The benefits of decentralized financing in ferrous scrap futures contracts

Mettalex launched exchange-settled daily contracts for bulk exports of ferrous scrap to Turkey and for containerized shredded scrap exports to India that are settled based on the Davis Index US-origin HMS 1/2 (80:20) bulk cfr (cost and freight) Turkey index and the Davis Index containerized shredded cfr Nhava Sheva index, respectively, in late May. What makes these contracts different from other contracts available to the industry is, unlike futures contracts, a maintenance margin does not have to be provided, says Humayun Sheikh, CEO of U.K.-based Mettalex.

Mettalex has started with the contracts it has because Turkey is the world’s largest importer of ferrous scrap that ships in bulk vessels, while India is the world’s largest buyer of containerized ferrous scrap. “Bulk cargoes by their very nature are very large contracts,” Davis Index CEO Sean Davidson says of the Turkey contract, which also is why it makes sense to hedge such transactions.

Davis Index is based in Singapore with North American offices in Toronto.

“All open positions are 100 percent backed by stablecoin collateral that is provided by the user,” Sheikh explains. “There are no margin calls on Metallex. Users know exactly what they can lose/earn before opening a position.

“Any user that has BUSD can either use it to provide liquidity to the Mettalex DEX and earn trading fees and MTLX tokens OR use it to trade on the DEX,” Sheikh says of Binance’s U.S. dollar-pegged stablecoin.

Additionally, open positions don’t have a predetermined expiration date on Mettalex, he says. “An open position can be settled either by the user or by the real-world price of the asset breaching the band.”

Sheikh explains, “Unlike other derivatives instruments, leverage is determined by an automatically determined price band (based on historical price volatility for that specific market) and the current price of the asset between the floor and the cap of the price band. The closer the oracle-reported price of an asset is to the floor or the cap, the larger will be the leverage for taking the open position. This presents asymmetric opportunities for traders.”

Davis Index provides reliable price data that are key to the proper functioning of Mettalex’s contracts, he says.

Davidson says traders of ferrous scrap, the largest scrap commodity traded by volume, should benefit from hedging tools in the same way that nonferrous scrap traders do. While a number of instruments exist to hedge ferrous scrap trades, he says they haven’t taken off in the same way nonferrous hedging instruments have for a variety of reasons, including the time it takes to set up such transactions and other potential barriers to entry. “Working with Mettalex cuts out the middleman,” Davidson adds, noting that the platform is “agnostic to the financial institution you want to go with,” lowering the cost associated with hedging by 10 to 15 percent.

Metallex says hedging tools remain largely inaccessible to small and medium-sized enterprises because of their high costs. Additionally, commodity market participants face obstacles related to front running, poor liquidity, price manipulation and loss of value in the form of margin calls. However, Mettalex says it is enabled by decentralized finance (DeFi) liquidity and automated by blockchain-based smart contracts, using machine learning to automate market making and price data delivery mechanisms.

“The current system provides the industry with less than a handful of instruments, and the basic risk and costs are just unworkable for most companies,” Davidson adds. “Mettalex is finally answering the call for a decentralized exchange that can list any commodity. We look forward to providing our price benchmarks on the Mettalex platform to give the manufacturing, demolition and metal producing sectors the precise hedging instruments they need.”

Mettalex’s Autonomous Market Makers act as a party to all trades on the exchange, ensuring the system is fully collateralized with stablecoin liquidity and setting the prices of long and short positions, according to the company. Autonomous software agents from U.K.-based Fetch.ai enable commodity-focused price data to securely flow into Mettalex and settle markets.

Sheikh says ferrous scrap contracts enabled by DeFi offer a number of advantages:

• There are no third-party fees.
• Autonomous market makers allow any trade to be performed at any time because someone always will take the opposite position of any trade.
• Mettalex is available at all times.
• Users identify with their Ethereum or Bitnance Smart Chain addresses only.
• No single company provides liquidity on Metallex; it is peer generated.
• The Mettalex team does not have access to user funds. Instead, collateral for open positions is stored in smart contracts.

“All trades and open positions are fully transparent,” he says. “Users actually own their open positions—they are represented by ERC20 or BEP20 tokens in their Etherum wallets. Stablecoins generally provide more utility than fiat currency (government-issued currency that is not backed by a commodity such as gold) since they can be used in various lending platforms to generate yearly yields much higher than 5 percent. No bank is currently offering such high interest rates,” Sheikh says.

He adds that Mettalex is the hedging tool that small and medium-sized companies in the commodities space have been looking for. “It will help them manage risk at a much affordable rate than alternatives.” Sheikh adds that the greatest benefit is the “abundance of liquidity in the DeFi space,” which he says “will make spread[s] tighter and improve the overall cost efficiency of trades.”

Metallex plans to introduce iron ore, aluminum, copper, lithium and other scrap contracts in the future. “We just need to listen to what the community of traders and hedgers want exposure to and deliver it.”

Davidson adds, “To be good, any contract needs market participants. When the market sees certain instruments will work for them, they will start talking with other market makers.”

Despite the deal with Mettalex, Davidson says his company is open to working with other entities that want to use Davis Index pricing to settle their futures contracts. “I’m hoping that innovations like this will spur more change in our space.”