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Digitalizing diamond

09 february 2018

About blockchain coming into the most conservative industry

(INTERFAX) - The diamond industry is perhaps the most conservative of all. It was originated in the 16th century by the inhabitants of the Jewish Quarter of Antwerp, who passed their skill of precepting and processing diamonds from generation to generation. Fervidly treating their craft, inaccessible to outsiders, they used to complete one-time orders from monarchs and aristocracy. Up to now, very much in the industry is built on trust and special relations between several dozens of sightholders and diamond miners, who can easily be counted on the fingers of one hand.

They have already been observing the established ritual of transactions for several decades. A sightholder, after a little preliminary inspection, pays for a set of boxes – plain paper envelopes containing a mix of diamonds; some part of the assortment approximately corresponds to the buyer's request, while the rest is completed by the seller in accordance with his preferences.

The mystique of these relationships was ruthlessly violated with the advent of gem-quality synthetic diamonds to the market a few years ago. Synthetic diamonds are a complete analog of natural diamonds but synthesized in the lab and sold with an average discount of 30%. Manufacturers of synthetics in the West position it as a technological novelty using “eco” and “conflict-free” descriptors, which finds a response among the main group of jewelry consumers - American millennials. The industry faced two threats at once: legal and illegal substitution of natural diamonds with lab-made stones.

Illegal mixing of synthetic and natural diamonds became a nightmare for diamond miners, whose message was based on the limited and unique nature of their products. Besides, the irrevocable status of the diamond ring as a companion of real feelings, formed under the influence of the "A Diamond is Forever" advertising campaign launched by De Beers in the late 1940s, has been largely shaken. Modern boys and girls feel a slight chill at the word ‘forever’ and prefer bitcoin mining farms to diamonds. The #affordablediamonds hashtag standing for synthetic stones got lately popular in the social networks. And this explains a lot in the changing priorities of major consumers, for whom it is more important to have impressions than the awareness of the hefty sum of money spent to prove one’s serious intentions. Finally, you may use the saved money to buy something else in addition to the ring.

Nevertheless, diamond miners still have a set of tools to highlight the uniqueness of natural diamonds and to strengthen consumer confidence. Among them, there is a tracing system that will permit to solve the problem of undisclosed synthetics and to refute the stereotyped conflict status of natural stones, featured in the "Blood Diamond" movie with Leonardo DiCaprio, but currently devoid of valid reasons. “In a world of fleeting connections and disposable luxury, diamonds must stand for enduring value that is grounded in confidence. Confidence that a diamond has been responsibly sourced, confidence in its value and confidence that it is the real thing,” Bruce Cleaver, CEO of De Beers said recently.

Ideally, such a tracing system should provide information on the time and place of diamond mining, on diamond manufacturers and on all the steps that preceded the emergence of a stone in a jewelry store window. The State is also interested in improving the accounting of precious stones - which, due to their characteristics, are more difficult to deal with than gold bars - and restrict the turnover of counterfeit goods. In 2017, Russia’s Ministry of Finance made the first public mention of the details of the project to introduce a registration and marking system for precious stones in jewelry.

MARKING OF POLISHED DIAMONDS

"It is of fundamental importance for diamonds to ensure the history of their origin - in order to exclude the penetration of blood diamonds and, most importantly, synthetics. There were scandals when the goods sold at the boutiques of the world's leading jewelry brands were found to contain synthetics,” Alexey Moiseev, Russia’s Deputy Finance Minister said some days ago.

The project has three stages, and only the first one refers directly to diamonds, during which it is planned to establish an electronic document flow between the producer, the diamond cutter and the control bodies. "As soon as a diamond is mined and its primary sorting takes place, all the information about it should be recorded in an electronic database," Alexey Moiseev said. As an example, we may take a refinery of precious metals, whose database contains information about each bullion produced. The information from the electronic database of the diamond producer will be passed to the diamond manufacturer and then to the jeweler to be recorded on the paper tag accompanying the product.

