Monday, July 8, 2019
Our previous eight blog posts have shown the mineral supply chain is full of complex problems that have multi-faceted causes.
Blockchain, paired with careful system design, provides us with tools to tackle these problems.
Blockchain has four key characteristics that make it suitable to address these increasing regulatory challenges. In the upcoming posts, we will explore these characteristics in detail and build up a model for tracking the mineral supply chain.
The first two characteristics we will look at are the core results of using blockchain. They are tools that allow us to create a system that can keep track of the history or provenance of the materials we are transacting and ensure that record is trustworthy:
The next two characteristics provide incentives for every supply chain actor to use our well-designed technology tools. They are how we can turn our system from a novelty for companies who know each other well, into a global infrastructure that can address some of the deepest problems the mineral supply chain faces:
The success of our mineral blockchain tracking system depends completely on designing the technology tools properly, as well as the incentives.
Let’s start by delving into the tools of the trade in this blog.
When most people think of blockchain they think of tokens. Tokens are digital assets that are created according to rules agreed upon by everyone using the blockchain. They cannot be produced in any other way, and cannot be duplicated or forged. This property means we can limit the number of tokens available, and this rarity means they can represent real-world assets such as minerals or metals.
If we are going to use a token to track our minerals, we first need to decide if we want to use a fungible or a non-fungible token for the task. Fungible tokens are all alike and interchangeable, similar to cash in a bank account. Non-fungible tokens are all unique, like collectable trading cards. The decision comes with tradeoffs no matter which we choose.
The simplest type of token we can create is a fungible token. With fungible tokens we only keep track of the quantity we have; every token we purchase can be merged into a larger pile of tokens making them all indistinguishable from each other.
Fungible tokens are the most commonly created type of token in the blockchain world. They are easy to handle, like a currency, can be stored in a wallet as a number, and moved around like cash. Metals are also fungible so it seems intuitive that a fungible token would work for tracking responsible materials.
So, if we tokenize a supply of known fungible metal using a fungible token, how could it work?
Imagine we start a company that wants to produce responsible gold for investment purposes. They purchase all their gold from one large scale refiner that purchases all their supply from one large scale mine. All of the production practices are responsible and are regularly audited so our company can be confident that the gold is responsible.
We purchase this gold in the form of 1oz bars and put the bars into a vault. For each bar in the vault we create a fungible, digital token on a blockchain which is then sold on the open market. This gold token would contain a link back to a website that shows how responsible the gold is. At any point, the owner of a gold token could redeem the token with our company to receive a gold bar from our vault.
Our previous example had very limited use of blockchain. We were able to create a digital representation of the gold in a vault, but the gold didn’t move. We can think of this as being able to track the amount of gold in the vault, which is one actor at one level of the gold supply chain.
Can we just add actors each with their own fungible tokens to get better depth to our supply chain tracking?
Imagine a gold mine processing ore onsite into “doré” bars, which is partially refined gold that still has silver mixed in. For each bar, they create a doré token, which is fungible. Just like the example above, the tokens are not traceable to a particular bar, but rather the amount of tokens are limited by the quantity of doré produced on site.
When a shipment of bars is sold to a refiner, the mine would send an equivalent amount of doré tokens to the refiner. The refiner would then be able to destroy the doré tokens in order to create gold bar tokens.
The gold bar tokens would be sent to our company along with the gold bars which are then put in the vault. With the gold bars in the vault, our fungible gold bar tokens can then be sold on the open market as in the example above.
This system will allow us to track volumes of doré produced at the mine and volumes of doré that are converted to gold bars, however it does not allow us to track specific bars or shipments.
This method essentially introduces a level of non-fungibility into our system. Although both the doré and the gold bar tokens are fungible, they cannot be mixed with each other.
By adding layers of non-fungibility we get greater visibility into what’s going on in our supply chain, at the cost of it being more complex to implement.
Now that we have designed a basic token-based tracking system, we want to have an even greater level of detailed information which metals come from where. Perhaps traceability is more important to us than trading liquidity. For this, we can use non-fungible tokens to represent metal in our supply chain.
Non-fungible tokens can be created to represent specific shipments of metal ores or ingots, so they are not interchangeable with another token, and effectively act as a digital twin that can be used to demonstrate who owns it. Each token can contain a link to data that demonstrates the responsibility of the shipment that it is linked to.
We can use a non-fungible token in our gold scenario which will act a bit like passing a baton from person to person in a relay race. When it gets to the end, it will have the fingerprints of everyone who held it, giving the owner a detailed history of the item.
To illustrate, let’s go back to our gold mine again. Our responsible gold mine wants to sell responsibly sourced gold to their customers.
They extract gold, melt it into doré bars that are weighed, and a non-fungible “doré” token is created to represent each bar. This time, the doré token contains a unique ID, which is put on a tag and attached to the doré bar, as well as a link to a database of due diligence data about the company that produced it. As the doré bars are passed from owner to owner, the associated non-fungible tokens are also passed along to each new owner.
When each doré bar reaches the refiner, like before, it is processed into 1 oz gold bars. Unlike before we will not destroy the doré tokens, but rather freeze them so they can no longer be traded. When the new gold tokens are created they will link to the old doré tokens so we have a record of where they came from. When we put our gold bars in a vault, each will have a unique ID and customers can sell them on the open market, or redeem them for their specific gold bar.
And of course, we lose all the benefits of fungible tokens. If we are tracking individual gold bars with a unique ID, we need to check these IDs whenever we trade them and make sure we have the right ones if we sell the physical bars. There is no getting around this. The point of tracking individual bars is to de-commoditize the gold.
If we want to say that a gold bar that comes from a responsible source is different than one that funded human rights abuse, this is the trade-off.
It is important to note that the methodology that we have built up is not the only way to apply blockchain to address issues in the mineral supply chain. If you’ve read the Minespider white paper, you probably noticed that it describes a system that is a bit different than what we described here, and that is because it was designed for a more complex and more generalized scenario.
The main goal of this blog post is not to completely solve the problems of the mineral supply chain but rather to get familiar with the tools that blockchain gives us, and to begin to think through the implications of different ways of applying them in a systematic way.
In this post, we looked at how to build up the technology in scenarios where we had a lot of implicit trust between the supply chain actors. In our next post, we will look at different ways we can use blockchain technology to address the points of mineral and metal processing in larger scenarios where we might not have as much trust between players.
Nathan Williams is an experienced blockchain entrepreneur. He is the founder and CEO of Minespider, a second-layer protocol for responsibly sourced mineral data on a public blockchain. Nathan is a regular conference speaker, moderator, blockchain aficionado, and co-host of the Analysis in Chains blockchain podcast that boasts over 175,000 downloads. Nathan holds a BS in computer science from McGill University and an MBA from Concordia University.