TL;DR

• As car markets mature they require more sophisticated financial tools

• Car futures are a financial tool for making finance and innovation more efficient

• Participants with financial strength are more likely to build industry-wide tools

• Price networks and statistics enable futures contracts for cars, even though they are not pure commodities

This article builds on the car-tickers article, as part of a short series of business cases for the car market uniquely solved by smart-contract technology. US consumers benefit from lower costs when more sophisticated financial tools are used to support an industry, and financial efficiency then typically unlocks more innovation.

Introduction to Car Futures

The Internet and car advisory services such as Consumer Reports and CarGuru's have shifted car dealership information advantages back toward retail buyers, reducing profit margins and forcing manufacturers to improve reliability across the board. These developments have been a tremendous benefit for US car buyers and owners, who now pay less for more reliable vehicles.

This has also made operating dealerships more challenging, leading to consolidation. Financial strength and managerial excellence has accompanied this consolidation.

Today less than a dozen dealership networks buy and sell over 3 million cars per year, representing $50 billion in transaction value. This is roughly the size of the US soybean market. Larger if we add in the top 3 car rental companies’ annual fleet turnover. Yet the financial tools available for managing this inventory are quite limited compared with commodities markets.

The car industry needs futures contracts. Car Futures.

Futures are financial contracts that allow producers of commodities like wheat, corn, gold and copper to lock-in a sales price in advance of delivery*. Note that cars do not have to be as exchangeable as bushels of wheat to have a vibrant futures market, which is great because they never will be. Statistics and contract expiration dates take care of this, as we'll see below.

* Background and some references on traditional futures. Farmers, miners and others use futures to invest in production more confidently, given the risk of a sudden price drops between investment and harvest/output. Similarly they can buy contracts to offset a loss of production during a year when the commodity is under supplied, and benefit from the rise in prices.

Commodity futures can be settled with physical delivery, but car futures would use the cash-settled method found in equity index futures. In the US commodity futures are regulated by the CFTC, and security futures (e.g. S&P 500 index futures) are jointly regulated by the CFTC and the SEC.  Federal laws for futures are 100 years old.

Car Inventory Management and Innovation

Dealerships carry more car inventory than ever. Inventory depreciating over time, requiring maintenance, and subject to market cycles that create lean years. Financing, and parts & services revenue smooth out these cycles for savvy dealerships, but the cycles remain. By protecting against sudden price variance, futures unlock finance and accounting methods used to smooth earnings in other cyclical industries for decades. Methods that might even prevent the existential risks we saw in 2022:

An additional benefit may apply to electric vehicles, which are expected to have more lumpy parts & service needs than gas cars (i.e. a battery pack after 10 years rather than more regular brake pad and oil changes). As EV’s become a greater share of the US fleet, financial tools to manage economic risks become even more important.

Transportation Services Innovation

Let's say your dealership wants to build a rental business next to your dealership to take advantage of the depreciation sweet spot, and diversify your revenue.

Renting out some inventory offers attractive returns, but because you have a well tuned cash-cow business you're unlikely to take the risk. Futures contracts provide an insurance policy to mitigate the risk of cars depreciating faster than anticipated. A way to hedge, like a farmer protecting the crop before harvest.

If they can easily purchase futures contracts, dealerships are more likely to take a chance on consumer friendly innovations that maximize the utility of their inventory.

Eventually, as the futures market matures, it's possible smaller dealerships or even enterprising ride-hail contractors for Uber or Lyft might purchase depreciation coverage from an insurance company. The insurance company would then employ futures contracts to re-insure the portfolio against an unusually high spate of claims.

Car Futures are Amazing! What gives?

"Sounds great, but if car futures are such a good idea why don't they exist?" Glad you asked. The answer: now is the first time in history that futures are possible. Consider the preconditions for building a car futures market:

• Large marketplaces with well financed participants

• Prices reflecting nationwide exchange that are fast and credible

• Commodity units that trade in sufficient volume

We've already discussed the unique financial strength from consolidation. Extending this thinking a bit more, larger companies with big balance sheets means more willingness to support the industry as a whole.

