April 20, 2021

An early history of the C market: Exchanges and derivatives through history


In recent years, the coffee sector has rightly recognised sustainability as a key priority. However, for anybody who wants to be a part of making the supply chain more sustainable, learning more about commodities markets and the C market in particular is crucial.

But as well as learning about these topics in detail, it’s also helpful to understand how and why they started. Commodities exchanges have been a part of human society for thousands of years. Their roots go back much further than European colonialism just a few hundred years ago. They are an organic, evolved response to the economic peculiarities of supply and demand. 

To learn more about where commodities exchanges originated and how they developed, we’ve looked at a few key examples through history. Read on for a guide to the early history of commodities exchanges, futures, and options. 

You might also like our article on “rethinking” the C price.

What is an exchange market?

Perhaps the oldest example of a forward exchange can be found in the Book of Genesis. In Genesis 41, the Pharaoh of Egypt receives a prophetic dream, which Joseph interprets as foretelling seven years of plenty, followed by seven years of famine.

In turn, Joseph responds by levying a flat tax of 20% on all grain production through the seven years of plenty. When the famine strikes, Joseph (and Egypt) then sells grain back to neighbouring countries through the seven years that follow, and prospers as a result. In one fell swoop, Joseph effectively invents both the grain exchange and commodities speculation. 

At its core, this is essentially how the C market functions today. The C price is the exchange price. It is determined in real time by the execution of transactions. 

These transactions are simply people buying and selling contracts from each other, with the exchange facilitating the deal. 

In its most basic form, the exchange works like so: 

  • Producers will offer up their lots of coffee to the exchange for delivery. 
  • The exchange buys them at its rate, and takes them into its warehouses (these become “certified stocks”). 
  • Buyers may then purchase coffee from the exchange’s “certified stocks”, once again at the exchange rate. 

While not without its own significant issues, this serves a number of purposes in the supply chain. 

The exchange will always buy coffee, meaning that in times where there is an oversupply, the farmer always has a buyer. Similarly, the exchange should always have coffee to sell. 

This helps stabilise the world’s coffee supply, ensuring a steady flow of goods even throughout a mass over or undersupply. 

Futures & ancient Mesopotamia

To understand the C market fully, however, we need to understand its contracts. The act of buying or selling on the C market is achieved through forward contracts, also known as “futures”. 

Futures contracts are more than four thousand years old. They can be traced back to around the same point at which humans pioneered copper metallurgy and the plough.

Buying a “long” contract means you agree to receive coffee from the exchange at a predetermined point in the future. Conversely, going “short” is an agreement that you will deliver a coffee lot at a set date. 

So, if a retail trader sitting at home on their iPhone buys a lot of coffee futures and holds them until they expire, they will be legally bound to take delivery of 37,500lbs of green coffee from a warehouse certified by the Intercontinental Exchange (ICE).

Forward contracts bring an important dynamic to commodities exchanges. For example, let’s say that in June, you agree to buy coffee futures for delivery in September at US $1.30/lb.  

However, in August, the price then rises to US $1.40/lb. But rather than waiting another month to receive the physical coffee and sell it on, you can instead sell the contact itself, taking your US $0.10/lb profit. 

Trades like these are the essence of “futures speculation”, which has been a feature of commodities markets since antiquity. 

The first contracts of this nature date back to ancient Mesopotamia (around 2000 BC). They were written in cuneiform on clay tablets. 

These tablets contained almost all of the modern features of a futures contract: a description of the parties involved, the goods to be transferred, the date of delivery, and the agreed price. It’s even believed that the Sumerian temples acted as warehouses, and enforced quantity and quality regulations.

While starkly different in appearance, these temples effectively performed the same function as the ICE. The primary difference was that the temples did not buy the goods they held; instead, they merely facilitated the trade. 

In modern terms, this is best described as an over-the-counter (OTC) arrangement: a deal where the counterparties engage directly, rather than selling to and from the exchange. 

