Based in Singapore, I have been involved and invested in Bitcoin and Cryptocurrencies since 2011. I launched and ran a Bitcoin point-of-sale payment service in 2013 and became one of the representatives of the space in the region, having spoken with various global media and at international conferences.

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Commodities: You (Probably) Don't Need Blockchain For It, Part III.

Commodities: You (Probably) Don't Need Blockchain For It, Part III.

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This is part of the series, where I explain applications of blockchain and cryptocurrencies for different domains. Even if you are only interested in this particular domain, I still recommend reading the first part, which explains basic principles on which each specific case is built.

Using blockchain in commodities trading faces similar issues as the supply chain. After all, the first steps of the supply chain typically start with commodities, which in stages break down to units of goods.

Blockchain reaches its limits when it comes to the physical world. Putting a prediction market smart contract onto the blockchain makes sense because it deals only with data (plus it’s outlawed practically everywhere). The contract resolution, settlement, and representation of all parties involved happens in the digital realm and is based on a digitally distributed consensus.

That’s different for commodities and physical assets and goods. An execution and settlement of a smart contract pertaining handover of a ton of iron ore are relevant only as far the human input confirms the handover and given there are only two parties involved in that handover, you can’t rely on a consensus.

Another limit lies with the very nature of the commodities - their units are interchangeable, combined to bulks from different sources and then split without any consideration for the origin. Try to ask someone who suggests using blockchain for supply chain (because they read about its traceability at Bloomberg) how they would handle the very origin of what often are commoditized goods and you will immediately uncover limits of their own knowledge.

Cryptocurrencies

Cryptocurrencies could, however, provide means of trade settlement superior to what is currently available in the ways described below.

Transaction costs

Cheap international transactions have been the selling point of Bitcoin from early days. Many of my fellow Bitcoiners used to mock Western Union for their allegedly high fees, but they misunderstood the last mile aspect of it. Western Union has a booth in the most remote villages of Asia or Africa where the unbanked of the developing world could almost instantly receive cash sent to them by their family members working abroad. They couldn’t care less about Bitcoin and the smarter crypto-remittance companies understood this and focused on offering more modern user experience with competitive prices on selected payment channels.

The situation of many of those who are at the source of the commodities trading is not different. I recently visited remote farms in Flores where macadamia nuts or vanilla beans are sold for a small fraction of the price we buy them for in Singapore. The people growing them make in a month as much as I paid for a dinner a couple of days before that. There is no way these people could use or liquidate a cryptocurrency in a manner of days, which is as far of a horizon as they see. So even if it could cost next to nothing to transfer crypto to them, it is hardly a value proposition given the last mile transaction costs and their own time preference. This might, of course, be different in countries like Venezuela, which are in hyperinflationary collapse.

The situation might be different the higher in the chain. Companies directly dealing with international transfers feel the pain of the fees on one hand and on the other, their banking relationship might allow them to handle the cryptocurrency settlement and 3rd party cryptocurrency settlement services might emerge to capture this segment of the market. The question is, how much does a transaction cost issue disappear with economies of scale in the highest parts of the chain. Do the largest traders and shipping providers have the ability to manage their international cash flow and negotiate with the banks to the point where crypto loses its proposition? I’m not privy enough to the cost structure of these trades and transactions so others would have to do their homework.

As the example from part II. shown, transaction fees are just one part of the problem. The time it takes to send money on some payment channels also locks valuable capital in the process. Even though established and trusted trade partners can opt for moving the goods prior to the payment being settled, immediate transfers could still improve their cash flow. New and small buyers who don’t have the goodwill and ability to negotiate with the sellers would be able to get the goods moving quickly thanks to immediate upfront international payment.

Censorship resistance

International sanctions block some parts of the world from the trade of many commodities. Cryptocurrency transactions could circumvent the sanctions in payments, but the parties involved in the trade would still have to figure out how to make the physical delivery possible. The US still has a near monopoly on international clearing, which makes it much easier for its government to enforce the payment part of sanctions. If that monopoly was circumvented by cryptocurrencies, the physical delivery part might prove to be much easier to execute.

Change of settlement currency

This one is related to the point above. USD has dominated the commodities market as the main settlement currency for decades and US banks practically have a monopoly on international payment clearing, which makes enforcement of sanctions much easier. Governments of other countries have been trying to change that recently.

If businesses, instead of waiting for another centralized hub, which would be subject to the same (if not bigger) censorship pressures would start switching to cryptocurrency settlement, this change could happen organically. That cryptocurrency could even be a USD-pegged stablecoin. As screwed up as the Dollar is, it still retains a level of trust unprecedented in other (crypto)currencies. And if (or rather when) over time, the USD loses that trust, the chasm between one cryptocurrency and another, perhaps gold-pegged or fixed supply (like Bitcoin) is much smaller than between USD-based clearing and a cryptocurrency, or even CNY.

Back to Blockchain

Once the trade is settled by cryptocurrencies on a large scale, some real blockchain solutions might start kicking in.

Where trust or lack thereof is an issue is where blockchain and ability to execute smart contracts on it comes really into play. The main limitation still is in where the transaction and the contract crosses between a digital realm and the physical world. While a smart contract can fully autonomously execute an exchange of a digital asset (piece of data) or a digital commodity (cryptocurrency), it is not able to facilitate a handover of the physical physical commodity.

Open and distributed blockchains using those settlement cryptocurrencies and with reputational systems built into them could emerge and make it easier for new parties to get involved in the trade, and lower the risk for the existing traders. Instead of having to rely on third parties and references, they could rely on verifiable information maintained by a wide, properly incentivized consensus.

But none of that will happen without cryptocurrencies being involved first, the same way as OpenBazaar wouldn’t be possible and meaningful without Bitcoin gaining liquidity and being used to trade goods and services prior.

Continue reading:

Bitcoin vs. Bitcoin Cash: One Year On

Bitcoin vs. Bitcoin Cash: One Year On

Supply Chain: You (Probably) Don't Need Blockchain For It, Part II.

Supply Chain: You (Probably) Don't Need Blockchain For It, Part II.