Why Blockchain Is The Future of Commodity Pricing
(Source: forbes.com)

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(Original link: forbes.com)

Commodity pricing hasn’t changed in three decades. Even for the most liquid, high-value and intensively traded commodities – oil, natural gas and gold – price setting is opaque. Changes have been made to methodologies and regulation in commodity pricing, but selective reporting and fewer participants submitting trades have lowered confidence in the published prices. The current relationship-focused, self-submission-based system has made it difficult for regulators to police the market. If the market moves to an automated and consensus-based system, would the users of these pricing benchmarks have more faith in the price?
One technology offers the market the ability to reconsider how these critical benchmarks are determined. Enter blockchain. The technology enables all trades to be securely and accurately captured, and yet it is a team sport – competitors, partners and third parties can all win with blockchain.
To be sure, transparency is not always a net positive. The trader’s art is to exploit and capitalise on informational asymmetries, to gain an edge and hunt a profit. The difficulty in convincing competitors to collaborate and play fair cannot be underestimated.
Blockchain could facilitate the solution. The upsides to commodity traders are meaningful. Greater liquidity to intra-day trading markets. Moving from daily published prices to near real-time publishing. Creating new markets and trading opportunities with benchmarking capabilities not available today.
Disrupting price setting? Blockchain may be the future for commodities pricing
Getty This can be done. A newly created pricing body owned and governed by its members – a blockchain consortium, motivated by improving the accuracy and reliability of commodity prices.
Liquefied natural gas (LNG) pricing could be a test case. The LNG market is coalescing around a new spot market, using old pricing solutions based on selective trade reporting and human judgement. Blockchain could be the architect of this transformation from a nascent growth market into one transparent to all participants.
Commodity markets: primed for technological disruption
Blockchain at its core is not technically complex. Essentially, it combines distributed computing networks and cryptographic encryption, both existing technologies. This combination removes the need for a centralised authority within any system or network where parties interact. The true beauty in any blockchain is finding a native use case, a problem that cannot be solved without it. Digital currencies, such as BitCoin and Facebook’s Libra, are prime examples, as are the countless applications in peer-to-peer microgrid trading and supply chain that have emerged in 2019.
So why is blockchain a native solution for commodity pricing?
1. It removes the need for the large intermediators
The commodity pricing market today is dominated by a handful of large players acting as the market reporter between buyers and sellers, collecting selective trades and publishing prices once a day. That’s how Brent or WTI, Henry Hub or NBP prices are set, as are gold. Price reporters collect market chatter, intelligence and hearsay. The deployment of a blockchain solution would effectively remove the need for any centralised intermediary because activity is collated and anonymously published.
2. Players can avoid the prisoner’s dilemma and trust the competition
For anti-trust and competitive reasons, competitors cannot share pricing information with each other, but the demand for a benchmark price led to the creation of the price-reporting agencies (PRAs) and opaque benchmarks as we know them. Smart Contracts – a self-executing set of rules on a blockchain – would guarantee that all trading activity and competitors’ prices were being used in the formation of price. Traders don’t need to trust that their competitors are playing fairly, the blockchain does this. All participants can see, and trust, the same pricing information, with its anonymous audit trail from trade to price.
3. It guarantees the past cannot be changed
What is written onto a blockchain cannot be changed or deleted. This is critical for the efficient functioning of the energy markets – trillions of dollars of physical and derivatives contracts are settled using these referenced prices. Based on these, operators explore, and bankers lend – even though there are marked differences in the same commodity price published by the different PRAs on the same day. All players would know that no one party could maliciously or intentionally change the past.
4. It removes the need for human judgement
No more “editorial decisions” to change methodologies at will. No more PRA “boxing”, the practice of excluding participants from trading within certain timeframes. Instead, there is faster and more accurate pricing with transparency on trading activity intra-day, adding liquidity to the market.
5. Because the PRAs need to reform
Their business models need to evolve and modernise. Block...