Blockchain technology is revolutionising invoice financing

Blockchain technology is seeing a wave of renewed interest in the financial services sector. Adi Ben-Ari, Founder and CEO of Applied Blockchain* explains why.

According to the Deloitte 2021 Global Blockchain survey, 83% of respondents within the sector believe there is a business case for the use of blockchain and digital assets within their organisation. Decentralised finance, public blockchain based financing, has grown from a negligible market to processing one trillion dollars in 18 months, including £170bn in total value locked (TVL).

As challenges in the global supply chain have shown, the invoice and trade finance industry is ideally suited to the benefits of blockchain technology. These benefits include trusted data sources, increased security, more efficient transactions to reduce cost, and perhaps most significantly, increased liquidity.

Resolving the paper trail

The trade finance industry is still largely reliant on a centuries-old model of information exchange which has seen few signs of evolution to support the large-scale globalisation and digitisation of trade. From the manual creation of contracts to large paper-trails and version control issues, many aspects of the factoring and supply chain finance process are prone to human error and lengthy intervals in communication, delaying the overall timeline. This can disrupt anything from small-scale local transactions of goods and services to the global supply chain.

Blockchain technology provides a rapid and streamlined solution to these issues. The distributed ledger can process transactions anonymously and transparently at lightning speeds. Moreover, the information immutably stored on the blockchain can be verified by all parties simultaneously, making real-time changes accessible to monitoring and review without a manual transfer of information.

“Smart contracts”, programmable actions that are be embedded in the blockchain, can further simplify factoring procedures by automating large parts of the process. Once previously specified conditions are met, the smart contract automatically carries out the terms of contract agreements, such as the immediate release of funds. This eliminates the need for intermediaries and can prevent errors and delays in the manual transaction process. In other words, the gap between payment request and receipt is eliminated entirely.

The key here is the action carried out by the smart contract. In order to realise the efficiency of the technology, the smart contract must move funds and/or assets. Early supply chain finance blockchain implementations focused on business processes. However, business processes could be modelled and digitised without the need for blockchain technology. It is the transfer of value through smart contracts on the blockchain that reduces the need for intermediaries, making the process more efficient.

Addressing security issues

The strategic importance of receivables finance to global trade makes it particularly vulnerable to security issues like fraud. This major problem is estimated to cost the global economy over US$5tn, and it is a common issue for factoring processes in particular, where fraud can be harder to detect. When factoring fraud occurs, prospects of recovery are very slim, and irrecoverable losses can be fatal for both factors and businesses who fall victim to fraudulent activities.

Blockchain technology can provide a holistic solution for security issues and prevent some types of fraud. Transaction records stored on the distributed ledger are immutable and entirely transparent, simplifying prevention and detection of some types of fraud. Once again, the possibility of human error is nullified by making invoice verification an automated process, visible by all parties at the same time. Further, the decentralised nature of the blockchain means that any data is distributed across a network of nodes, making it safe from central manipulation or hacking. Any compromised data would be immediately recognised as fraudulent, making the falsification of records near impossible.

In order to realise these benefits, all parties must transact directly on the blockchain. The security and value of blockchain solutions are considerably diluted when a third party or intermediary collects the information or processes funds on behalf of a transacting party. In other words, contracts, invoices and other documents must be created by the end users and mastered on the blockchain. Funds must be deposited into smart contracts by those end users, and investors must invest directly into those smart contracts.

Where data resides off-chain, for example historical bank account transactions, payments and invoices, as well as credit checks and government records, such sensitive data must be processed using privacy-preserving technology in order to avoid data leakage.

Where payments are made, they would ideally take a tokenised form of currency, such as a stable coin, a blockchain representation of a fiat currency such as GBP or USD, or a government issued central bank digital currency (CBDC). Where investment funds are collected, they should be deposited into a blockchain smart contract-based liquidity pool, where they can be dispersed by smart contracts after security checks are complete and pre-requisites are automatically verified.

A cost-efficient solution

The cost benefits of blockchain-based invoice financing would greatly outweigh any costs incurred in adopting the technology. Apart from the costs saved by mitigating losses due to fraudulent activities, the increased efficiency of the whole process goes some way to saving time and resource-intensive information exchanges. Intermediaries, for instance, previously needed to verify and execute contract terms, are replaced by automated smart contracts, creating a peer-to-peer mechanism between the transacting parties. Again, in order for this to be realised, all end users must transact directly on the blockchain, and not through any intermediaries. Once intermediaries are re-introduced, the majority of technical efficiency and security is lost.

Finally, blockchain technology opens up the factoring process to a range of businesses and lenders who had previously been unable to participate in trade finance. As tokenised assets can be fractionalised, this can enable more investors to access the receivables finance market and provide direct financing to businesses requiring funds. This has the potential to stimulate the trade finance ecosystem, allowing both factors and businesses unprecedented market access.

The future of invoice financing

Blockchain technology is exhibiting serious potential in a number of areas, yet the fast and secure transfer of transaction data is particularly well-suited to the invoice financing sector. Applied Blockchain’s framework estimates that the majority of the technology’s value will be most evident in the tracking and valuation of assets, the increased liquidity as well as the speed of payment processes. As it is an efficient group-secure transaction processing technology, the benefits of the blockchain truly align with the need to build an invoice financing ecosystem fit for the future. Eliminating most of the issues inhibiting the process in one unified solution is too valuable a proposition to ignore.

*Applied Blockchain specialises in building blockchain solutions for organisations in various sectors, and while the advantages that drive its adoption are increasingly recognised across industries, the company believes that the technology can revolutionise invoice financing by improving efficiency and security, as well as minimising the cost for all parties.