Optimizing Supply Chains with Blockchain
Foreword
I am writing this based on notes taken from watching a discussion between Scott Nelson and Vinay Gupta. This discussion was the first of five talks they have posted. The magic of this particular discussion is how clearly they are able to show the transitive property from A to B, B to C, C to D, etc. This continues until we finish the discussion at A = Z. Z is the idea that people can be paid for the exact value that they put into the economy. We can bring this change without political maneuvering or massive coordination. Interest free loans within a supply chain can reduce friction and provide the necessary liquidity to release a pent up 30% or more of global profit. This loan mechanism built on blockchain and based on self interest can align the goals of the autonomous entities involved.
The Supply Chain Industry
Most people probably understand what a supply chain is. Let’s use rice as an example. It isn’t grown in your garden, so you need a supply chain to get it to you. From the grocer you buy it from there is not one person or entity who carries the rice along its journey. Rice is a 16 stage process with endless fractal capacity.
This is true of most supply chains. They are shockingly large and complex systems. Over years of bad actors, inefficiencies, and sub-optimizing processes caused by the scarcity of money, this $54 trillion industry employs the most people of any industry on the planet. Supply chains account for ⅔ of the global economy. Topology of supply chains is more like a network than a hierarchy. They are the world’s largest decentralized autonomous organization (DAO). The supply chains of some large companies hold larger economies than mid sized nations. They are self regulating due to their global nature.
Supply chain management is the science of managing commerce.
All markets have their roots in commerce. Agriculture, mining, factories… if you didn’t get it from your garden, it came through a supply chain. Financial and insurance services represent near $15 trillion each with the majority based on supplying credit and protecting from risk in supply chains.
As a company involved in this complex process, it is rare to get paid when you receive the request. There is a gap in time from when the product is made and when the invoice is paid. Larger companies with lower cost access to capital tend to push on their suppliers to extend payment terms. Every time there is an economic downturn corporations extend their terms more forcing bankruptcy on smaller companies which do not have the same access to capital.
Half of the world is waiting for someone to pay. They are trying to make their receivables match their payables (and inventory). This is the magic formula. Higher up on the supply chain a company can function with very need for capital as they are paid quickly and efficiently by the company generating the order. Midway down the chain the amount of money a company has is tied up in who owes them payables. As you go down the supply chain, you encounter smaller and smaller firms waiting for invoices to be paid. All while having less and less access to capital.
Access to capital is where the problems we face today are generated. Small companies that produce the goods are more likely to be in countries with high cost of capital or no access. The pressure gets more intense at every economic downturn. The world bank has said access to capital at the end of the supply chain is number one economic problem to solve.
The issue of access to capital creates environments where rich have a disproportionate benefit from the capital they do have. If your cost of capital is 20% and theirs is 1%, they can be 19% less efficient and still have access to capital when you don’t. Therefore, efficient companies farther down the chain find it hard to grow and impossible to attain capital for research and development. The companies at the top have money for R&D, but they can be less efficient and more competitive. The cost of access to capital subsidizes inefficiencies.
The system makes inefficiencies hard to kill.
One of these inefficiencies is the global utilization of assets. Think about a truck driving with only one box, or a half full warehouse. Fifty years ago we had 90% usage of assets. It is now down to 70%. This happens because of hyper competition. Large silo companies don’t want to give up information. A side effect of not sharing supply chain info with other companies is the inefficient use of assets.
One eighth of the capital base of humanity is essentially empty trucks and warehouses.
Exponential Pace of Innovation
Choices are increasing. We have opportunities to do new or different things. Companies face a difficult decision when trying to decide the appropriate time to make a change. Large companies want to change systems to make themselves efficient, but they can’t keep up with how quickly the upgrades are made obsolete. A company used to be able to upgrade knowing this efficiency would generate x profit for 30 years allowing them to justify the expenditure. The time frame in which the value of the upgrade can be recuperated is getting shorter and less predictable. It no longer makes sense for them to update. This forces companies to focus on quarterly profits rather than doing deep optimization and long term planning.
