Blockchain in Global Commodities Trading

Transparency

Exchanges are regulated, providing traders and investors transparency of bid and ask prices for commodities, derivatives and other securities across financial markets. Using an exchange means playing on a level field, where anyone can buy low or sell high, providing they follow the rules of the game.

Counterparty Risk

Exchanges are centralized places where buyers and sellers make transactions with exchanges instead of with each other directly. To a certain extent, exchanges reduce counterparty risks. However, OTC market participants are exposed to the risks that one cannot deliver the goods at the agreed time or on the agreed terms.

Transaction Costs

Furthermore, physical global commodities trading comes with specific friction points. Imports and exports are subject to rigorous documentation requirements, much of which is still paper-based. Physically settled trades mean that commodities have to be moved around different locations, requiring physical inspection each time they change hands.

Liquidity

In exchanges, large volumes are traded between various parties under contract terms that are generally standardized. In OTC markets, smaller suppliers can sell through brokers or find buyers themselves. The result is that the bigger players have more liquidity in the market and usually have more price information to benchmark. On the other hand, smaller players have much lower liquidity and limited market information.

In a previous article, we outlined how tokenization of assets can change the way we do business in general. Tokenization in global commodities trading combines the benefits of exchange and OTC trading, while eliminating the disadvantages of both.

In the world of global commodities trading, these digital tokens could be used to assign ownership of commodities and trade between dealers in different parts of the world. As all information is recorded on the blockchain, and only private key holders can authorize transactions, a lot of the repetitions of goods inspections and paperwork can be eliminated. With blockchain, a transaction can be secured through an atomic swap and paper documentation can be replaced by blockchain records. This brings the combined efficiencies of reducing costs and saving time.

Blockchain can also replicate the transparency and security of a centralized exchange, while still keeping fees low and reducing friction. Peer-to-peer (P2P) marketplaces on blockchain allow a dealer to sell directly to other dealers or customers in an OTC arrangement. Unlike a centralized exchange, no brokers or other middlemen are needed in a P2P trade. Therefore, third-party commissions are greatly reduced, and settlements can be made virtually in real-time.

These marketplaces can also be set up to display the bid and ask prices to all participants, thereby creating transparency in OTC trades akin to using centralized exchanges. Because blockchain is a decentralized technology without the stringent requirement of listing, smaller dealers can benefit from the transparency.

Smaller dealers have an additional advantage in using a decentralized blockchain exchange platform. Because asset-backed tokens offer the opportunity for fractional ownership, smaller dealers could enjoy fractional participation in larger, and potentially more lucrative deals. Smaller dealers could therefore join forces to make bigger trades, increasing their individual potential for liquidity and bringing greater liquidity to the overall market.

Smart contracts on the blockchain can also automate the settlement process in commodities trades. This applies whether the commodities being traded are cash or physically settled, or if derivatives such as futures or forward contracts are used.

Smart contracts allow for full automation of tokenized cash-settled derivatives, as the settlement funds can be held in escrow until the contract’s end date, then released automatically. Even in a physically settled trade, participants can use blockchain-based key signatures to confirm the delivery of goods. Furthermore, all parties involved in the movement of the commodity can track the whereabouts of the assets in real-time. The traditional letter of credits and services from banks are no longer needed, saving significant costs and reducing friction through the implementation of atomic swaps on blockchain.

Asset-backed tokens on a blockchain offer real potential in the world of trade finance, to increase transparency and provide the possibility for trading without putting trust on an intermediary. Smart contracts have the potential to reduce counterparty risk, thereby providing more liquidity and reducing costs in a commodity or derivatives trade. Asset-backed tokens can also enable anyone to participate in a large volume trade through fractional ownership.

Commodities markets are the oldest forms of trade finance, but their development has been more evolutionary than revolutionary, at least until now. Asset-backed tokens and other features of blockchain have the potential to completely transform global commodities trading. For commodities dealers and customers, as well as the broader global economy, blockchain is poised to deliver unprecedented value.

As a prominent blockchain infrastructure provider, CoreLedger is making blockchain technology simple for businesses to use. With CoreLedger’s offerings, clients can readily tokenize their offerings with fast-to-implement resources that will allow them to modernize their services. Thanks to our in-house developed software solutions and experienced blockchain specialists, CoreLedger is ready to help you make your next move with blockchain technology.

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