Smart Contract for Buyers and Sellers: The Future of Decentralized Trade

The idea of smart contracts has been around for a while, ever since Nick Szabo coined the term in 1997. Fundamentally, a smart contract is a code that is executed when certain conditions are met. So, what’s wrong with the financial industry today? A recent study by Cap Gemini shows that wherever you have central counterparties, there is the possibility of inefficiency, long and complicated settlements, a central point of attack for fraudsters, unnecessary overhead, and a concentration of risk.

Source: Cap Gemini 2016

How Smart Contracts Can Automate Trade Processes

Trade finance is an area I have helped to automate through three successive companies, both as an entrepreneur and as a banker. In 1988, when I worked for Computer Catalysts in New York, we designed a very simple rule-based system for corporates to capture the complex rules associated with a letter of credit using a template and meta-tag language. This allowed corporates treasuries to design their own letter-of-credit input templates for trade. Our rule engine scanned each template for compliance with the SWIFT MT 700 standard for letters of credit. Jumping forward 30 years to 2018, little has changed, because even though the message is electronic, the accompanying documentation is still paper-based. Below, you’ll find an example of how complex that paperwork really is for a standard letter-of-credit transaction.

First, there are a number of stakeholders in a trade transaction, and most of the documents flow between parties in paper form.

Second, there is a great deal of complexity within each trade transaction, with about 80 unique data fields across the 20 documents generally comprising one trade finance interaction: purchase orders, invoices, customs invoice, bill of lading, etc.

Source: BCG Digital Innovation in Trade Finance 2017

Third, banks and the industry as a whole realize that automation of the entire process would be hugely beneficial for everyone; therefore, myriad programs, such as MarcoPolo, WeTrade, Maersk, IBM, and many others have embarked upon the use of blockchain to simplify this landscape. There are about 40 rules governing letters of credit, and last year, Citi initiated a multi-million-dollar program to automate this process, starting with the groundwork of ensuring that 98% of all documents can be converted to digital form using intelligent OCR. Once the rules are codified and the supporting documents have been made electronic, we will be ready to rock and roll with smart contracts, except for a few small things: the globally-acceptable governance, legal certainty, and regulation required to support blockchain-based smart contracts. At present, these are all progressing at a snail’s pace, which is why we are focusing our initial attention on a simpler subset of the industry: open account trade and supply-chain finance. The purchase order is at the center. This is a much simpler document than the LC, which we are working to codify as a set of smart contracts guaranteeing payment terms, due date, interest-rate penalties, etc.

We look at the industry through two lenses. The first is smart contracts for goods, and the second is smart contracts for services. As we step back and examine the landscape, we see the opportunity for building smart contracts around smart assets. This is our vision for the future, as it will bring together buyer-supplier networks and supplier-financing networks.

The Tallyx Smart-Contract Framework: The Solution for Supply-Chain Finance

A key goal of our smart contracts is to provide outcome-driven clauses with auto-validation and auto-triggered payments when underlying conditions are met. In the example below, our smart contract would trigger instructions upon maturity to debit the buyer’s clearing account and credit the supplier. In our ecosystem, the “platform” below is a set of smart contracts deployed on the blockchain and “owned” by participants and stakeholders in our network, not by any central entity. Not even us.

Most of the work surrounding the management of business obligations is done manually today, but with the introduction of blockchain smart contracts, it is a natural progression to encapsulate this manual work into a protocol powered by artificial intelligence and advanced analytics.

Our smart-contract framework will cover the negotiation of buyer and seller agreements, record those agreements on a crypto-ledger, and validate claims against the agreements, providing for negotiation and acceptance/rejection of claims. We will start with the purchase order and extend this out to cover invoices — and, eventually, the letter of credit itself.

What do these smart contracts provide? Basically, the ability to change the basis of trust between buyers and sellers without reliance upon blind acceptance of institutional reputation, or the wider social-media fabric, both of which have shown critical weaknesses in their capacity to be used by corporate or nation-state actors to further their own selfish agendas.

Further, our smart-contract framework will facilitate multi-party agreements. Even in the supply chain, integrated project delivery (IPD) formats are becoming popular for large orders in order to share risk and assure SLAs. This needs to be woven into the blockchain ledger and the contracting world for enterprises, with sufficient security, audit, and corporate consensus. Therein lies the challenge, as well as the opportunity — which the Tallyx team is qualified to fulfill.

Additionally, smart contracts provide a solid foundation for the creative destruction of the highly centralized, platform-dominated world in which we live. This will occur through grassroots decentralization. Take Amazon and Alibaba, for example. They have so much data on customers, are willing to forgo early profits, and are capable of leveraging their global reach to exert a type of influence that is far broader than their market share[1]. This has caused the FTC to take notice, but I believe that a grassroots movement led by buyer-and-seller smart-contracting has a better chance of leveling this very uneven playing field.

From a technological viewpoint, the promise of industry 4.0 and IoT requires mature smart-contract implementation to ensure that “things” can interact, pay, and settle automatically based upon a set of established rules.

There exist a number of interesting industry initiatives to further develop the necessary framework and taxonomy for smart contracts. This includes Digital Asset, which has proposed a smart-contract modeling language to Credits, Eris, and many others.

Tallyx is a member of Accord, a cross-industry initiative to build smart-contract taxonomies across industries, and it feels great to be a part of this exciting new journey. Although we don’t have all the answers we believe it’s time for a #shiftchange

1 — New York Times, David Streitfeld, Amazons antitrust antagonist has a breakthrough idea.

by Aditya Menon CEO&Founder Tallyx