If you follow technologies serving the commodities markets, you will have likely heard of ‘blockchain’. And if you have heard of it, but are still confused about what it might mean for your particular niche of the industry, you’re probably not alone. These days, it seems that many experts, both inside and outside the industry, are holding up blockchain as the panacea to improve any number of commercial processes, from wholesale trade enablement to retail inventory tracking, and everything in between. If one listens to the buzz, you could certainly conclude that blockchain is the Swiss army knife of commerce…but, is it?
What is blockchain and what is its current status?
Blockchain is a potentially disruptive technology that allows data to be stored securely without the need for a central authority. This implies that financial and other transactions would no longer stored in a singular central database but instead be distributed across many computers or locations – a process otherwise known as distributed ledger technology. Each transaction is recorded and added to the previous one, resulting in a growing chain of information that is sitting in a multitude of locations. Essentially, any new event that happens in the life of that transaction creates another record block that is linked to the chain of previous events (blocks) and everyone involved in the transaction has visibility and awareness of the latest event.
For a somewhat more technically versed description, Wikipedia offers the following –
“Blockchain is a continuously growing list of records, called blocks, which are linked and secured using cryptography. Each block typically contains a hash pointer as a link to a previous block, a timestamp and transaction data. By design, blockchains are inherently resistant to modification of the data. A blockchain can serve as “an open, distributed ledger that can record transactions between two parties efficiently and in a verifiable and permanent way.” For use as a distributed ledger, a blockchain is typically managed by a peer-to-peer network collectively adhering to a protocol for validating new blocks. Once recorded, the data in any given block cannot be altered retroactively without the alteration of all subsequent blocks, which needs a collusion of the network majority.
Blockchains are secure by design and are an example of a distributed computing system with high Byzantine fault tolerance. Decentralized consensus has therefore been achieved with a blockchain. This makes blockchains potentially suitable for the recording of events…and other records management activities, such as identity management, transaction processing, documenting provenance, or food traceability.”
The promise of blockchain
The paradigm busting promise of blockchain is again, that once deployed, a blockchain solution wouldn’t just commit its data to a centralized location (like an exchange for instance), but would instead distribute that data across a large number of machines and databases; providing full visibility into each transaction and resulting in increased security, controls, and trustworthiness of the data, all while simultaneously reducing the costs of managing the transaction “the old way”. However, similar to other technologies around which there has been a lot of buzz, it isn’t going to be a simple proposition. For those familiar with the Gartner Hype Cycle (https://en.wikipedia.org/wiki/Hype_cycle), blockchain probably sits somewhere just to the left of the “Peak of Inflated Expectations” at the moment, despite growing support from very large and influential technology firms and market players.
The outlook for energy companies
In terms of energy and commodities, a number of large utilities, traders, and banks have funded and are actively involved in a number of blockchain proof of concept (POC) initiatives. In Europe, Centrica, Shell and others are involved in the Energy Web Foundation consortium, which is “focused on accelerating blockchain technology across the energy sector”. Another, the Enerchain Project, is backed by a number of energy traders and utilities to develop and trial an energy trading infrastructure. Globally, IBM is spearheading a POC for blockchain management of international oil trading with Trafigura and Natixis, a bank heavily involved in oil trade finance. In all, these various efforts are intended to determine blockchain’s effectiveness in the real world, and assess its true benefits and limitations when applied to commodity markets.
Even without these existing efforts, the technology has shown both theoretical and practical potential (it does have a relatively long and somewhat successful history as the underlying technology behind Bitcoin). When applied to the commodity markets, it doesn’t take much imagination to think how it might be used along various supply chains – trade execution, collateral management, deal clearing, metering, billing, documentation of ownership, certification of renewable energies, traceability of GMO and fair trade products, and much more.
Unfortunately, for blockchain to be an effective solution in these diverse markets, each new application will require a clearly delineated process framework in which all participants agree on operating rules based on common standards…and history has shown that developing commercial standards can be notoriously difficult to achieve in most commodity-centric industries, particularly when the markets cross national borders. With a tangle of rules and regulations in each market, state or nation, determining a common business “code” agreeable to all the various governmental regulators and numerous private and public enterprises can be a daunting task and potentially take years to resolve depending the scope of the particular market.
Additionally, some technical challenges do exist. Despite its origins in the cryptocurrency markets, blockchain wasn’t originally envisioned to operate in diverse, dynamic and transaction intensive markets like commodities. Early reports from some of the POC efforts indicate the technology has struggled a bit in the time required to establish new transactions (new blockchains), and has been limited in its ability to process large numbers of transactions in a timely and secure manner.
So, while there continues to be a lot of discussion and some financial commitment from financial, energy and commodity companies to evolve blockchain from being an interesting technology to powering high-value applications, at this time it remains firmly entrenched in the POC stage.
Blockchain projected savings
But, if blockchain can overcome these hurdles and these POCs do yield one or more practical solutions, the potential cost-saving and improved process efficiencies could be significant and will have ultimately been well worth pursuing. It’s been reported that some of the energy companies involved in these early efforts have projected savings of 30 to 60 percent in their structural costs if blockchain solutions can be developed and adapted to meet their needs. Areas of benefit they note include reduction of labor costs, elimination or reduction of semi-automated processes like intra- and intercompany reconciliations, reduced capital costs and accelerated cash flow via rapid settlements, and reduced technology costs through the elimination of any number of commercial systems.
With all the attention and investment we’ve seen to date, it’s likely that blockchain (or more accurately, distributed ledger technologies) will play some role in the future of commodity trading and/or the associated supply chains. Given enough time, money and creative thinking, there is little doubt that the technology concerns can be overcome. Unfortunately, the most challenging hurdle for wider adoption – achieving the consensus required for establishing the “rules of the road” among a large number of diverse enterprises and regulatory bodies – will likely be a much more time-consuming process. Given that, the most likely path for initial blockchain adoption will be in relatively small or isolated markets where consensus is more easily achieved. For example, it was recently announced that blockchain will be deployed as the enabling technology for a newly established peer-to-peer energy exchange in Australia, called Power Ledger, which will facilitate trading of renewable power between residents within a single building or across small local networks.
If these types of smaller-scale applications prove successful, we will almost certainly see increasingly wider adoption across any number of industries and commodities. And when that happens, blockchain will have evolved from being a lot of hype and potential, to being a proven technology that provides real-world commercial benefits. Still – and again referencing the Gartner Hypecycle – to get there, it has to survive the always challenging “Trough of Disillusionment” and then make headway up the “Slope of Enlightenment”; and for now there remains some way to go.