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Blockchain in commodities: is faster really better?

For many in the financial services industry, bitcoin has become synonymous with money laundering. But blockchain – the technology that enables the transfer of bitcoins – opens up some intriguing possibilities for participants in commodity markets.

In essence, a blockchain is a distributed ledger shared by all computers participating in the system and containing an immutable, tamper-proof record of every transaction ever executed on it.

While this technology certainly brings up a number of important questions around legality, security and data privacy, one of the key implications for physical markets is blockchain’s ability to support instant or near-instant transfer of title and ownership.

So is faster settlement better for business?

Well, it could be. Instantaneous settlement would transform an industry accustomed to T+3 settlement times, potentially saving billions from increased back-office efficiency and automation.

This reduction in costs could also encourage investment banks to return to commodity markets. The huge costs traditionally associated with post-trade processes have led many banks to abandon these markets in search of more cost-effective alternatives.

As well as streamlined processes and simpler auditing, the faster trades and reduced counterparty risk enabled by blockchain could increase the number and size of revenue-generating opportunities available to market participants.

For all these reasons, blockchain initiatives are gathering pace in equities and FX markets. But few have begun to apply blockchain technology to the unique intricacies of physical markets. One early frontrunner is ItBit, which claims to have developed a Delivery vs Payment (DvP) ledger to accelerate settlements in the $250bn gold market.

Or do we actually need more time?

Of course, it’s possible that the entire concept of instantaneous DvP may be unsuitable for physical markets.

The trouble with physical markets, of course, is that they rely on physical processes – many of which are very time-consuming and rely on a trail of paper records that will need to become electronic for blockchain to be viable. Reliance on physical pieces of paper to record warehouse receipts, warrants and other records of title and possession must be created in one location, shipped to another location, endorsed, and then flown back to their point of origin. Accelerating these processes by digitising documents would reduce the costs and risk of high-value financing transactions considerably.

Even with digital documentation, however, physical assets must still go through time-consuming lifecycles that bring unique challenges to commodity markets’ adoption of blockchain.

A cargo of crude oil, for example, must be loaded, shipped, unloaded again, driven to a refinery, refined and then distributed. These processes can take weeks, or more often months, to complete, so faster transaction settlement times don’t necessarily bring any benefit. In fact, buyers would have to pay much sooner than they’re used to, while the physical processes involved would continue to take the same amount of time as before.

The changing physical nature of commodities also makes them very difficult to represent accurately on a blockchain across their entire lifecycle.

How, for example, do you maintain a single record for metals that change shape, consistency and form throughout their journey from the ground to the end-customer? And what about before they even leave the ground – how would blockchain enable financing for physical assets yet to be weighed and measured?

Could blockchain make clearing houses and exchanges obsolete?

A widespread move to instantaneous DvP powered by blockchain could completely transform the way financial markets are organised. With a trusted, immutable and public ledger the need for intermediaries would cease to exist, potentially rendering the exchanges and clearing houses we currently rely on redundant.

However, it’s likely that commodity markets will continue to rely on intermediaries as glue to keep the ecosystem together and act on behalf of the market as a whole. Whether that will be a traditional clearing house or a leading member of a blockchain consortium remains to be seen.

Whatever the future holds, it’s time to act now

While the jury’s still out on blockchain, our conversations with commodity market participants highlight the importance of getting started with investigating the possibilities of the technology.

The blockchain bandwagon may run out of steam – or it could steamroller the entire industry. The most important thing is to start examining how blockchain could help your organisation achieve continued success as markets evolve over the coming years.

Sign up and read our whitepaper on 7 Ways Blockchain technology could disrupt the post-trade ecosystem