This has a direct effect on what happens to humans. Companies have a greater need for generalists. Specialists are needed less and less. Therefore companies cannot get better. There isn’t enough time in the technology improvement cycle for people to become specialized.
The way we form economic relationships carries some of the blame in this problem. We give a salary in exchange for intellectual property and everything the individual creates. This is a disincentive for people to create. The capitalist environment encourages production at the entity level. Within the large silos the innovation driving competition does not exist. Well qualified and creative people at large companies end up spending much less time solving efficiency problems that require specialization. Those in possession of specialized skills to solve the inefficiency are rarely in a position to execute the necessary upgrades.
The system creates a feedback loop of pervasive short term-ism.
Talent is locked into companies that won’t use the talent properly or will mismanage it. When the inventor wants to invent something, the company has a different agenda for them. The startup world understands the quickening pace, but we still face challenges in how we engineer the incentives to extract the greatest possible economic output from entrepreneurial minds.
The model has broken because it comes from an era that isn’t here anymore.
Post Industrial Era
Supply chains and commerce need liquidity in capital, assets, and talent. The accelerating rate of change requires the support functions of the chain to be as liquid as the requests. When the support cannot keep up, we call this friction. Slowing down is not an option for these companies. They cannot slow down the passing of time, and even if they could they would still face competition.
It is not the rate of change that makes the system sub-optimal. There are three levels of centralization that have served a purpose which have been outgrown to varying degrees.
Centralization of production
Centralization of capital
Centralization of risk
Centralization of production began when the first traders realized they could sell items to nearby villages. Previously an occupation consisted of figuring out what the village needed and solving that need. Further down the timeline we get to Fordism and the assembly line. Complicated to build devices requiring levels of specialization would be inefficient for one person in every village to learn. It is much more efficient to produce the vehicles in one location and ship it to another. The nature of this is what creates the need for a supply chain.
The next centralization we encountered is that of capital access. A company can compete because of their access to capital rather than increased efficiency through centralization of production. An example would be a first world company taking money to a third world country to pay less for the production of the good.
Centralization of risk is the idea that value isn’t created or lost. It is only exchanged. This is not true. If it all balanced out, we would not have had an economic collapse in 2008. Because of the centralization of risk, the banks allowed the people to borrow beyond their means thinking it would spread risk out far enough to never lose. This idea of hedging risk is a flawed concept because it is based on stable production. Everything starts nicely hedged because the assumption is stability, but the exponential change in the rate of innovation is not taken into account. Most likely it is because we as humans tend to think in linear models. We create massive instability by believing we can manage risk.
Everyone buys everyone else’s risk, and it all ends up in these centralized silos which are “too big to fail”. Similar to when we allowed companies to pollute rivers. We needed legislation to fix it. At this point, advocacy for better legislation may fall on deaf ears. This means we must find a framework within the current system to execute change. Centralization is not so much a policy as it is the natural progression of our current system. For a long time centralization was progressive to humanity increasing the quality of life through more efficient use of capital.
In an industry where economies of scale no longer have an effect, centralization is inefficient use of capital.
Cost of Decision Making
Small companies are more adaptable in rapidly changing environments. They also do not present the risk of a large corporation. The risk of failure in these small agile companies is evolutionary pruning at its worst, and rapid innovation at its best.
Ford used to take in coal, steel, and rubber, and out came the car. Now a company orders what they need, and a vast network of suppliers will pull the item. This network is composed of thousands of autonomous decision makers.
Large companies amortize the cost of decision making. This is a natural effect of the current system. They realize the need to be smaller to make agile decisions once bandwidth is reached. Large companies mask this inefficiency by purchasing smaller companies. Their lower cost of capital allows them to do this.
Liquidity is the root problem.
The entire structure is built around an ineffective stock model. Buying stock is buying risk. Risk is based on the creative efficiency of the team that engineered the current stability of a company. The people at the head of a company can’t get liquidity for themselves without selling. IPOs are difficult to accomplish. Private equity is the other option available, but they have to sell. The system makes it difficult to keep the brain on top of the capital.
