How Blockchain will revolutionize energy trading
Many energy companies are exploring the possibilities of blockchain. One of the most investigated application is energy trading, since it has the capabilities to solve some of the issues inherent to this topic. Energy trading is characterized by a large number of intermediaries and by back office costs that the blockchain could possibly mitigate. In our article we will look at how blockchain can improve energy trading processes by looking at two aspects of the blockchain technology, namely data storage and process automation.
Blockchain is attached to many possible innovations in the energy sector such as EV charging, data storage, payments, microgrid management and demand response. However, few of those ideas have been implemented so far. Energy trading is one of the most commonly explored topics alongside EV charging and microgrid management . In this article we will look at how blockchain will change exchange based energy trading. All in all, blockchain has the potential to make energy trading more efficient and more transparent. This article focuses on exchange based energy trading since there is a large quantity of standardized trades and interactions between the actors within this market. Blockchain technology could have more impact on performance improvement in this context than on other trading arrangements. To explain the benefits of blockchain for exchange based trading we will take a stepwise approach, by firstly investigating the database capabilities and secondly the automation potential of the technology.
Blockchain technology’s recent entrance into energy trading
At the conceptual level, the main benefit of blockchain trading comes from the use of smart contracts (computerized transaction protocols that execute the terms of a contract) and the database storing capabilities of blockchain technology. The benefits of those two aspects of the technology can be summarized in four segments, Decreased Transaction Costs, Increased Transaction Speed, Increased Trust & Auditability and lastly Increased Process Efficiency (See figure 1 for more detailed explanations).
Figure 1: Blockchain energy trading benefits
Benefitting from improved database systems
The first step toward realizing benefits is to use the blockchain as a data storage platform. This would allow the different players to benefit from having easier access to data on a centralized database and prevent them from sending the same information multiple times. The main drivers are to improve communication, information availability and to reduce costs for the various members of the network.
Considering the technical aspect, using the blockchain as a storing system enables each of the participants to become one node of the blockchain network and hold a copy of the records on its system (thus, the same information). Participants (nodes) of this network would for instance be traders, suppliers or distribution operators.
One of the benefits of storing data on a blockchain is the immutability: it is impossible to reverse a transaction once it has been approved by the other members of the system . A blockchain system could only be modified by recalculating all the previous transaction by simultaneously controlling 50%+1 members (nodes) of the blockchain. This means hacking 50%+1 members of the system to take control of the platform, which is highly unlikely. Furthermore, to prevent members from colluding or engaging in other unauthorized behavior a central regulator could be placed at the head of the platform. This regulator could be in charge of preventing and monitoring both external (hacking) and internal frauds (members attempting to temper with data, or abusing weaknesses) by maintaining the platform and creating policies.
This system also leads to:
- Increased Process Efficiency and Reduced Transaction Costs: All members have the same information on their database and no need exists to multiply the database to store information coming from different parties for the participants. As a result IT costs are reduced for each of those companies as the integration costs of the various databases are shared by the actors and the cost of maintenance decreases. Furthermore, if processes are integrated this requires a high degree of standardization, which will benefit actors on the long term due to less administrative and back office tasks.
- Increased Speed: Information is shared on one platform directly between all the participants and without intermediaries. Furthermore, data-transfer is instantaneous in a blockchain system (network should reach a large size to suffer from bloating).
- Increased Trust & Auditability: Participants and external individuals cannot engage in fraud since false transactions will be flagged by the system. As these possibilities of fraud are reduced risk premiums also decrease. Secondly, the complete history of transactions is available to the participants, thus, enhancing the transparency of the system and trust since actors all have access to the same information.
The main trade-off of such a system would be that data should all be entered in a similar form. Participants would have to agree on a uniform way of sharing and entering information to reduce administrative burdens. This will cause challenges on the short term for organizations to adapt, but will be rewarded on the long term with improved operational processes.
Scaling up to leverage on task automation
After implementing a blockchain system as a database storage system, it is easier to build up more solutions on this platform. The second step would be automating tasks, to reduce human interference and intermediaries in trades which further reduces the costs of trading .
Costs reductions would be realized through the following actions
- Matching supply and demand more efficiently will diminish the need for brokers.
- Automating the transfer of ownership of an asset in a trade will surpass the clearinghouse by retrieving the payment and assigning the title automatically.
The first actors to have their activities threatened would be the brokers (facilitators between a buyer and a seller). This is the result of less information asymmetry between the various market parties and of a platform where supply and demand could meet each other more easily without the need for an intermediary. Thus, contacting a broker to find a certain traded asset would not be as interesting, since they can find the asset either themselves or with the help of the platform, resulting in Increased Process Efficiency, Increased Speed and Reduced Transaction Costs.
The role of the clearinghouse is to ensure the financial integrity between trade partners. The clearinghouse is an intermediary that enhances the trust in a transaction by making sure each party honors the settled conditions of the contract. Smart contracts ensure that the assets (whether commodity or money) are transferred automatically when a transaction is agreed .
There is no need for buyer and seller to engage a clearinghouse to act as a clearing party. The blockchain platform retrieves the money and transfer the title to the parties automatically. As clearinghouse charge commissions, automated energy trade would result in Reduced Transaction Costs and would Increase Speed tremendously, since the title of ownership and the payment are swapped almost instantaneously.
The only limitation to the replacement of clearinghouses is in preventing the possibility of default by one party. The trading members of the blockchain should attach assets (money) to the system as a deposit to mitigate the possibility of default of one party. This could possibly lock a significant amount of assets in deposit since it is relative to the volumes traded. Consequently, the blockchain should be given power to enforce such issues legally (take from the deposit).
An approaching revolution
Blockchain has the theoretical capabilities to make the process of energy trading more efficient and more transparent. Through the suppression of friction and through process optimization, the price of trading is likely to decrease. However, many unknown factors remain, such as how to implement a full blockchain platform to many different actors or how to create a large scale blockchain system. Furthermore, certain parties such as the brokers or the clearinghouse will have to review their business model to adapt to the transformation that blockchain could cause.
At Sia Partners, our consultants and data scientists can help organizations with blockchain projects by identifying use cases, creating business cases, leading the development, testing, and transformation of your business accordingly. Previous projects executed by Sia Partners include supporting a large European railway company and a large bank to implement a blockchain based use case.
About the authors
Arthur Dulong – Jr Consultant Energy & Utilities
Arthur is passionate about innovation and the energy sector. He has a background in finance and information management. Following his passion for innovation, he has been working on data science oriented projects such as evaluating the effect of renewable energies for a large DSO or evaluating wind farm investments. His previous experience also led him to investigate the potential of blockchain for e-goverment use.
Lei Thewessem – Consultant Energy & Utilities
Lei is part of the data science team within Sia Partners, and has a background in policy- and investment analysis for the energy sector. He has contributed to business transformation and forecasting projects at several large power producers and grid operators.