"Further on, any customer buying a diamond jewelry piece may use his or her smartphone to scan this tag for the diamond code and find out that this diamond was mined in Yakutia or in the Arkhangelsk Region, then cut in Smolensk and set into a jewelry piece in Moscow," Alexey Moiseev explained. These data will be accumulated in the integrated information system of the supervisory authorities monitoring the turnover of precious stones from mine to market.

The third stage is the most expensive and technically complex. It involves applying nano marks to diamonds. Such a mark will duplicate the QR-code from the tag and contain all the information about a stone. The marks will be put by Gokhran, while the controllers of the Assay Chamber will inspect these marks at jewelry stores. The purpose is to control the identity of information on a jewelry tag with the data of a nano mark on a stone. The mark should be less than 1 mm in size, so as not to affect the consumer qualities of precious stones.

The cost of applying nano marks to diamonds is to be borne by the State, so the production costs of diamond manufacturers and jewelers will not increase, the deputy finance minister explained. According to Alexey Moiseev, the involved costs are estimated at hundreds of millions of rubles, but they are understandable from the point of view of protecting the consumer from buying goods that do not correspond to their names and characteristics.

The technology has yet to be selected and options are being discussed with specialists from Belgium, although Russian equipment will have priority, Alexey Moiseev said. De Beers’ International Institute of Diamond Grading & Research has proprietary technology for applying unique marks to diamonds. In addition, there is globally used technology that is applicable only for investment diamonds (when precious stones are placed in a tamper-proof box).

Until recently, state marking in Russia was applied only to fur-coats and alcohol. This year, tobacco was added to this category where the marking is carried out on a digital basis and is protected by cryptographic technologies. A digital code is put on a pack of cigarettes, and the goods traceability - control of their movement and withdrawal from the turnover - is carried out on the basis of data obtained from the cash register equipment. Due to the tracing at each stage, the occurrence of "duplicate" goods is excluded, thus negating the possibility of counterfeit. The system of digital marking of tobacco (this year the authorities intend to distribute it to footwear, dairy products and other goods) is sold by OOO Operator-CRPT (a subsidiary of the Center for Advanced Technologies Development, which is a joint venture between Alexander Galitsky’s Elvis+ Group (25%), Rostec’s Avtomatika Concern (25%) and Peter-Service, which is part of USM Group and a supplier of billing systems to MegaFon (MOEX: MFON) (50%). According to the Decree issued by the President of the Russian Federation this last December, the marking of all goods in the Russian Federation will be unified on the basis of the Operator-CRPT system until 2024.

The decision to start marking jewelry goods has not yet been made, although the Ministry of Finance plans that the system will be put into operation in 2019-2020. The ministry has been instructed to launch diamond marking in 2018, Alexey Moiseev told journalists. The initiative to integrate jewelry goods into the overall project of digital marking will positively affect all the stages of jewelry turnover, including online trading - with the marking system made operational the jewelry trade will become fully legal and the 15% of market players operating in the gray zone will leave the scene, believes Nikita Poklad, President of the Association of Online Jewelry Stores.

WITH A HOPE FOR BLOKCHEIN

While the initiative of the Ministry of Finance will form new business conditions for Russian diamond manufacturers and especially for jewelers, ALROSA will be affected only indirectly and insignificantly. The marking procedure will not be applied to rough diamonds, as they usually go straight to manufacturers and, besides, rough diamonds are not sold to individuals in the Russian Federation. The guarantee of origin for polished goods produced by DIAMONDS ALROSA is an important component but taken that polished goods account for about 2% of the company's revenue, it is clear this measure is certainly not enough in the struggle for clean supplies.

In the long run, synthetic diamonds embrace not only polished diamonds, but rough diamonds as well. And demand for these rough diamonds, as it is admitted by one former core-business employee of ALROSA, is quite significant even among sightholders. Limited supply prods them to neatly move towards synthetics. Having exhausted the limits offered by ALROSA and De Beers for a single customer, a sightholder will have to either limit his or her business or turn to synthetics producers, Interfax was told by this source.

