Trade and logistics: Tokenising trade connections and assets
The future of trade and supply chain finance is tokenised_Part 1
Niche Cocoa is a Ghanaian cocoa processor that supplies semi-finished products such as powder, butter and liquor to buyers in Europe and Asia. The buyers will then process them into consumer products like chocolate. Niche Cocoa first needs to buy cocoa beans from farmers. As supplies of beans are generally available throughout the year, there is a short period from buying raw beans to processing them into products at their 60,000 ton/year facility in Free Zone, near the Tema port. Buyers from Europe and increasingly China approach the company, review samples and quotes before placing an order. Once products are ready, they are shipped to buyers.
Niche Cocoa borrows from local banks to buy cocoa beans and to run the facility. Banks typically employ independent collateral managers to monitor the stock and flow of inventory. Once the products are shipped as evidenced by a Bill of Lading, Niche Cocoa issues an invoice to the buyer. Standard payment terms vary between 30 to 90 days. In need of working capital for a new production cycle, Niche Cocoa reaches out to a specialist financier who buys the invoices from Niche Cocoa and arranges for collection directly from the buyer. In the process, they charge 2.5% for a typical 3 month financing (10% APY). Niche Cocoa accepts the terms as the financing allows Niche Cocoa to deliver larger orders in the next cycle.
Niche Cocoa is among millions of SMEs around the world who needs working capital in the form of trade and supply chain financing to carry and process inventory and to plug the gap between invoicing and payment.
Let unpack what is happening here:
Trade/logistics: Buyer and seller ‘meet’ and agree on trade terms such as goods, price, quality, quantity, delivery etc. Logistics transaction is about transforming goods either in time (storage) or in space (shipping). The lack of trust and heavy paperworks make it difficult for SMEs to access the global market.
Payment: Buyer pays for goods when certain conditions are met such as proof of shipment (Bill of Lading), on receipt of the shipment or according to a payment term. This payment is made via the correspondent banking network. When finance is used, a financier transfers money to the borrower, also through the banking network. Payment is both slow and costly. Depending on corridors and amount, participant could pay up to 7–8%, according to the World Bank.
Finance: Working capital finance is to bridge the timing mismatch between when an invoice is raised and when it is paid; when inventory can be converted to invoices once shipped; or between receiving a purchase order and its fulfilment, where raw materials are transformed in form (processing), time (storage) and space (shipping). Working capital financing could cost SMEs 15% — 40% depending on countries and instruments. For USD financing it could cost SMEs 10–12% in for invoice financing.
We believe that blockchain/tokenization coupled with other technologies such as AI and IoT will have huge impact on trade and supply chain finance in terms of trust/transparency, speed and especially costs.. This paper focuses on the impact of tokenisation on trade and supply chain finance in each of three areas.
Trade and logistics: Tokenising trade connections and assets
The COVID-19 Pandemic has highlighted the importance of resilience supply chain. Visibility brings resilience. With a clear view of the conditions of suppliers along the supply chain, stakeholders are able to prepare for and deal with supply chain disruptions.
There have been digitisation efforts of the global supply chains. Tradetech is a major development area in recent years. HSBC’s Serai started with connecting apparel suppliers in Bangladesh to global buyers. It allows users to set up profiles, showcasing their products and finding relevant partners through a search function. Serai is integrating with other technology solutions to provide enhanced services such as a 3D Visualisation tool that allows closer examination of products. All these help enhancing visibility and trust in the supply chain. Being set up by a bank, it is anticipated that trade and supply chain finance solutions will be integrated in the Serai platform eventually.
Tracking and traceability
A trade for physical goods requires a movement of the goods from A to B. This is logistics. Supply chain visibility means that stakeholders can track the goods during as it transits through the supply chain. It is also important for traceability as consumers increasingly want to know the source i.e to ensure that it is environmentally and socially sustainable (e.g. no child labour).
Tracking shipment is a major issue. Financiers often lack up-to-date information of the cargo whereabouts let alone its conditions. Here Internet of Things (IoT) has a huge role to play. Monitoring micro climate conditions (e.g. temperature and humidity) of storage of fish or grains or tracking a container as it transits through different ports or choke points or tracking a vehicle as it moves from a warehouse to a distributor’s forecourt and eventually sold to a customer are just a few use cases of IoT within global trade.
In the supply chain of commodities, when financing is involved, often banks engage independent collateral managers who provide safe custody of physical commodities. This is to ensure that inventory movement is controlled and the collateral is adequate for financing. Often this control is done by human who guards the inventory with a physical lock..
Whether being digital or manual, the above efforts are about giving financiers more and better information to make lending decisions and manage risks after lending. In fact, lacking of information, whether financial, commercial or supply chain, is the main reason that trade and supply chain finance is only available to large companies. SMEs find it difficult to access finance due to a lack of information and acceptable security such as hard assets.
We believe that the IoT, AI and blockchain will fundamentally change the way trade and supply chain finance is done. Whilst IoT transforms data acquisition (e.g. environment, locations), AI gives insights on data from many different sources. Blockchain ensures unknown parties to share data securely with its inherent qualities — immutability and a traceable chain of custody.
Tokenisation of supply chain assets
Through tokenisation, assets in supply chain such as stored inventory, goods in transit, invoices and even purchase orders can be used in collateralised lending. Asset backed tokens can synchronise financial flow with information flow, removing the need for reconciliation and lower fraud risks.
Whilst a Bolivian cattle ranch has been tokenized, inventory can be tokenised, leveraging the existing collateral management practice. Collateral managers (CMA), trusted third parties (because of reputation and adequate insurance) monitor inventories in terms of movements and conditions. Blockchain tokens are issued by collateral managers once they have accepted the type, quality and quantity of each inventory deposit at an accredited storage. This digital token can be a security, like a tokenised electronic warehouse receipt, or simply a digital representation of inventory under custody that is recognised by parties under a contract (financier, borrower and CMA).
Goods in transit can also be tokenised. CargoX, a blockchain document transfer platform, has been working on a tokenized electronic Bill of Lading solution. The solution replaces paper Bill of Lading, a key title document in international trade that needs to be couriered around, with a Non Fungible Token (NFT) on Ethereum blockchain. It is still early days as the token is yet to be generally accepted but, like the stored inventory case above, it is being recognised among parties involved under contract law.
Tokenising invoices and purchase orders is far simpler as it doesn’t involve a third party vouching for physical existence as in the case of inventory. Once an invoice is accepted by a buyer it is tokenised. Tradeshift, a leader in supply chain payment and marketplace has been working on invoice tokenisation.
Dubbed “Smart invoice” the tokenised invoice can trigger payment on due date, removing the need for time consuming follow-up and laying a foundation for many financial application (programmable money).
Perhaps one of the major developments in tokensing supply chain assets is a project that Coca Cola has been working on. Coca Cola looks to tokenised invoices from its bottlers, making it secure to share data among them.
Key blockchain concepts
Blockchain: A public, distributed, immutable database where transactions are validated not by a single centralised party but by many incentivised parties through a consensus mechanism (way to come to agreement).
Tokenisation: Process of digitising an asset or a liability to digital representation on a blockchain.
Fungible Token: Tokens that can be used interchangeably with other tokens within a particularly type e.g. a payment token.
Non-Fungible Token: Tokens that are unique and can’t be used interchangeably with another token e.g. an invoice token
Stable coin: Tokens whose values are pegged against the value of a currency or a commodity.
Smart contract: A piece of computer code residing on a blockchain that is capable of self execution when certain conditions are met
Oracle: Computer program or human report of real world events (such as commodity prices) to the blockchain. Oracles can be both centralised or decentralised