How corporates can use blockchain technology in supply chain finance

Blockchain technology is gaining a lot of attention, but what is it exactly? How can it be applied in supply chain finance? What is there to gain for corporates and what is the impact on costs? Orchard Finance Consultants believes blockchain technology can affect supply chains significantly, whether it concerns commodity trading, production of cars or publishing of books.

In the current way of doing business each party in the supply chain purchases goods, adds value and sells these good to the next party in the supply chain. This requires financing of inventory and the necessity of third parties to finance a transaction or at least process a transaction. Opposed to this traditional way of doing business, by using blockchain technology parties can work smarter and as a result reduce costs significantly. Payments in a supply chain can be triggered by a certain, predefined action, occurring at any point in time. In this article we first explain blockchain and then elaborate on how it can impact financing of supply chains.

Blockchain explained
Blockchain technology allows two parties to transact, without making use of a central authority or third party intermediaries. In other words: there is technology available that can allow you to trade directly with any counterparty around the world, in a secured, fast and cost efficient manner. In practice it works as follows: both parties have access to a wallet or some sort of online interface. The buyer can show he has sufficient funds to purchase the required goods. Also he can display the criteria which the seller needs to meet before the payment will be executed. The seller can see that the buyer has the funds and the criteria he needs to meet in order to receive payment. Simply said: as soon as the criteria are met, the funds are transferred automatically and unconditionally from the buyer to the seller.

This meeting of criteria and executing a payment is called Smart Contracts. Good to know is that certain criteria can be met automatically, like tracking goods via their GPS location. Other criteria, for example like checking the quality of goods, can be done by a human and via the wallet/interface the criteria can be met (or declined).

The blockchain technology is already widely being used, the most famous application on it being bitcoin. This is a so called cryptocurrency, a digital currency that is used as an alternative money system, besides ‘normal’ currencies like EUR or USD. The attractiveness of Bitcoin is that there are extremely low processing fees, simply because there is no intermediary involved in the transaction. bitcoin has a proven track record but there are also other areas where the blockchain technology is useful: it can be used to provide notary services based on blockchain technology and recently 11 large global banks announced they will test a trading system, based on blockchain technology.

Blockchain applied to Supply Chain Finance
Ok, so now we know what blockchain is, how can this be applied to supply chain finance? It is important to understand that supply chains are complex by nature; various parties are involved; from raw goods supplier, producer, distributor all the way up to a consumer. Generally speaking the parties in a supply chain are located in numerous countries. Each party in the chain takes care of financing its own working capital and inventory. Supply chain finance is a bucket term for a wide variety of financing instruments, used to finance various parties in a supply chain. In actual trade between a buyer and seller in different countries, the most common used instrument is Letter of Credit (LC’s). This is a cumbersome process, costly (costs range around 2-4% on annual basis), prone to error and involves a financial intermediary to process the transaction. The great advantage of LC’s is that payment is secure and guaranteed (by the banks). Below you see how a LC works when a buyer (applicant) and seller (beneficiary) trade.

Image 1: mechanics of Letter of Credit.

The main advantages of a LC is that a payment is guaranteed and it is secure. As said, the main disadvantages are that it is costly and cumbersome. By making use of blockchain technology, more specific: smart contracts, the advantages of a LC remain but the disadvantages are taken away. In general it works as follows: two parties agree to trade goods, the seller gets via his wallet the confirmation the buyer has sufficient funds and the criteria he needs to meet. When the goods are shipped, and the pre-defined criteria are met, the payment is executed. The great thing is that when the structure is set up, the transaction costs are minimal. It can be compared to physical mail (e.g. EUR1 per letter) vs e-mail (negligible costs per e-mail).

This way of financing a supply chain is radically cheaper and more efficient than the current way of doing business. At the same time the required security and guarantees remain intact. The technology is available, although some caution should be in place. The bitcoin has been around since 2012, so in principle blockchain is proven technology. However, above example would require a different blockchain than the one used for bitcoin. There is huge interest in this new technology, but in practice there are just a few corporates worldwide that trade according to above example. The potential benefit is clear to all, it allows massive simplification of (banking) processes and significantly reduces costs. The blockchain technology can offer great potential for corporates: increased control, speed and reliability of their supply chain at a fraction of the cost of the current infrastructure.

About Kris Wielens

Kris Wielens is Senior Consultant with Orchard Finance Consultants. He is based in the Netherlands, he has more than a decade experience is (corporate) payments and was formerly involved in building a Supply Chain Finance company. Please reach out via kris.wielens@orchardfinance.com in case you are interested in knowing more about what blockchain technology can mean for your supply chain.

About Orchard Finance Consultants

Orchard Finance is a leading independent Dutch consultancy and staffing company in the areas of Finance and Treasury. Tailoring to our clients, we offer advisory services, project management and staffing support. Our professionals have a long standing reputation based on operational and project experience in banking, corporate finance and treasury management & control. Our clients’ finance and treasury operations have been our focus since the start of the company in 2003.