Back in October 2017, I wrote a 3 part article on the potential impact of block-chain based technologies on commodity trading.
You can find the articles here part 1, here part 2 and here part 3
Now it’s time to see what has happened and how wrong I was (hint, I was not. In fact I gave myself a well deserved pat on the back)
So 2 years down the road, how is the disruption that seemed there to happen(at least to the evangelists, that is) going?
The answer is…well, not there quite yet.
The reasons are various and, as I pointed out in my article 2 years back, there is a certain “if it ain’t broke don’t fix it” kind of mentality.
In the physical commodity word, relationship still matter and there is a certain tendency to be suspicious about new ways of doing things.
As a matter of fact, a few projects were started between 2016 and 2019, but behind the hype, the effort (and resources…) that companies have put on the matter has been lackluster, and hence the results have been far less than spectacular.
As a matter of fact, a few projects were started between 2016 and 2019, but behind the hype, the effort (and resources…) that companies have put on the matter has been lackluster, and hence the results have been far less than spectacular.
A few initiatives have been dropped altogether, and the one who are still “live” are of negligible size and relatively small impact.
On one side is true that there is always a tendency to overestimate the impact of technology in the short run and to underestimate it in the long run, however when it comes to practical application of this new technology I find it increasingly frustrating to try to make sense of what’s going on oon the market, and where any promising development might lie.
On one side we have the mess that is the crypto-related scene, where everyone and their dogs is hyping the “disruption” that their “new thing” is going to bring about in the next quarter or 24.
On one side we have the mess that is the crypto-related scene, where everyone and their dogs is hyping the “disruption” that their “new thing” is going to bring about in the next quarter or 24. On the other hand you have the “big guys” which are not fond of disrupting anything.
But it seems to me this is just a pitch for venture capital money rather than a bona fide call for innovation.
On the other hand you have the “big guys” which are not fond of disrupting anything.
Actually you might as well say that disruption as a word is quite out of fashion, as in the word of physical traders the appetite for disruption is really none. Which is perfectly understandable since, when you are running a multi-million-dollar business, with high complexity and razor thin margin, the idea of “disrupting” is as appealing as a having a root canal without anesthetics.
So for the sake of clarity, and for my own mental sanity, I will leave the crossroad between crypto currencies and trading outside the scope of my interest this grey area of “Crypto vs Commodity trading” and will go back to my basic question: Where we are on the implementation of smart contract and distributed ledgers in the world of “grown-up” commodity trading?
The answer is: not very far.
A few pilots have actually taken off, mostly in what is essentially document transaction. Standard Chartered bank and a few other players have started to use a platform called Voltron, which is essentially a semi-private (hence a far cry from the ideal distributed, public ledger) network where the documentation for letters of credit and other trade finance instruments is exchanged. This has led to a reduction of the time necessary to close a transaction to almost 12 hours. Which is a significant improvement over the traditional 24/48 hours that it usually take to confirm a documentary warranty, but is still a far cry from “real-time trading” or “automated smart-contract based trading”. The platform however shows some potential and it has raised the interest of several high profile players in the financial institution side of the market, as trade finance is essentially a low margin business in which every drop of efficiency needs to be squeezed. However, there are still a number of (mostly) regulatory hurdles to clear, on top of which the issue of the IT landscape, and of the integration in company systems.
As a matter of fact, Voltron offers some good insight in what a blockchain environment could look like. There are a number of other players such as Marco Polo (of which BNP Paribas is one of the participating banks) which is also based on the same “Cryptoplatform” as Voltron, a platform developed by a consortium called R3.
Voltron offers some good insight in what a block-chain environment could look like.
R3 itself has an interesting and somehow turbulent history. The consortium had amongst its finding members the likes of Barclays, BBVA, Commonwealth Bank of Australia, Credit Suisse, Goldman Sachs, J Royal Bank of Scotland, State Street, and UBS.
In the intervening years some other heavy hitters joined the consortium, such as Westpac of Australia, Natixis and some others. However already by November 2017, several high profile banks had left the group, such as Santander, Morgan Stanley and JpMorgan.
Bank of Canada itself had conducted a study and concluded the platform was not meeting its needs, most notably in terms of privacy.
The company also boasted the “biggest investment ever” for a distributed ledger, a funding round standing ad $107 million. Not pocket change by any measure, but it is kind of small considering the potential numbers we are talking about in the commodity/payment space…And don’t let me started if I compare this kind of funding to the crazy amount of money that complexly pointless companies, like the infamous WeWork have attracted, then let’s say that it does not look exactly impressive.
A better story seems to be Komgo, a Startup based in Geneva which is concentrating in Trade finance (as I predicted…)
A better story seems to be Komgo, a Startup based in Geneva which is concentrating in Trade finance (as I predicted….:D) . It boasts amongst its participants Shell and Gunvor and a host of banks.It looks promising, and it has onboarded also its first non-shareholding client, Total. It also boasted a healthy financing round of around 700 million USD.
However in terms of volumes, it is still quite small, and, as pointed out in my previous article, operating in a very specific space of the deal life cycle, which is the trade finance subprocess.
Which brings Elephant n.1 in the room: the system does have privacy issues. Which is kind of ironic considering that the whole point of the chain was initially “transparency”.
And now we come to elephant n.2: in the list companies that support distributed ledger project there seems to be very little in terms of trading houses. Which means that, at least for now, the interest of the market makers in these technologies is not exactly booming.
Which beg the question: Why? Why aren’t trading companies jumping at the idea of cutting transaction costs, complexities, personnel and, eventually, increase profit?
Why? Why aren’t trading companies jumping at the idea of cutting transaction costs, complexities, personnel and, eventually, increase profit?
The reasons are multiple. On one hand, as previously said, there is a certain dose of skepticism.
On top of this, the amount of resources in terms of management time and IT investment is far from insignificant, for something the benefits of which are far from proven.
So, essentially, the disruption behind the corner is…not so behind the corner.
Why? Usual suspects:
- Performance: whereas for a simple trade finance process, performance is indeed improved compared to the traditional way of doing business, the level of performance achievable of a complicated ledger encompassing all the life cycle of a commodity deal is not clear. On top of this, the investment in computing power is not necessary insignificant, and, lest we forget, the actual numerosity of physical trades, especially on oil is not high, however the complexity (think pricing structure…) is
- Privacy: trading firm thrive on information asymmetry. No one is very happy to share too much data with other market participants. Pricing agency are not happy to see their oligopoly challenged(and they have the financial muscle to fend off the new entrants….)
- Compliance with law and regulations: in it current form, I do not see the Chain simplifying the reporting and compliance burden. And the requirement for mandatory clearing, amongst other things.
- Legal issues (and this is a big one in today litigious world). Yeah, I know, blockchain will make fraud close to impossible (No, it won’t) but what about litigation? Which court of law is going to enforce a chain-based trade? What happens if a counterparty default? Which legal firm is going to be able to assist?
So, to conclude, is the Chain doomed to stay as a niche in the market? Not at all. As the Komgo example shows, it is possible to find real-life application for this kind of technology. It will require more time than most people realize, and it will need to scale up. As long as market participants remain skeptical (as shown by the fact that not many company are putting significant financial resources behind Chain start-ups) it is going to be difficult to reach the economy of scales that have made other technologies and platform (think again, EFET) appealing.
I still see the most standardized, high-numerosity, low margin areas of the business as the most likely candidates for block-chain implementation. However it is going to be most likely an incremental process rather than a disruption.
At the end of the day, it’s 2019. And Disruption is really out of fashion.
Chainergy 
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