As much as the purists among us would love to transact freely via fully decentralized exchanges without interference from regulators immediately; the reality of our new crypto environment is that if we want access to markets in the world’s largest economies we are going to have to jump through some proverbial regulatory hoops. In the preceding article in this series, I mentioned the CFTC and necessary designations required to run a commodities exchange in the United States. As is evidenced by the SEC action against Ether Delta, the government will follow the code until they arrive at a centralized human developer to charge with violations. Like it or not, the US government has the resources and time to pursue, fine, and criminally charge.
We can debate and philosophically spar over the fairness and equitability of these legal actions over a bottle of burgundy, however, to have granted access to the greater economic dynamism and capital energy, we must play by a few rule. And not so coincidentally, the data structure we all know and love, blockchain, can allow for adherence to regulatory frameworks in a way that was unavailable to markets just 15 years ago.
In order to bring our exchange to the farmers and elevators who will use initially use it, we must gain two separate but interwoven designations from the CFTC, that of a Designated Contract Market (DCM) and a Designated Clearing Organization (DCO). The first (DCM) allows for the “official” exchange of futures and options on the basis price (Previous Article) Approval as a DCM contains within it the standardized legal framework and structure of the tradable basis price contract. This contract will be traded utilizing the Tezos protocol. A set of programmable smart contracts to transact and trade futures/options on the basis.
The second component of our exchange required to operate is approval as a Designated Clearing Organization (DCO). This ensures that as an organization, our exchange and its members, will need to provide collateral to cover any defaults between buyers and sellers. If the buyer doesn’t have the cash or the seller does not have the commodity, the exchange and members collectively offset the counterparty risk, by ensuring that every trade is fulfilled, either cash settled or delivery.
Tezos is already equipped to digitally structure an organization that allows smart contracts to effectively manage collateral needs of the exchange as a DCO. The cost of a seat or membership at the exchange will go to mutualizing the collateral needed to support the exchange as a clearing organization. In addition to the custodial aspect of the funds, the capital used to purchase an exchange seat can be converted to XTZ and provide a return to members via staking. Members of the exchange will receive a return on their bond as well as the revenue generated by trading options themselves. In a hybrid bond pool, we split the collateral into USD and XTZ, stake and bake the XTZ, thus providing a return to members on their bond. The returns on staked XTZ will also allow us to maintain a stream of revenues that can be rerouted to gas fees and maintenance of the exchange.
In the exchange’s function as a Designated Contract Market, we will use Tezos smart contract tokens as a 1 : 1 mapping on the Basis Price contracts. The Basis Price Futures Contract will accurately reflect the Basis Price for the delivery of 500 Bushels of Grain at a specific date and elevator location. Each token will represent this type of approved and standardized commodities contract: tradable, redeemable, and deliverable.
As the application process for the DCM and DCO continues, we will keep writing and updating on the exchange project. Tezos offers a unique protocol to bring this new type of commodities exchange into being. Stay Tuned.