Commodities trading and supply chains are heavily reliant on trust. Trust and the quality of that trust established over years of doing business together, is fundamental to ensuring products are delivered on time and multi-million-dollar payments are made without contest.
When assessing how far a corporation is willing to participate in commercial agreements with an entity or individual, there will be a set of pre-defined tests that might be applied; creditworthiness (Dun & Bradstreet), modern slavery (Modern Slavery Register), trade sanctions (OFAC) and the simplest test of all “Are they a good customer?”. Individual corporations will have different approaches to counterparty on-boarding and the risk (financial, operational, reputational) they are willing to take, documented in the company risk policy. Trust can be used as a label to identify how much risk a company is willing to expose itself to with a counterparty (customer/supplier); higher credit limits, more complex transactions, new business models.
Trust is Everything
A trader will have met his counterparty face to face to shake hands on the master agreement and may well have visited the oil field, gold mine or coffee farm. But when it comes to the daily operations of executing the complex chain of events required to extract, ship, store, process and deliver a primary commodity at the correct quality and on the correct date, the majority of this is carried out over the telephone or via email – the trader never sees the commodity while it is in transit. This means there is a heavy reliance on the embedded trust in both personal relationships and the paper documents used to qualify each stage of a transaction, that it has been completed to the agreed process and terms.
Historically this would be achieved by having a qualified delegate, an agent or inspector, on the ground to oversee key events. Using the loading of a cargo as an example, the agent would validate that the product loaded, met specification (quantity and quality) and sign the bill of lading in conjunction with the ship’s captain. The document would then be faxed to the trader and the bank, authorising the ship to leave port. The original documents would follow by courier, some days later. The confirmation would trigger insurance, hedging, planning and finance events associated with the ongoing transaction.
A number of attempts have been made to embed the process and associated documentation into technology solutions, the most successful of which focus on the relationship with the bank that is providing trade finance for the transaction. Payments would be triggered as “Cash for Documents”, which meant waiting for documents to appear before releasing funds. Any delay with “Sight of Documents” could cause the bank to withhold funds and delay the supply chain process.
The “handshakes” in a supply chain represent authorisation for transfer of ownership in the eyes of lawyers, banks and insurance companies. At each stage the responsibility for safe delivery of the product and its value is transferred to the next custodian; the chain of custody. Authorisation can only be supplied by someone with the required authority. Across an end-to-end supply chain, there will be several handshake events between parties. In order for these to be captured digitally, multiple individuals will need secure access to the same system, only being permitted to see the details of the transaction that are specific to them; a feature of permission based private blockchains that reside on distributed ledgers (all parties have their own copy of all records).
Blockchain technologies provide encrypted, digital handshakes in an internet accessed format, that use private keys (very strong passwords) to validate signatories, their identity and authority and keep a record of what an individual agreed to and signed for. Safe to say that the technology behind crypto-currency trades can be applied to Commodities transactions, or any physical asset. What used to be signed for on paper, could now be authorised from a mobile phone connected to the internet, where the inspector and ship’s captain use their Private Key as their signature and proof of identity. A transfer of ownership would take place once both private keys have been applied to approve the transaction and demonstrate agreement or consensus. As the loading transaction is completed, the bill of lading becomes digitally approved and in doing so instructs the bank to release funds, lawyers to execute transfer of title and insurance companies to activate policy coverage.
Chains of Trust
If the rules of participation in a commodities trade are mirrored in the governance of a transaction’s blockchain record, the associated events across the entire supply chain can be mapped to a digital sequence that represents a workflow of legal, fiscal and commercial terms and actions. Smart Contracts are programmed to monitor a sequence of events in a blockchain and update the sequential status of a trade. The combination of workflow, encrypted digital signatures and embedded trust, allow counterparties to operate in geographically different locations but accessing a single seamless platform of record for their shared transaction. Smart contracts actively gather the information from the ledger and issue completion signals and payment instructions when all necessary events are confirmed.
Is this Legal?
The legal framework in some countries does allow for digital transactions to be executed against a master contract, where principal terms and conditions have previously been agreed. The governance provided by contract law will undoubtedly see change as new processes and resulting disputes are encountered. Currently, participants in an ecosystem must agree to terms and conditions as part of an on-boarding process. Legal systems are already adjusting the regulations associated with transfer of title, to enable Smart Contracts to become legally binding and enforceable (ref. current stories in the press about Gibraltar).
The Business Case
A blockchain platform is ultimately a means of replacing a significant amount of paper-based administration and creating a secure digital store of the details relating to the events leading to the completion of a transaction. These characteristics facilitate the processing of secure transactions in shorter timeframes. Quicker transaction cycles mean shorter financing periods and lower cost of trade finance. Add to this the benefits of capturing stock traceability, quality test results and accounting related information at source (no interfaces or re-keying required), the ledger provides data that can be used as part of management information with a closer to real-time experience and a golden source of transaction data that can be referred to during disputes. The business case surrounding lower cost of transaction data collection and control alone is material.
Blockchain has staked a claim in the cryptocurrency markets as the platform of choice. The commodities markets are at the early stages of adoption; a number of the big commodity supply chain organisations (ref. Cargill, Louis Dreyfus, BP) are investing in prototype private-ledgers and completing inaugural transactions. There are significant commercial benefits to be derived from applying blockchain methods to geographically dispersed transactions. Existing business processes that are based on paper controls and human trust, present opportunities for complete re-engineering. It is early days in the application of blockchain to commercial business workflow and smart contracts, but processes of the future are likely to be designed with digital trust, encrypted provenance and private key authentication at their core. The likelihood is these will remain on private blockchains and not public ledgers for the foreseeable future but, consumer pressure for transparency and traceability leave an element of motivation for further iterations of the platform (Blockchain 2.0). The upshot of this body of technological and operational change, is the possible replacement of trust intermediaries (dis-intermediation) such as inspectors, traders, brokers and banks with Blockchain agents and Smart Contracts as the moderators of trust, which has the potential to alter the operation of trust structures in the commodities industry.
“Trust me, it could happen.”
About the Author
Simon Hartland has worked in the technology industry with a particular focus on supply chain and commodities for over 20 years. He has contributed to projects across Africa, South America, Asia and Australia.