We have models of value transfer based on old options. When there is too much risk in buying businesses, people tend to put money in stocks, bonds, and funds that centralize risk. This happens because money is scarce.
The fundamental model of money scarcity is no longer needed.
Innovation Bottlenecks
The system drives a wedge between capital and talent. Venture Capitalists try to lower the risk in an inherently risky investment. Their job is based on never losing on high risk investments. VCs need legal art, blocking rights, and preferences. These are all legal jargon allowing them to renegotiate terms when the startup isn’t either super successful or a complete bust. This includes well over 90% of startups in an environment that is increasing in risk due to the rate of change.
The problem is how we treat money.
Those who have it want to protect it from deflation and live off the interest it accrues. Fiat currencies account for approximately $60–70 trillion. Add in stocks and bonds for a total upwards of $150 trillion. Supply chains hold $700 trillion of valued assets. This includes buildings, vehicles, boats, forklifts, and everything else used in the process. There is currently not enough cash to represent these assets.
Because money is limited in supply, people who have it want to keep it. People who don’t have it are trying to get it. They must go to an entity or person who does have money, and rent it from them. The person who loans the money then sells it to the highest bidder.
Why does less money exist than the value it is supposed to represent?
Monetary systems have almost always had two currencies. Market places in middle ages had two or three anchor merchants issue script like a promissory note backed by the product the merchant sells. Farmers would bring their crops to the market and turn them in for a note representing the asset they put in custodial care. The notes would then be used for trade in the market place. This is common all around the world. Egyptians use clay tablets the pharaoh would seal as a moniker for some set of goods.
What many of us think of as a barter system, was really debt.
Every market had its own system of debt. Between systems was specie. Hard currency like gold and silver. The notes used within a market were considered soft currency. The soft currency provided liquidity and the hard currency provided fungibility.
It was not until the 19th century that we begin using legal tender and national currencies. At the time, asset based lending was in the form of bank notes. People give the bank shares to their crops to hold in exchange for a bank note good in the local ecosystem. This practice created local area networks where the liquidity was good.
Governments then saw the specie being taxed, but not the bank notes. The measurement problem of not knowing how to tax the bank notes is the root cause of governments creating one legal tender. Rulers have high costs.
“It’s good to be the king, but it’s expensive.”
In the past value was created in the form of gifts. Those who had gave to those who had not. Lords go off to battle and are given land in return for their bravery and sacrifice. Land was given through the US government with the homestead act. The land existed, but it could not be sold until is was designated as a plot with a title of ownership. New asset classes like stocks and bonds were created out of thin air. The problem was that as we created more value, we did not create more currency to represent that value.
Scarcity is at its peak right now.
Prior to the gold standard was continental currency. It wasn’t specie. It was backed by future taxes. The gold standard was created in the mid 19th century and was in place for almost 100 years. The dollar was backed by by gold during this time. In the beginning you could walk into bank and exchange for gold. When that requirement was dropped in 1914, the gold standard stayed until Nixon officially nixed it in 1971.
The gold standard was a failed experiment.
Velocity of Money
There wasn’t enough currency to go around before Nixon decoupled it. The fundamental problem occurs when the asset is appreciating. No one wants to spend money that may be worth more tomorrow. Bitcoin has this issue. We need a liquidity mechanism in society. If I give you a $5, and you give it back, $10 has circulated. The simple act of exchanging money creates value out of thin air. This movement of money in an economy is called velocity.
Velocity of money grows an economy. It also supports an increase in efficiency. When money is scarce, people hoard it because they don’t know if they will get more. Industrialized places don’t notice it as much. A good example is Japan’s savings rates. They have a lot of people, but not a lot of money.
In global trade money goes from big companies, to mid sized, to the smallest. Friction causes people to lose the will to spend money. When friction is present, it slows the movement of money to the point that the money never reaches the smallest companies.
Those at the end of the supply chain have a near zero access to capital.