Olive oil, tulips & options: Thales of Miletus and Dutch flower traders

The final major component in understanding the contracts traded in the coffee sector is the option.

As their name might suggest, options give the owner the right – but not the obligation – to buy or sell a lot of coffee futures at a predetermined price. This can be very powerful when used correctly.

To explain the principles here, let’s look at Thales of Miletus, an ancient Greek philosopher. Thales was named by Aristotle as the founder of the discipline of physical science. He is recognised as one of the key figures responsible for moving philosophy’s focus from mythology to physical and rational explanations of the natural world.

Anticipating a particularly large olive crop one year, Thales put down a deposit for a number of olive presses (machines used to extract olive oil from olives). This gave him the right, but not the obligation, to purchase these olive presses at a predetermined price. 

When the crop came in, and was as large as expected, olive presses were naturally in high demand. Thales then sold his contracts to buy these olive presses at a much higher price. This returned him a very healthy profit, without the need to pay the full price of the underlying asset.

However, it wasn’t until 1973, some thousands of years later, that the first formally traded options exchange was established in Chicago. This is because in the 17th century, a phenomenon known as “tulip mania” showed just how unstable options contracts could be if they were unregulated. 

Tulip mania is generally considered to have been the first recorded speculative economic bubble in human history. High artificial prices for tulip bulbs saw large swathes of the Dutch population invest in tulip options. At some point in 1637, a single tulip bulb was worth more than ten times the yearly salary of a skilled craftsman. 

However, in just a matter of years, the tulip bubble burst, and the average price of the tulip bulb plummeted. With no regulatory body present to enforce the execution of the contracts, buyers disappeared, and so did capital. 

However, once the contracts were proven as an enforceable OTC product by a number of American brokers, options saw a comeback in the late 20th century. With a central exchange to enforce the fulfilment of contracts, options became and remain today an extremely popular tool for investors.

The Dojima Rice Exchange: The first centralised modern futures market

While Mesopotamian temples exhibited many of the features of the modern ICE, the market more closely resembled an OTC market, as the temples did not buy the goods. 

To find the first example of a truly modern futures exchange, we must instead look at 18th century Japan and the Dojima Rice Exchange.

The rice exchange was formally established in 1730. It had all of the modern hallmarks of a futures exchange. There was a spot and futures market, standardised contracts, lines of credit, settlement through a central clearing house, and the requirement for traders to be registered and hold a licence. 

Many landlords (sellers or coffee producers in the modern C market) used the futures market at the Dojima Rice Exchange to offset risk. However, because the rice tickets issued were freely transferable, there was also a large amount of speculation.

The Dojima Rice Exchange also provides the first hard evidence of the theory that futures markets reduce price volatility by improving transparency, efficiency, and resource allocation. According to a 2018 paper by Bernardina Algieri, price volatility for rice as a commodity was “7-8% higher… 15 [to] 20 years before the creation of the Dojima futures market”. 

While there are criticisms of the modern C market, it’s important to remember that it is a representation of economic and social necessity that has naturally evolved over time.

Producers and consumers, as sellers and buyers of goods, have always faced challenges with volatile prices and poor price transparency. Ancient Mesopotamia is commonly considered one of the birthplaces of modern agriculture. This means that we can confidently say that these challenges are as old as farming itself.

In the specialty coffee sector, these criticisms are especially common. But rather than creating volatility and problems in the supply chain, futures markets and their contracts are structures that have evolved precisely to address these issues. We can say with some level of confidence that the emergence of these structures points to their importance. Financial markets cannot exist in the same way without them.

Going forward, if we are to drive sustainable change, thought leaders across the industry must appreciate the historical importance of structures like commodities exchanges and futures markets. It is integral if we are to have any hope of improving outcomes for stakeholders across the coffee supply chain. 

Enjoyed this? Then try our article on how the C market affects coffee farmers.

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