So, is the situation hopeless? No, it is just needed to identify synthetics and not allow it to mix with natural stones, diamond miners say. This answer has a share of common sense, if we recall the insignificant share of gem-quality synthetics (according to Morgan Stanley, it is no more than 1% of the global diamond market in value terms) and the trend of lab-grown diamond manufacturers to offer their goods for use in high-tech areas. Still, why do lab-grown diamonds happen to penetrate the boxes of natural rough diamonds sold by miners and how to deal with this phenomenon, which certainly threatens their margins?

From the moment a diamond is extracted from the earth (or synthesized at a laboratory) and then transformed into a polished stone shining in the ring on a girl's finger, it is being held for quite a long time by a limited number of diamond market players in the so-called midstream. This segment includes both sightholders and diamond manufacturers; moreover, the majority of them is engaged in both diamond manufacturing and reselling diamond boxes to the secondary market. Theoretically, it is at this stage that a "window" opens for illegal admixing of synthetic stones to natural diamonds. Unfair midstream players may use lab-grown diamonds as a substitute for more expensive natural stones in order to reduce costs. The synthetics manufacturers operating in the legal field are not interested in passing off their goods for natural stones – in the first place, it is clear from the outset that they do not mine diamonds; and secondly, it would not be very consistent in the light of positioning your product as ultra-modern and eco-friendly.

To ensure transparency of transactions in this segment, De Beers and ALROSA plan to use the blockchain technology originally developed for digital currency. Last December, De Beers was the first to announce investments in a blockchain platform, which will provide "a single, immutable record that traces a diamond’s individual journey through the value chain." Data on each diamond will be recorded in a highly secure electronic log and each event or transaction is to be registered in a database backed by advanced information security technology. What is important, the system will be able to keep confidential the transaction details, which the buyer and the seller do not want to disclose. De Beers is in negotiations about a possible joint venture with the Antwerp World Diamond Center coordinating the trade in the global industry’s capital, which accounts for about 80% of the world’s rough diamond turnover.

According to De Beers, the blockchain platform is in the interests of both end consumers concerned with the authenticity and positive effect of luxury goods, and the midstream, which will have a chance to reduce selling costs without losing confidence. Also, it is necessary for retailers and the banks, which are crediting the industry.

“By leveraging blockchain technology, we will provide an additional layer of assurance to consumers and industry participants, with every diamond registered on the platform having a record as everlasting as the diamond itself,” said De Beers CEO Bruce Cleaver, summing up the gist of the matter.

So far, ALROSA’s experience does not cover rough diamond origin tracing. In the end of 2016, the company became a partner in the tracing program for large stones run by the Gemological Institute of America (GIA). This is a digital program installed on smartphones, in which the GIA certificate number is used as a password opening access to the history of a polished diamond, containing all the information about it: the place of extraction of a rough diamond from which it was made, its photographs, its planning-machine layouts produced at a diamond cutting factory. The negative aspect of this program is that it is developed for polished diamonds above 1 carat in size, thus producing a contradiction, as such diamonds are usually bought by wealthy people, while e-gadgets are mostly used by those who buy smaller stones. Besides, the customers of DIAMONDS ALROSA receive paper certificates containing codes permitting to trace the origin of each rough diamond turned into a polished diamond. To abandon such certificates, this method is planned to be extended to an electronic platform by launching a pilot project in the Russian market.

Recognizing the need to address the issue of origin in the rough diamond segment, which is strategically important for ALROSA, the company announced in late 2017 that it was mulling a possibility of introducing the blockchain technology "or other technological ideas" into its rough diamond production. The details are not yet known.

Inventiveness, a rich arsenal of knowledge and willingness to change shaped the face of the industry that once opened the potential of crystals, matured in the Earth’s depths for billions of years, to humanity and created a unique emotional atmosphere around the tradition to give them as gifts at the most important moments of life. During its long history, the industry survived many ups and downs. At one time, the termination of diamond supplies from India seemed no less dangerous than the present challenge of synthetics, while the invention of the skife (a polishing wheel impregnated with a mixture of olive oil and diamond powder) produced no less revolutionary changes. Now the diamond industry will again have to change in order to preserve consumers - at least that part of them that remains loyal to natural diamonds.