Commodity Futures Exchange

I’d been watching SSN feeds for weeks, tracking Vanduul attacks on UEE’s major fuel supply lines. I spent the last three days setting up trades across a bunch of different accounts – some with my money, some with money I begged from friends and family. This was going to be my big score – my ticket to fame and fortune as a fuels commodity trader. All I needed was a call from my cousin on the UEES Paul Steed. The Steed was tasked to stop the Vanduul incursion just short of the last major intact fuel supply route to the central planets. If the Steed failed, fuel prices would skyrocket and I would be rich. When my cousin sent word the Steed had to pull back, I plowed every cent into fuels futures and waited for SSN to broadcast the news. When they did, prices skyrocketed into the close. I’d just bought a round of drinks at the Blue Horseshoe Bar for the crowd when SSN ran a story about some punk who discovered a new jump point into a new system – a system just 3 jumps from the central planets and filled with multiple gas giants capable of producing epic quantities of fuel. When the markets opened the next day, all I could get was fractions on the credits I spent. I turned nearly a million creds into 10,000. What am I going to tell my family and friends?

Economic friction from having to find another player to conduct trade is often dealt with via the creation of auction houses – centralized places where buyers and sellers (again players or NPCs) can bid for goods and take delivery upon completion of the sale.

A commodities futures exchange is something different. Instead of transacting for physical goods, buyers and sellers in a futures exchange transact in contracts for delivery of a commodity. The contracts are for a specific quantity and a price. The commodity in question is probably not even obtained yet because the contracts traded on the exchanges are for future delivery. You never have to be physically present at a commodity exchange because the only thing exchanged is money for contracts.

The primary benefit of a commodity futures exchange is price stability for both producers and consumers. Producers can lock in a certain sale price months in advance of actually producing the goods. Consumers can do the same. This level of predictability can insulate an economy from short-term price spikes since both producers and consumers can lock in prices on the types of raw materials typically traded on these financial exchanges.

Coding such an exchange in the Star Citizen universe would not be difficult. Any number of existing vendors have trading systems designed for use in real exchanges. These systems can work and live on any operating system and attach to any database. The database work is not complex and neither would the interface as this has all been done before.

Creating the operating rules is where the difficulty comes in.

For example, perhaps the biggest decision in creating a commodity futures exchange is whether to allow “leverage”. In a real-world commodities exchange, the buyer doesn’t immediately put up all the money necessary to acquire the goods. They put up anywhere from 1% to 10% of the value, with the remainder due only when the contract is executed at the specified future date. This makes the cash required up front much less onerous on the consumer while providing a little advance income for the producer.

Should “non-physical” participants be allowed? A non-physical participant in an exchange is neither a producer nor a consumer of the good being produced. Their advertized function is to add liquidity in the market by buying and selling the contracts for a profit. Under this theory, their liquidity helps smooth the flow of transactions and reduce volatility. However, they also compete with real consumers on the bid side, driving up prices. They can also compete with producers on the ask side, driving down prices.

Should “short selling” be allowed? Where most financial market transactions are “buy low and sell high”, a short sales is “sell high and buy low”. A short sale starts by borrowing a contract from someone who owns it already, usually for a small fee. The short seller sells that contract, hoping to buy it back at a lower price later to return to the real owner. Short selling is also, in theory, designed to improve liquidity for the purposes of smoothing prices.

Should derivatives be allowed? Instead of buying the contract, you could buy an option to buy the contract at a future date. That option is considered a “derivative” instrument. That may sound odd, but derivatives are a very significant part of our real-world commodity markets.

There are some significant advantages coming from having a commodities exchange with these features. Trading is made easier by not having to transport goods from the mining location to an auction house and then to the distribution location. They can simply be moved from the mining location to the distribution location. The certainty of price from forward-dated contracts can be important for both producers and consumers. Allowing non-physical participants expands the number of roles available to players, potentially adding a meaningful new method for economic gain without the need for piloting or to set up an in-game shop. Stories about the in-game financial markets would help with overall immersion.

That all sounds great. The disadvantages would have been much more difficult to explain if we weren’t currently living with those disadvantages in the real world.

Allowing non-physical participants creates an opportunity for manipulation. This is particularly true when combined with short selling and the leverage typically involved in derivative instruments. The St. Louis Federal Reserve published a report (PDF) showing about 15% of the price of oil in the 2004-2007 period was due to speculation by non-physical participants. Matt Taibbi in chapter 4 of his must-read book Griftopia about how the America economic system nearly collapsed in 2008 provides additional color.

I believe commodity exchanges could be worthwhile as long as care is taken to choose the best parts of this financial market construct. Limiting leverage, disallowing derivatives, and banning short selling would seem to be easy places to start that would also simplify the coding requirements. Whether or not to allow non-physical participants is a harder question. My answer would be “not yet, if ever” given what I’ve seen of their effect on real-world commodity prices.

It may be the only thing that can be reasonably borrowed from real-life commodity exchanges is the virtual aspect. Separating the exchange of money from the exchange of goods would absolutely reduce friction and risk since every transaction would then involve only two shipping points (source and destination) instead of three (source, auction house, and destination).

 

One thought on “Commodity Futures Exchange

  1. A footnote to this blog post:

    I could go on and on and on about the positives and negatives of just the four exchange features I highlighted in this post. The real-world financial markets (which I have 13 years experiene covering) are wildly complex and full of forehead-slapping features. I purposefully tried to limit the scope of this blog post so it would not turn into a tome. I’m happy to discuss any of these concepts (obviously) to explain or future explore how they might affect the Star Citizen economy.

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