The live cattle futures contract has become disconnected to the cash market for fed cattle. The problem is the result of a cash market that has changed over the years and a failure of the cash market reporting to reflect the change in how cash cattle trade. This in turn has prevented participants in the futures contract from the necessary cash information required to make knowledgeable decisions about price direction in the futures. The current situation is plagued with uncertainty and confusion in both the cash market reporting and futures trading causing increasing volatility.
Major change is now necessary to adapt an industry to modern times, modern technologies and the technical and analytical tools available today to all of those connected over the internet. Bringing the entire industry behind one unified plan is a challenge but a necessity.
Problem number one is the cash markets. The problem is described as a thinning of the number of reported trades between packer and cattle owners. In Texas it is not unusual for 1-2000 cattle to serve as the base prices for 100,000 cattle slaughtered in that area. Kansas is following the same trend with cash sales reported in the 10-15,000 number. Other regions are also reporting decline numbers of cattle sold in the cash markets as reported in Mandatory Price Reports.
Problem number two is the futures market. Volatility has become common to the contracts and the liquidity necessary to reduce volatility will be impossible because of the fact traders cannot see or understand the cash market and new traders are unwilling to participate in the market.
Any attempt to reform the current system must begin with a complete auditable ledger of all cash transactions in the cash markets. The construction will be a Blockchain. A Blockchain is a public ledger of all transactions that are executed in a particular market. It is constantly growing as ‘completed’ blocks are added to it with a new set of recordings. The Blocks are added to the Blockchain in a linear, chronological order. Each node (computer connected to the designated network from a Feedyard) is required to be approved by the governing body as an approved client. The approved client performs the task of validating and relaying transactions to the Blockchain host in return gets a copy of the Blockchain, which gets downloaded automatically upon joining the marketplace network. The Blockchain has complete information about the IP addresses [internet addresses, geographic region, etc.) of the approved clients and their balances right from the genesis Block to the most recently completed Block.
CURRENT CASH MARKET
You hear many people complain the cash market is broken or almost non-existent -- but it is far from it. Cash cattle are trading in more ways and under various formats than any time since the beginning of commercial feeding in the 1960s. Each week we see cattle traded on:
1. grids with a fixed starting base price,
2. grids with a variable starting base, [cash or futures]
3. flat beef,
4. cash based formulas,
5. futures based basis with formulas or grids,
6. cash live prices,
7. Variable cash live prices, [premium or discount to cash or futures]
8. Beef Brand formulas, [with set Brand specifications]
9. Contracts with fixed basis to futures,
10. CME deliveries,
All transactions regardless of trade type will be converted to a live price FOB the feedyard. The transactions will be entered either automatically or manually into a pre-approved Excel spreadsheet that will be submitted to the Blockchain.
Blockchains have been popularized for their use in Bitcoins – an attempt to create a universal global currency. The Blockchain is seen as the main technological innovation of Bitcoin, since it stands as proof of all the transactions on the network. A block is the ‘current’ part of a Blockchain which records some or all of the recent transactions, and once completed goes into the Blockchain as permanent database. Each time a block gets completed, a new block is generated. There is a countless number of such blocks in the Blockchain. The term was created when the Blockchains are linked to each other (like a chain) in proper linear, chronological order with every block containing a hash of the previous block.
To use conventional banking as an analogy, the Blockchain is like a full history of banking transactions. Bitcoin transactions are entered chronologically in a blockchain just the way bank transactions are. Blocks, meanwhile, are like individual bank statements. The beauty of the Blockchain system is its ability to adapt to any market. No market would benefit more than the cattle markets where little innovation has developed over the past 50 years and the markets are crying out for more price transparency when none exists.
The starting point for cattle price reports would be feedlots. The hosted Blockchain will reside with a trusted third party or cattle association and each approved member or feedlot would be assigned a member codes that would be held offsite and be protected against accidental exposure. All firms agreeing to participate and submitting Blocks of price transactions would receive access to the composite and generic Blockchain thus providing complete and real time data price points. No individual client would be able to view any other client’s information but all could view the composite.
Depending on the level of participation, the country would be divided into reporting regions in a manner protecting the proprietary information provided by the clients. Cattle descriptions would be divided into 1) beef breeds, 2) Dairy breeds, 3) Mexicans. Delivery periods would be part of the Block information submitted upon completion of each transaction. Each transaction would be reported as a flat price or a basis price with the associated futures month or delivery month if it were a basis trade. Special beef programs such as organic or Never Never will be reported separately.
Market clients would be able to view their transactions, whether purchases or sales, [their Block] and compare to the aggregate Blockchain. From the Blockchain will be created public indexes designed to serve as potential settlement options for futures contract.
A governing board elected by the clients would establish the rules and regulations governing all reporting. The governing board would need to have authority for a third party audit of outliers or blocks that failed to fall within normal ranges. Audits would be done by independent third parties selected by the governing board.
The current CME contract is lacking a transparent reference point. A healthy derivative requires an underlying cash market that traders can see, analyze, and develop theories regarding price direction. Because there is insufficient reporting of the cash market to allow futures traders to understand the market, the natural result has been confusion and volatility.
The CME live cattle contract would be modified to a cash settlement price based on the Blockchain ledger of price points. This would include all formula, negotiated grid and basis transactions for the 5 region area. At expiration all futures contracts would settle to a series of Blocks submitted by the approved clients including all transactions converted to a live price FOB the feedyard source.
The governing board of the Blockchain would develop the standards for reporting. Daily price reports of all transactions consummated within each region would be published publicly and would be the basis for all contract settlements. Formula and other committed price points would be submitted and reported weekly for the appropriate week of slaughter. All price points would be converted to live prices FOB the feedyard.
Approved clients would agree to audit authorities of all reported transactions. Basis transactions negotiated for forward sales of cattle would be reported separately. If the project included packer participation, the Block ledger balances would be double entry transactions confirming accuracy.