Most nations want to print a certain amount of money. They want to encourage spending, but must balance this desire with the potential for rapid inflation of the price of goods. The governments are stuck not being able to create money to represent our physical assets because they risk political turmoil during the recovery period of inflation. We are stuck in a self defeating negative feedback loop.
Physical Assets on the Blockchain
Blockchain allows digital assets or “tokens” to be created from electricity with rigorous rules. The rules may apply to creating more tokens, who has access to tokens, and what happens to tokens when inside a smart contract. This will allow us to go back to asset backed currencies. We can take some kind of asset, and issue the digital equivalent of bank notes or marketplace script. The asset itself can be represented by a token, which is held in safe keeping in a smart contract, in exchange for spending tokens. The token representing ownership of the asset can only be retrieved if the rules of the contract are met.
Smart contracts allow the parties involved to know the rules of the smart contract cannot be changed and are not subject to interpretation beyond the code.
In the days of the bank notes, the bank would hold the title to property in exchange for bank notes. Upon completion of the terms of the contract, the rightful owner could retrieve the title. In this example the bank does not take possession of the home. Instead, it takes possession of a legal document that symbolizes ownership of the home. We now need to apply this concept to the token representing the home in the same way as the title. To accomplish this we would need a legal contract that creates a digital title for the asset.
With strong land rights, a house title can be on the blockchain today. I can prove that I own the house. I create a legal contract to signify a token as the digital title. I can then exchange the title for bank notes. In the digital world, I can create a smart contract that issues tokens in exchange for custodial care of the token representing the home.
I can borrow from myself by minting the currency.
A legal or bank intermediary may be necessary to get the house on the blockchain, but once it is on the blockchain, a smart contract could issue tokens for the house title token. The smart contract would only release the home title token if the minted tokens are returned to pay the loan. The smart contract allows us to create secured loans without a need for a bank.
It is a system of banking without banks.
The tokens issued are essential new currency issued against the value of the home. A cryptocurrency backed against the physical asset. Extrapolate one step further to a cryptocurrency backed by all the physical assets of the society rather than banking against gold, future taxes, or scarcity.
We are talking about being able to use all of the physical assets of society, which are almost 10 times the value of currency assets currently available, by borrowing from yourself without a bank. You would then lose the asset if you don’t pay the loan down.
This is how banking was done for 5,500 years. When national currency was created, the federal reserve charged the country fees to create it. The private federal reserve creates the system of scarcity. Similar to the politicians, they hang on to what they have. Even if they know what is right, they are stuck in the negative feedback loop that will not allow them to adjust to the changing world.
Economic systems are composed of members and guests. Members pay a fee called taxes in exchange for access to the system. Guests participate freely and safely through KYC/AML laws.
This whole process can be turned digital.
I have gold. I put it in custodial care. I create a legal contract that the gold is represented by a digital token(s). I have a bunch of lumber. I can do this same process. I have a warehouse and thirty semi-trucks. This is what can provide liquidity in supply chains. Loans on the orders generated by the top of the supply chain which are secured by the assets the supplying company owns.
This makes capital accessible before the customer pays.
Commerce Without Fiat Currency
In supply chains, If C needs to get paid by B before B gets paid by A, then B must pay interest on the loan to make this happen. If they are all making a product for someone down the line, they all pay interest on an order due to friction in the payment systems. This allows those with access to capital to squeeze extra money out of those farther down the chain.
Imagine you sell coffee beans. With the blockchain you know that Starbucks has placed an order. You can have confidence in lending to yourself to fill the order, not only because you know they always pay, but because you can see how it will travel through the supply chain to eventually get to you. Economies of omniscience tell us we can loan money in the supply chain because they are low risk due to transparency. Access to the data allows lending against the orders and invoices further down the supply chain. Money can be rerouted around bad actors to the entities they would be defrauding.
Anonymous digital currency backed by physical assets allows us to massively lower risk.
