After a decade in cryptocurrencies, I now believe that the most important real-world use case for tokenization, blockchain, and smart contracts may be the tokenization of weather derivatives, rather than simply creating a digital warehouse of traditional yield-producing assets such as bonds.
Let me explain why.
Weather derivatives are financial instruments that pay out when certain weather conditions exceed a preset threshold. For example, a utility company may purchase a contract that pays you if winter temperatures remain unusually high and reduce heating demand and revenue. Airlines may hedge the costs of flight cancellations due to storms. Indian farmers may be able to protect themselves from monsoon failure.
These instruments exist precisely because weather is one of the largest unhedged financial risks in the global economy. The World Meteorological Organization estimates that weather-related disasters have caused more than $2 trillion in global economic losses in the past decade alone.
The traditional weather derivatives market has collapsed
The problem is that the markets built to manage this risk are themselves broken.
Weather derivatives are highly specialized, mostly local risk-based, bespoke contracts and often short-term, which significantly limits secondary trading activity. The total notional value of the market is approximately $25 billion, which is a rounding error when compared to the interest rate and credit derivatives markets, and an equally significant rounding error when compared to the $2 trillion in weather-related losses recorded over the past decade, not to mention the scale of potential future disasters.
