The role blockchain can and should play in supply chain finance

Blockchain has been described more than once as a “solution looking for a problem.” In recent years, the hype around this topic — namely the use of a distributed, decentralized public ledger to create an immutable record of transactions — has vastly outweighed its real-life applications. So what could blockchain have to offer the world of supply chain finance?

Blockchain and trade

The benefits of blockchain in the context of trade finance have been widely discussed. Blockchain offers the ability to exchange trade-related data between participants without the need for paper. A key concept where blockchain is concerned is the use of smart contracts — in other words, self-executing contracts based on computer code that is stored on a blockchain. Other benefits include better visibility over the progress of goods along the supply chain and consequently, more information about the origin of goods.

This means blockchain could have a role to play in alleviating the trade finance gap — the gap between the demand for trade finance and its availability.

The Asian Development Bank noted in a 2019 article that technologies including blockchain could go some way to alleviate the trade finance gap, estimated to be $1.5 trillion — although the ADB also noted that high costs and a lack of global standards present obstacles where adoption is concerned.

But while hype is a common feature of conversations about blockchain, there is also plenty of activity taking place in the area of trade. Numerous developments in blockchain-based trade finance have been announced in the last couple of years, many of which focus on digitizing trade data and simplifying paper-based instruments like letters of credit. Notable blockchain-based trade finance networks and platforms include the Marco Polo Network, ICC TradeFlow and Contour (formerly Voltron), many of which have developed through close collaboration across different industry players.

Blockchain and supply chain finance

So far, so good — but what about supply chain finance?

To recap, supply chain finance — also known as reverse factoring — is a solution used by companies making purchases (buyers) to offer their suppliers early payment on their invoices. Unlike traditional factoring, in a supply chain finance arrangement, funding comes via the buyer’s bank at a rate based on the buyer’s credit rating. As such, suppliers can typically access funding at a more attractive cost than they can achieve independently.

In the context of supply chain finance, the benefits of blockchain may be less apparent than for something like trade finance, which has long been associated with unwieldy paper-based processes. But there has nevertheless been plenty of discussion about how blockchain could play a role in supply chain finance solutions.

For one thing, the ability of blockchain to create an immutable audit trail for all transactions has the potential to increase trust between the relevant parties. Blockchain could also be used to achieve a single source of truth for activities such as invoice receipt and approval, which are key when it comes to determining which invoices can be paid early. Other benefits could include using smart contracts to automate transactions, or the use of blockchain to enable pre-shipment supply chain finance.

Another point of interest is the role blockchain could play in opening up supply chain finance to more players in the supply chain, such as SME suppliers. Traditionally, bank-led supply chain finance programs have focused on the buyer’s largest 20 or 50 suppliers, but the benefits of the program can be greatly increased if it can be accessed by the company’s whole supplier base.

Of course, blockchain is not the only way of achieving this. Some supply chain finance providers already enable companies to onboard thousands of suppliers — known as the “long tail” — by offering a streamlined onboarding process.

Some also argue that blockchain provides the ability to access a wider range of funding providers than a traditional supply chain finance solution. But again, this is something that is already offered by multi-funder platforms.

Limitations of blockchain in supply chain finance

In practice, while blockchain may have a role to play in supply chain finance in the future, this is unlikely to happen anytime soon.

For one thing, developing and implementing viable blockchain solutions is likely to involve a lengthy lifecycle given the nascent nature of the technology — not to mention considerable investment.

Developing blockchain-based supply chain finance solutions would also require considerable collaboration among participants, including an agreement to build and share a common system. The benefits of implementation would likely only be achieved with a critical mass of participants, meaning that a community of parties would need to be committed to adoption — without the prospect of any concrete financial benefits.

Other potential obstacles are likely to include the conflicting needs for both transparency and security when it comes to sharing information. And of course, agreed standards would be needed if a particular approach were to gain traction across supplier ecosystems.

One of many

What’s more, it’s important to recognize that blockchain is not the only technology that may shape the future development of supply chain finance. Also of interest are developments in areas like robotic process automation (RPA), artificial intelligence (AI) and machine learning — some of which are already delivering concrete benefits.

AI, for example, can be used to gain a greater understanding of supplier behavior, leading to more accurate predictions about whether suppliers will accept early payments in different situations. We will explore some of these concepts in posts to follow.

In conclusion, blockchain may not have much to offer supply chain finance in the short term. But it can certainly be regarded as one of several technologies that may help shape this area in the years to come.