For example, now that CarMax and Lithia Motors are nationwide they are more likely to absorb the short-term costs of new initiatives in the interest of long-term, industry-wide objectives. New initiatives such as the "Nationwide Car Pricing Network". Building a car-ticker price network has never been more likely than today, due to the confluence of technology and consolidation.

With respect to commodity units and volume, it may look like we’re stuck. A pound of coffee is a pound of coffee and bushels of wheat are nearly all the same, whereas slight differences in cars (e.g. wear and tear, trim level, etc.) can change price a lot. True, cars are more like commodities than ever (see the Appendix) but they still vary. Fortunately the power of computers, statistics, and the ingenuity of market makers provide a workaround: averages and contract expiration dates. Once we have a reliable, credible price feed, the contract market makers will take care of the rest.

Here’s how it works: price consortium members post confirmed sales to our smart contract on-chain from their dealership management system. Records like this:

The smart contracts will then do some averaging and then publish out to the rest of the system the updated price, with confidence intervals. Then futures contract market makers will build contracts based on their trading platforms standard. Two possibilities:

More detailed contracts like on the right above, means less liquidity and volume per contract, which in-turn means higher market maker fees per contract. That’s up to the market makers: It's just code and data! The possibilities are vast.

Existing Laws and Car Futures

Futures are a regulated industry. This is good. It means car futures contracts just have to conform to established rules and we're off and running. In the US this means they would trade at certain exchanges called designated contract markets (DCM). DCM's must comply with many core principles, but primary among them are:

• Core Principle 3: contracts must not be readily susceptible to manipulation

• Core Principle 5: speculative position limits or position accountability, to reduce the potential threat of market manipulation or congestion

The car-ticker price feed described above is the first step in addressing manipulation. Despite dealership consolidation the market is still relatively fragmented and we need serious, often cut throat competitors to cooperate in order to build the high availability, neutral price feeds.

The next step would be to use the existing DCM infrastructure to price, buy and sell contracts, whose value is derived from the price feeds. Ideally this fully addresses manipulation. Relying on the DCM's already trading billions in other futures contracts will also address Principle 5 ideally.

Other Business Cases for Futures

• Gap insurance hedging for re-insuring finance terms on leases

• More efficient dealer financing, similar to equities portfolio theory

Conclusion

Now that dealership networks have considerable financial strength and political power, there may be more will than ever to build tools that are important to the future of the industry. This article points out several opportunities for growth that should interest all parties and how they also might benefit from more financial stability.

Car futures contracts, built on the car-ticker price feed, would bring dealerships into the modern financial era and connect more closely to the gears of the financial machine the industry so heavily relies upon. Futures contract market makers are likely to rejoice at the idea of new transactional revenue from the creation of this hybrid commodity.

There are multiple miracles that must occur before anything like this can be built, but understanding the possibilities are key to taking the first step!

Please get in touch to discuss this idea. Also, here is a related piece describing a business that Futures would benefit as well: Data Mining for Car Revenue.

Appendix: Commodification of Cars

Traditional futures markets rely on vast quantities of things that are all the same to make a contract. In the internet era, we can subdivide more, especially in an industry as data-rich as autos. However, even with autos there will be opportunities for futures contract market makers to average across car subsets. Let's take a look at commodification, and why pounds of wheat are starting to look a lot like pounds of cars.

The commodities industry model applies to cars because over the past 25 or so years the reliability of consumer cars and light-trucks has improved dramatically, creating less difference for a given class and model of car. This is partly due to management practices at car manufacturers, and also the rapid spread of information and business intelligence through the internet. Similarly, the success of any car designs is so quickly identified and duplicated most cars are relatively interchangeable, as evidenced by the humorous "design is dead" meme on social media.

People love their cars and see them as extensions of themselves. But in reality almost all cars are quite reliable and, within given subset. The key is to define contracts within a statistically accurate group of cars, for example: Toyota and Honda CSUV's.