Re:factor and Blockchain: What, Why and How
Re:factor is a peer-2-peer factoring environment aimed at facilitation of investing into trade receivables at the global level. Re:factor is heavily based on the blockchain technology which provides data safety and ensures transparent transaction handling on the platform side. Let’s talk about various aspects of how a distributed ledger plays into re:factor.
Blockchain Helps to Prevent Data Loss
Factoring services are usually associated with a much larger number of transactions compared to lending, since factoring has to do with a multitude of receivables, while loans are usually issued in a single or few tranches. Thus, factoring services require a powerful OS to process and store a massive data flow, when a counterparty has a noticeable number of suppliers.
Providing data continuity, integrity and safety demands top security measures. Re:factor uses blockchain technology for that. The platform records all operations with the receivables in a decentralized ledger. If the database that contains current or previous transactions is partially or completely lost, all the data can be recovered from the ledger.
P2P vs Banks: Gearing Towards Trust
P2P peer lending has an advantage over banking since there is no middleman between the lender and the debtor. This allows one party to earn substantially more by investing, while the other can save when borrowing and/or get other benefits, such as simplified application process, no collateral, faster and more flexible decision-making process, etc.
However, conventional banks have specific financial competences, have gained solid reputation and significant assets and are traditionally trusted by investors. This is what P2P financial platforms have to work towards yet. Blockchain technology on re:factor is geared towards strengthening the trust of investors and other parties involved.
Decentralized Ledger Ensures Transactional Transparency, Eliminates Potential Manipulation
Re:factor records all transactions and fees related to receivable movement in blockchain, which eliminates the likelihood of fraud on the platform. It stores the data in a decentralized ledger available to investors and debtors, which leaves no room for overcharging supplier fees compared to investor fees, or making any retroactive changes in the investor reports.
Chronological Principle Protects Investors from Fraud
CROWDFACTOR, re:factor’s investing component, operates chronologically. First, platform underwriters establish limits of risk exposure to the debtors non-payment. Then, investors subscribe to them indicating the amount they want to finance not exceeding each limit. As the system adds receivables to related to a certain debtor, the seller is financed by the investors who were the first to subscribe to the relevant part of the underwriter’s limit of liability. Similarly, when the payments come into the account receivable of the debtor, re:factor distributes it among the investors chronologically.
In this regard, investors may be exposed to two types of risk associated with technical errors and fraudulent acts of a P2P platform operator.
- Risk of changing the priority order of investors while buying a lucrative asset. In such case, an investor who was supposed to be among first to buy the asset, won’t get an opportunity to purchase it.
- Risk of changing the priority order of investors while buyers pay-off their debts. The platform or its employees may change the debt priority level by choosing the debt of the troubled debtor to the higher-priority investor. In such situation, if a troubled debtor does not have enough money to pay off the debt to other investors, such investors will have a loss.
Decentralized Ledger: Tool That Eliminates Potential Fraud
To eliminate any investor disputes or potential manipulation on re:factor, decentralized ledger records the following information: timeline of subscribing to the debtors limits and paying the debts off, as well as any changes in the receivables amount and/or amount of transactions related to the receivables, such as debtors’ payments, returns of goods, retroactive bonuses, or direct payment to unauthorized sellers’ accounts.
This way, investors can always check the original data about what amounts of trade receivable liabilities or what receivables exactly belong to them. In such situation, there is no way ‘to swap’ the investors when distributing incoming payments from debtors in order to pay off the receivables. This becomes especially important for partial payment and subsequent debtor’s default.
Manipulation by Fraudulent Managers in P2P Factoring Platforms
Re:factor P2P platform lets investors buy trade receivables. The transactions are reflected in the investor’s personal account in Trade Receivables Ledger on re:factor. Then, debtors gradually pay off their debt, and the funds are transferred to the investor’s account.
Hypothetically, a fraudulent manager of the platform could manipulate the data about receivables status or movement, as well as debtors’ payments.
Fee Manipulation Scenario
Sellers pay a monthly fee for the services on the platform. This fee is first transferred to the designated account, and then distributed to the corresponding investors.
Re:factor is going to have multitudes of receivables. One investor with $500 portfolio can buy shares in dozens, hundreds or even thousands of assets. It is virtually impossible to monitor the investments manually in such a large number of trade receivables to make sure that there are no manipulations, or to keep track of fees and payments.
Re:factor has a large number of transactions, manages all data and takes care of accounting, so its employees could theoretically make arbitrary changes in the Receivables Ledger. Here is an example.
An investor sees receivables in his personal account, makes a purchase and sees the fee in the personal account which he would gain from this transaction. The platform employee arbitrarily sets a lower investors fee compared to the charge announced to the investor. Then, it sends monthly invoices to the seller on behalf of the investors for the factoring service fees. One of such invoices offers to pay a fee to a company controlled by this employee. In result, the employee keeps the overcharged portion and gives the investors the amount they see on their personal account (see the image below.)
Similarly, the employee can overcharge the sellers by announcing a higher commission rate to them.
Potential scale of such unjust manipulation could be enormous.
Investor Report Manipulation Scenario
Besides overcharging investor fees, fraudulent managers of the platform could potentially manipulate monthly investor reports. There, a platform employee can intentionally shorten the actual period of the receivable payment term by one or two days, for instance, in such a way that it would change the actual payment date to an earlier one.
The interest rate is accrued for each day of the receivable turnover, from the date of supplier payment date to the date of the payment receipt from the debtor.
By shortening the actual payment period of dozens or hundreds receivables in the investor report by one or two days, the employee could easily ‘eat up’ the fees for that time. It would be difficult for an investor to catch this, so the fraud scheme could go on for a long time.
Storing information about fees and other data in blockchain allows to eliminate risks of the platform staff misdoings. An access to this data, transparent for both investors and sellers, will enable independent parties to control the settlement correctness leaving no room for fraud.