Our gross domestic product or GDP is the profit or increase in economic value. It measures profit therefore the dollar value of all the transactions is much bigger. The gross world product was near $78 trillion in value. Supply chains account for $54 trillion of this number even after all the disasters, crisis, wars, and expensive habits. Even still, there is another 30% on the table due to friction in the supply chain that can easily be fixed with blockchain.
Supply chain management is the science of managing commerce.
Optimizing for Efficiency
Blockchain brings with it a collapse of complexity in this science. Mathematical answers are available to most of the problems in supply chain management. The problem has been that the physical world is rarely congruent with the mathematics. Digital assets on the blockchain can be manipulated accurately and efficiently with mathematics, and we can bind the two worlds together through law.
This digital movement will be beneficial for governments and people. People will have more capital and freedom of choice. Governments will collect more taxes. The movement towards optimization doesn’t need to be political. We can simply use technology to out compete the current systems.
Blockchain makes competing against the current systems inevitable.
Assets are not used efficiently. We now have the ability to map underutilized assets and provide liquidity to get them in use at anytime. Using these assets to their capacity via sharing transparency and lowered counterparty risk will be a huge increase in efficiency.
Sales and marketing didn’t exist until the 1880s. Sales wasn’t necessary until centralization of production. It was created as a way to inform people about the product. This wasn’t necessary when you are in the same village as the production. The problem with sales and marketing is that closing ratios indicate a lot of inefficiency. People are selling things that aren’t needed.
The role of the salesperson is inefficient use of capital when information is transparent and democratized.
We are now encountering the opposite problem. With mass production, the question changes from “What exists?” to “Which one do I want?” We must change the system so the business finds the asset rather than the customer finding the business. It works for the consumer that the business finds them rather than the consumer finding the business. I publish what I am looking for and the business finds me.
We will still need experts to help. Imagine looking for warehouse space in London. You find three locations that seem suitable. You will still seek the advice of someone who understands the local laws, customs, and community. Optimization will happen through curation. Curators will be the go between between creators and users. The system will have excess inventory allowing us to make better choices. Carbon footprint and fuel usage can go down through efficient allocation of resources. This will avoid last minute rush scenarios further optimizing the system.
An economically productive path for the restructuring based on better access to information exists today. There are many paths leading to an inevitable end state. Sweetbridge proposes liquidity provision in existing supply chains.
“Take a supply chain, instrument the blockchain into it, then provide financial services along that chain reducing capital costs and external borrowing. Thus increasing efficiency and forcing competitors to adopt the same practices.”
The giant change we need can be realized in small changes that are very self interested. It doesn’t require complicated multi-organizational maneuvering. It can happen one party at a time. The thing that makes people adopt the system is free loans. This means more innovation through research and development by those lowest on the supply chain.
The pre-condition for adopting the settlement system that the ledger is on the blockchain.
We must join economics with code and law to change the rules in the way we do things. In fact, we can make substantial improvements in society without requiring political will to do so. We can help finance the process of doing it in ways that cost governments nothing, but can increase the money they make.
We don’t need to overthrow the systems we have. We must work more efficiently within them.
The creation and adoption of electricity was not a political problem. An entire economic system was created by this one innovation. Blockchain allows you to create economic systems. You can build many economic systems on top of blockchain technology.
The blockchain is the operating system. The economic systems are the applications we are building on top of them.
Sweetbridge will be the drivers that you can plug into to connect your blockchain applications to the real world through legal and financial tools.
This will create friction-less liquid environments.
People will be emancipated from having to work for companies. They will be paid for the value they contribute.
This is how ChicagoHodl and Chicago Blockchain Project will use the blockchain. Engineering incentives to allow collaboration with the goal of making Chicago the best city in the world to work on Blockchain.
This post is based on the following video:
https://www.youtube.com/watch?v=dla42bY7k90&t=41s
Sweetbridge Talk: Scott Nelson & Vinay Gupta
“A Liquid Value Operation System: Supply Chain on the Blockchain”
For more information relating to this post look up:
Resources based economics
Gift based lifetime systems
Local exchange tokens
Wir Bank Switzerland
Distributed economics
