Blockchain technology is generating huge amounts of hype across a number of industries – perhaps none more so than financial services. One area of finance that has received less attention to date is invoice financing. However, as we explain in this article, blockchain has the potential to revolutionise invoice financing, for the benefit of suppliers, debtors and financial institutions alike.
To start with it will be useful to briefly summarise what blockchain actually is. For a more detailed explanation of the Blockchain technology and some of the legal considerations with its adoption, see our introduction to blockchain.
What is blockchain?
Blockchain is a platform technology which combines a decentralized database with sophisticated cryptographic security and process automation designed for the purpose of facilitating an exchange of value. Another way to explain it is that blockchain is a secure “smart” digital ledger, recording transactions in such a way as to allow the transfer of value (money, assets or services) between two or more people in a way which is instantaneous, validated, trustworthy and transparent, without the requirement for a central single authority or clearing house.
The most well-known use case for blockchain is as the technology which facilitates the crypto-currency Bitcoin. However, many entrepreneurs and major financial institutions are looking at how blockchain technology can itself be applied to many other types of transactions and processes, with financial services receiving a great deal of this attention. It is interesting that one of the very early use cases being examined within this emerging area is the application of blockchain technology to receivables finance / invoice discounting.
What could invoice finance on the blockchain look like?
Early movers in this area have already designed blockchain applications that provide an end-to-end process for sending and receiving invoices; confirming the authenticity, amount and other details on an invoice; paying the invoice; and acknowledging receipt of payment, including a feature for discounting the receivable on the blockchain /distributed ledger.
Establishing trust and certainty
Central to how the blockchain works is the creation of trust by the means of clever cryptography to establish a “consensus” on the blockchain ledger that a particular transaction has actually occurred. Once consensus is reached that transaction cannot be amended or tampered with and becomes an immutable and time-stamped record on the digital ledger. This gives any person looking at the blockchain ledger a very high degree of confidence that the transactions detailed did in fact take place. To quote a central blockchain commentator: “for the first time ever, we have a platform that ensures trust in transactions and much recorded information no matter how the other party acts” (Don Tapscott and Alex Tapscott: Blockchain Revolution, How the technology behind bitcoin is changing money, business and the world).
So, what if discounters were able to apply this level of confidence, consensus and immutability to the invoices of a company, it may be possible for discounters to benefit from:
- An immutable and time stamped record of the existence of every invoice raised by a company.
- An immutable and time stamped record of the debtor’s receipt, confirmation and verification of the invoice (against which a discounter would fund).
- If decided upon, an immutable time stamped record of the assignment of a particular invoice to a discounter.
These benefits could potentially have significant process enhancements, saving time and costs as well as significant legal and risk advantages.
Process enhancements might include:
- eliminating any requirement for on-site audits of receivables and debtors as well as debtor verification processes generally; and
- streamlining existing borrowing base certificates, receivables notification processes and month-end reconciliation processes for availability / purchase price calculations – the blockchain would be the golden source for this information and readily available, searchable and extractable.
Legal and risk advantages
Having verification from a debtor that an invoice is valid and goods or services have been received significantly reduces the risk of dispute and non-payment of that invoice. The debtor could be incentivised to acknowledge and confirm its invoices without delay, as its own track record of confirming invoices would be visible on the blockchain to its suppliers which could be used to influence the payment terms and contract prices it is offered. This immutable debtor verification could also potentially eliminate the risk of invoice fraud for a discounter as there would be no ‘consensus’ met for a “fresh air” or double invoicing transaction.
Time-stamping an invoice which has been assigned to a discounter could prevent multiple assignments or other disposals of the invoice, as the record of the invoice on the blockchain would carry with it the record of the assignment. This has legal significance as if a company did attempt to assign its invoice more than once, it would prevent any subsequent assignee being a bona fide purchaser for value without notice, thus protecting the first assignee.
Golden source of information
Core to blockchain technology is the fact that the information will stay on the blockchain and remain searchable, extractable and analyzable for as long as is desired by the parties. Permissioned third parties would therefore be able to view the full transaction and payment and performance history of any particular company.
For suppliers, the blockchain would evidence a complete and transparent record of their completed transactions and success rate on the blockchain (e.g. what percentage of goods / services are returned or rejected and for what reason) on which to base funding and recourse decisions.
In relation to debtors, the blockchain would evidence a complete and transparent record of their payment history on the blockchain on which to base credit limit / debtor limit decisions.
‘Smart contracts’ will usually come up in any discussion of blockchain and potential use cases. There is not currently a universally accepted definition of what a ‘smart contract’ is, but in essence it is a programmable contract that automatically executes when pre-defined conditions are met. An example of this is an insurance policy which automatically pays out to a policyholder on the occurrence of the insured event.
A significant potential ‘smart contract’ application which could directly benefit invoice finance is an invoice payment reconciliation smart contract. Invoices could be programmed with payee bank accounts linked to a “click and pay” feature. This would allow for such payment account details to be changed / updated, subsequent to invoice issue. This would mean that an invoice which is discounted after issue could be updated to re-direct payments to a discounter’s collection account. This would be a particular benefit where single invoice or specific batches of invoices are being sold and the company doesn’t want to update its payment details for all its invoices. This ease of re-directing payments to an assignee of a receivable could also facilitate the establishment of a liquid secondary market for trading invoices or bundles of invoices.
Another smart contract application which has been quite widely explored is the self-paying invoice. An invoice could theoretically carry a computer programme to automatically initiate a payment to the supplier when due.
Smart contracts raise many legal, regulatory and practical challenges. However the perceived potential benefits of smart contracts are so significant there are already a number of large banks and financial institutions as well as fintechs investing in the technology and already addressing those issues.
Will blockchain be the next technological revolution in invoice financing?
The invoice finance industry has already seen significant benefits from the use of technology streamlining processes and the customer experience. The industry has seen the emergence of a number of market entrants putting technology at the heart of their offering and gaining traction in certain market segments.
Predictions for the timing of the mainstream adoption of blockchain and smart contracts vary according to whom you speak and their industry. Capgemini Consulting predicts the mainstream adoption of blockchain and smart contracts across a variety of industries could be as soon as 2020. It of course remains to be seen whether invoice finance will be one of those industries. We do think it is at the very least worthwhile keeping a close eye on developments in this area. There are already some exciting developments happening in the area. Blockchain is still cutting edge technology and the first industry participants to fully realise its potential, may just give themselves a significant competitive advantage.