Blockchain and governance in commodities risk management

28 November 2017

Blockchain networks have the potential to revolutionise the way parties share and agree on data in the future. You might be familiar with the way it works, allowing parties who do not necessarily trust each other to reach an automated consensus on a shared set of data with potentially huge consequences for the way commodity markets will work in the future.

However there are a number of obstacles to its widespread adoption, and one of the biggest question marks is how the technology will be governed.

State of play

As blockchain technology matures and a greater diversity of stakeholders involve themselves in its development, a range of governance models have emerged. These can broadly be placed on a spectrum from fully democratic to absolute autocracy. There are advantages and disadvantages to each.

Let’s start with the democratic approach and the well-known example of Bitcoin, which makes a virtue of the absence of any centralised governance. The key advantage of this model is that there is no central authority demanding the trust of the network’s users, thus safeguarding the overall platform from potentially unwelcome change. However, contentious issues can lead to paralysis. A prime example is the stalemate the Bitcoin community has reached in deciding the best way to increase transaction processing speeds.

In the opposite scenario a single individual or organisation makes the decisions, thus solving the above issue. However this leaves users powerless in matters of community-wide importance and re-introduces an element of trust between those users and the network’s administrator.

It is the latter, centrally-managed blockchain model that commodities players are likely to adopt (led by platforms such as Corda, Ethereum and Interbit to name a few). It is therefore that element of trust that is making the question of governance so important.

Innovative solutions

New solutions to the governance question are still emerging. One example is Tesoz, a blockchain start-up which has developed a self-amending ledger. It achieves consensus not just about the state of a ledger, but also about the state of its own protocol through issuing votes which when concluded will implement change automatically. Whether this approach will have appeal for enterprise applications will only become apparent as the technology is developed and piloted further.

Regulatory oversight

Blockchain has not escaped the attention of regulators, who are considering how best to throw their hat into the governance ring. Their direct participation in blockchains could streamline market oversight and deliver cost efficiencies for corporates. However, exactly how regulatory enforcement would operate in the cross-border environment of a commodities market is yet to be addressed.              

In addition, the regulator’s appetite for playing a part in the governance of blockchain varies around the world. For example, the US Commodities & Futures Trading Commission (CFTC) has issued an initiative to contribute to the development of regulatory nodes and best practice thought leadership, while China has banned cryptocurrency exchanges. Governments have the power to both stifle and enable the technology’s growth - again, how this develops is another uncertainty.

Data security

Good governance leads to good security, and responsibility for this rests with all of a network’s users. A system is only as strong as its weakest point, which is often less to do with the software than the fallible human using it. In a blockchain environment a user’s private key is used to authorise transactions, and so a leaked or stolen private key would be disastrous. Therefore all users will need to implement appropriate safeguards universally to maintain trust in the system, perhaps similar to SWIFT’s recently implemented Customer Security Programme.

Final remarks

Purists hope for the triumph of user-governance, liberating blockchain networks from geographical politics. In reality, whether you’re a network administrator, commodities business, or a government, you will have some responsibility for the governance of the blockchain. But how this will play out as the technology develops remains to be seen.

You can find out more about blockchain (distributed ledger technology) and its applications here.

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