Highlight / April 3, 2021

How Blockchain Could Revolutionize Ag Trading

If you’ve so much as glanced at the news over these past few months, you’re likely well aware that Bitcoin and other cryptocurrencies have roared back to life. 

Bitcoin, the world’s first “synthetic” commodity, has reached new all-time-highs, up over 1000% in the last 12 months. 

Today one of the hottest and paradigm-shifting assets on Earth exists purely in digital form, tethered to the physical world only through computer equipment that assures the network’s security.

Blockchain: More Than Crypto

Think of Bitcoin as the cloud computing of money.

Bitcoin and other synthetic commodities are sometimes esoteric and confusing for new users. Without a firm grasp on finance, technology, and network security, getting involved with cryptocurrency is a daunting process. 

However, blockchain, the underlying technology behind Bitcoin, offers a plethora of promising applications that are straightforward and easy to understand. 

Blockchain technology will, in due time, disrupt the traditional commodity trading process with near-immediate settlement times, transparency, and fairness amongst participants. 

Blockchain for commodity trading is a new and timely technology for an age-old marketplace. Blockchain technology could de-complicate a market which, historically, has been slightly disorganized. 

Some segments of the commodities supply chain involve digital speculation of commodity prices. No physical wheat, corn, or oil is involved in such transactions. Other segments deal with mountains of the physical commodity in question. 

Both of these diverse segments can benefit immensely from utilizing blockchain to streamline their existing processes.

How Commodities Work and How They’re Not Working

 

The commodity futures market is one of the largest markets in the world, and rightfully so. The marketplace allows businesses to future-proof their decisions by locking in the price of a given commodity. Futures contracts remain good until expiry, at which point the contract holder takes delivery of the underlying commodity at the previously agreed-upon price. 

A locked-in price is beneficial for manufacturers. A factory owner anticipating a multi-month price rise in steel will likely buy a futures contract to lock in an amount of steel for today’s purchasing price.

Some segments of the commodities supply chain involve digital speculation of commodity prices. No physical wheat, corn, or oil is involved in such transactions. Other segments deal with mountains of the physical commodity in question. 

Naturally, a market like this invites speculation. Very little of commodities futures trading is performed by people who are actually involved in the industry in question.

In reality, very few people who buy commodities futures contracts want to take delivery. Most only wish to profit from the difference between today’s and tomorrow’s price. 

Just ask the people who were caught at the end of a contract when oil prices went negative last year and couldn’t find a buyer in time. 

Speculation

 

Speculators aren’t a net negative to the market. They add liquidity and aid in the price discovery process. 

However, there are downsides to the rampant speculation in the commodities futures market.

Most speculation is short-term and provides comparatively low liquidity, ultimately resulting in a net negative for commodity markets.

Top off those inefficiencies with technology stacks that don’t readily integrate well with existing trading platforms and the current liquidity in the commodities futures market is nowhere close to its full potential. 

The above chart offers a visual representation of the statistical analysis that explains why most commodity markets don’t conform to the efficient market hypothesis. 

We’ll keep it straightforward – short-term speculation and low liquidity lead to significant price slippage across markets. 

Conversely, long-term speculation and ample liquidity minimize slippage as arbitrageurs can normalize the prices between the various commodities futures markets. 

Allowing existing commodities markets to communicate with one another in a trusted manner seamlessly will solve this issue. There exists ample liquidity – markets simply aren’t coordinating effectively.

The secret to resolving this conundrum – blockchain. This automated process minimizes costs for both speculators and businesses while allowing the market to take full advantage of existing market liquidity – not to mention the transparency. 

Transparent, But With Common Sense

 

When it comes to transparency, there’s a threshold of tolerance. Business owners don’t want the competition to know the amount or price of a commodity they’re buying.

Additionally, commodity markets themselves don’t want foreign markets to have unfettered access to all of their trading information. The information has a price, and, for some information, that price is invaluable. 

The diverse value of inflation means that the current situation is a catch-22 of data silos. 

Too much transparency destroys competition and, in the process, efficient markets. 

However, the global commodities market is currently disconnected and can significantly benefit from increased interconnectedness. Allowing trusted parties to view data while keeping that same data hidden from the general public is necessary for breaking down these current inefficiencies.

Once again, blockchain accomplishes a happy medium through various transparency levels by allowing the release of relevant data to verified parties using a single technology stack. 

Companies can push data to one blockchain for the public, another for their business partners, and an internal, proprietary blockchain for company use, all while assuring the information’s integrity. 

How a blockchain records transactions

Dealing with Fraud the 21st Century Way

Another benefit of leveraging the new and innovative blockchain technology in commodity markets is optimized fraud detection.

Fraud impacts commodity trading in the form of elevated prices, which is a net negative for both traders and business owners. 

Underdeveloped markets have experienced around $1 trillion of trade-based money laundering activity since 2011. Primarily accomplished through charging elevated prices for delivered commodities, that is a massive figure. Doubly so for underdeveloped economies.

Blockchain reduces the costs of due diligence and regulatory reporting while optimizing the process of trade financing. 

Currently, trade financing is a confusing process involving manual letters of credit. These inefficiencies pass on to producers and consumers as elevated commodity costs. Commodity trading reflects these currently high and erroneous costs.

Once again, the interoperability, transparency, and real-time settlement afforded by blockchain technology decreases costs and introduces new efficiency levels to commodity markets.

Irregular trades are more easily spotted with blockchain, improving efficiencies at all commodity supply chain stages.

How Will This Affect Agriculture?

Increasing the efficiency of a market benefits actors at all stages. For agriculture, the ability to more securely lock in prices via futures contracts will allow for better forecasting of things like operating income. By planning farther into the future, producers will be able to build stronger businesses. 

The traceability impact will also be enormous. Certain sectors of the ag space – timber especially – will find themselves totally revolutionized in terms of market security. Blockchain for timber trading is an entire essay in and of itself, but the point is this – it would be a hugely positive change. 

Introducing blockchain into commodities trading is only one of the many impacts that the technology will have, for agriculture and for the global economy itself. But if you’re not a producer or a speculator, how do you benefit? 

What you’re really looking for is exposure to the ag sector. This can take many forms, but direct ownership of real assets in farmland may be the most relevant. After all, why not participate in the production of the commodities themselves?

To learn more about how you can access real assets in farmland, check out Farmfolio’s LOTs.