby spot discrepancies. Greater transparency would also lead to fairer prices. However, it would impact the profits of merchant traders that rely on pricing inefficiencies to make money. Price-reporting agencies would also need to find new ways to expand their businesses.
Risk
With the settlement in almost real time, blockchain would largely eliminate clearing risk and diminish the role of clearing-houses, such as in the clearing of trades (if a counterparty defaults, for example) and in the physical delivery of goods (fraud and poor quality).
Tamperproof step-by-step verifications would reduce physical delivery risks, particularly those arising from fraud, by enabling participants to track inspections and certifications.
Regulatory Oversight
With Blockchain regulatory reporting can be significantly improved. Today, participants submit compliance reports. Regulators would have automatic access to the shared ledger (public protocols) and could inspect trades in real time. Similarly, energy network companies entrusted with balancing electricity or gas supply with demand in power markets could inspect the positions of market participants in real time.
IT Investment and New Processes
With more transparent, synchronized markets using blockchain solutions will change the ways in which commodity companies operate, particularly in trading physical goods. Players must identify the best solution for their processes and consider the additional IT infrastructure costs. New IT and processes entail likely also change-management.
Growth-Financing
Initial coin offerings (ICOs) allow companies to transform the ownership of assets or other rights into blockchain-enabled virtual, tradable tokens (STO, ICCO, TAO, ETO). Sold upfront to finance investments and expansion. However, one must be aware of the regulatory requirements for each jurisdiction investors are attending the sales, and which country the fundraising company is registered. ICOs are a cheaper and better choice than other funding options for large industrial-scale commodity projects.
Types of Token & Coins
Cryptocurrency valuation is derived from a coin’s success in adhering to the characteristics of money. On the other hand, crypto token valuations depend on a different set of factors, such as protocol adoption and robustness. Crypto-commodity is a general term used to describe a tradable or fungible asset that may represent a commodity, utility, or a contract in the real- or the virtual-world on the blockchain network through exclusive tokens.
Utility Tokens
These are tokens that offer access to a firm’s product or service within their platform or ecosystem. Token holders can use their tokens to make purchases of services. This means that the token has a specific utility and derives its value from it. Utility tokens are (mostly) exempted from federal laws governing securities, provided the tokens are structured properly.
Security Tokens
These tokens represent shares of the business and derive their value from a tradable asset. The potential of security tokens is significant, especially if a company creates its own self-sustaining ecosystem in which transactions are facilitated using the tokens. A security token is designed as investments, therefore attract federal securities regulations and compliance.
Examples of Tokens backed by Commodities
Tokens can be used as virtual currencies, which have the same characteristics as any commodity (like gold) that can be traded with profit-making intentions. Commodity-backed cryptocurrencies included tokens linked to gold, silver, and oil — each commodity with its own advantage and disadvantage.
Commodity-backed stable coins are one of the most exciting developments in the crypto world. Commodities such as gold or diamonds giving the tokens stability and value.
Other examples:
1. Bananas — Two Russian entrepreneurs and a Thai agronomist walk into a banana plantation in Laos… a true story for Bananacoin, a cryptocurrency backed by bananas.
2. Cannabium — This token is backed by liquid cannabis extracts (from legal sources only).
3. PowerLedger — Crypto backed by renewable energy of the sun. As solar energy technology spreads and becomes more lucrative, crypto assets can be used to serve remote locations to access electricity.
4. “El Petro” — Oil-backed (apparently:) is unique and interesting. Venezuela’s economy has been plummeting. In a bid to continue to export the country’s reserves of oil even as the local currencies are plagued with inflation (and to — perhaps — bypass international sanctions and regulations), his government began issuing the crypto coins based on their oil reserves.
5. Diamonds are an easy-to-redeem commodity with a good potential of a soon-to-be unlocked market. Among commodities, diamonds are one of the most stable in value. While gold, silver, and other commodities are exposed to financial markets and speculators’ whims, diamonds have remained steady for over three decades (enjoying a positive appreciation).
So.. Should Commodities be Tokenized?
The answer to this question truly depends on the motivation behind the task. Tokenizing commodities can be beneficial to commodity trading by introducing liquidity, fractionalization for better ownership status, mitigating fraud and eradicating counterparties.
Prior to the world having blockchain as an option, the commodities market is generally fine. When it comes to the general public population, there isn’t a huge demand to own commodities such as grain, wheat, and energy as an investment. Precious metals such as gold, silver, nickel, yes. However is tokenization better than owning the metal bars themselves? The cost of owning these precious metals aren’t high enough to warrant fractionalization. For people with deeper pockets, fractionalizing ownership is not a problem as well.
Blockchain can help standardize the price of commodities across the markets. This can be helpful to businesses dealing with commodities but bad for commodity traders. Blockchain will also help solve efficiency issues in tracking the goods. Could this result in lower operational costs? Most definitely.
It is important to note that IN THEORY, blockchain can solve all of these issues. The road to mass adoption of blockchain technology is still a long one. Having said that, I think commodities should be tokenized or at least attempt to as experimenting with blockchain and commodities would yield an excellent source of data and knowledge that can be applied to other industries and/or markets.
Sources: Hackernoon, Investopedia, BCG, Accenture, Coindesk, Moonwhale
I hope you enjoy this article! Please leave any feedback below. Let’s wish for a better 2019. :)
About me:
Iliya Zaki is the Head of Marketing and Business Development for Moonwhale Ventures.
Moonwhale Ventures is an STO Financial Advisory, offering companies strategic advice on STO process & structure, as well as token issuance incl. lifecycle management and secondary market on-boarding for their projects. Moonwhale is also building an End-to-End Security Token Offering (STO) Investment Platform that will cater to investors looking to invest in STO projects, and to companies looking to raise capital through STO to finance business expansion or new ventures.
For more information, visit: Moonwhale STO Solutions