Foreword

Supply chain finance plays a critical role in the modern business environment. With the rapid growth of global trade and the continuous expansion of multinational corporations, supply chain finance has become a key factor in ensuring smooth business operations. It involves multiple aspects, such as fund flow, trade financing, and risk management, providing greater support to various participants and promoting efficient supply chain operations.

In traditional business operations, there are often issues such as shortage of funds, delayed payments, and risk exposure at various stages of the supply chain. These issues can hinder the smooth operation of the entire supply chain and have adverse effects on production and business operations. Supply chain finance offers effective financial support and risk management mechanisms, enabling better collaboration between different enterprises and achieving common economic benefits.

In this course, we will introduce the fundamentals of supply chain finance and explore the applications of blockchain technology. We will discuss how the innovation of decentralized finance extends to the field of supply chain finance, leveraging its advantages in areas such as enterprise credit rating, financing, and payment solutions, to enhance transparency and traceability in fund flow and risk management, creating a robust supply chain ecosystem.

Introduction to Supply Chain Finance

Supply chain finance is a financial service and solution designed to reduce financing costs and enhance business efficiency for both buyers and sellers during transactions, aiming to facilitate fund flow, trade financing, and risk management in the supply chain.

From its initiation to completion, supply chain finance works by automating transactions and tracking invoice approval and settlement processes. Under this paradigm, buyers agree to a supplier’s invoice for financing from a bank or outside financier.

By providing short-term credit that optimizes working capital and provides liquidity to both parties, supply chain finance provides unique advantages to all participants. Suppliers can receive payments faster, while buyers have more time to settle their debts. Both parties can utilize the cash on hand for other projects to keep their respective operations running smoothly.

In essence, the core concept of supply chain finance is to have independent financial institutions (such as banks) provide financial support to various participants in the supply chain, facilitating smoother execution of business between upstream and downstream enterprises.

This allows suppliers to get paid early and buyers to pay later. In this process, financial institutions (such as banks) bridge the gap in fund procurement, thus enhancing the responsiveness and efficiency of the supply chain.

Source: https://ctmfile.com/story/does-supply-chain-finance-work-for-international-supply-chains

Major Challenges

The emergence of supply chain finance is driven by the challenges that businesses face in fund flow and fund risk management. Businesses encounter various issues during their operations, including:

1. Pressure on Fund Flow
   Enterprises in every link of the supply chain need circulating funds. For instance, raw material suppliers need funds to purchase materials, manufacturers need funds to pay suppliers and employees, retailers need funds to buy inventory, and end customers need funds to pay for products or services. However, liquidity may face delays and uncertainties due to various factors such as industry conditions, unexpected events, and national policies, leading to cash flow shortages among participants in the supply chain.
2. Risks and Uncertainties
   Various links in the supply chain may face risks and uncertainties, such as delivery delays, damaged goods, supplier bankruptcies, etc. These risks can result in losses and fund interruptions for businesses.
3. Delayed Payments
   To manage their cash flow and mitigate operational risks, businesses may delay payments to suppliers in the supply chain. However, this can create financial pressure on suppliers, especially for small and medium-sized enterprises (SMEs) that may not be able to sustain long outstanding amounts.
4. Financing Difficulties
   Businesses may require additional funds to support their supply chain activities, such as purchasing inventory or expanding production capacity. However, traditional financing methods may be costly and challenging to obtain, especially for SMEs.

Generally, the supply chain of a specific commodity starts with raw material procurement, goes through intermediate manufacturing processes to produce the final product, and then reaches consumers through a sales network, connecting suppliers, manufacturers, distributors, retailers, and ultimately end customers into an integrated whole.

In such a supply chain, large-scale and competitive core enterprises, due to their dominant position, often impose stringent requirements on their upstream and downstream partner companies concerning delivery, pricing, and payment terms, putting immense pressure on these companies.

Since most upstream and downstream partner companies are small and medium-sized enterprises, they find it challenging to obtain financing support from banks, leading to an imbalanced and tense financial situation within the entire supply chain.

Solutions

To address the inconvenience in funding procurement faced by small and medium-sized companies within the supply chain, supply chain finance seeks to identify larger key core enterprises in the supply chain and integrate logistics, information flow, and fund flow based on industry characteristics. It provides comprehensive financial services to the core enterprises and their upstream and downstream partner companies.
Financial institutions, such as banks, inject funds into relatively vulnerable upstream and downstream companies, resolving their financing difficulties and the imbalanced supply chain. Simultaneously, they integrate the bank credit system into the buying and selling activities between the upstream and downstream companies. This is achieved by increasing the commercial credit of these companies through guarantees and commitments from the core enterprises. It encourages the establishment of long-term cooperative relationships between SMEs and core enterprises and enhances the competitiveness of the supply chain.

Factoring and Reverse Factoring

In supply chain finance, there are two common concepts that need our particular attention, which are factoring and reverse factoring.

1. Factoring
   Factoring is the most common practice in supply chain finance, where a supplier sells its accounts receivable to a specialized financial institution, known as a factoring company. The factoring company provides immediate payment to the supplier, usually a certain percentage (typically 80% to 90%) of the accounts receivable amount, and takes responsibility for collecting payments from the core enterprise.
   Factoring helps suppliers solve cash flow issues and improve fund turnover. At the same time, the factoring company manages and collects accounts receivable, relieving the burden on the core enterprise. Factoring can provide suppliers with some risk protection, as the factoring company assumes the credit risk of the accounts receivable.
2. Reverse Factoring
   Reverse factoring is another approach to address funding constraints within the supply chain. After a supplier sells goods or provides services to a core enterprise, they can sell their accounts receivable to a financial institution based on the authorization of the core enterprise. The financial institution pays the supplier’s accounts receivable in advance and is subsequently reimbursed by the core enterprise upon maturity.

This paradigm allows the supplier to receive payments for accounts receivable earlier, thereby alleviating their financial pressure. At the same time, the core enterprise can extend the payment period, increasing cash flow flexibility. Reverse factoring also offers financing opportunities for suppliers based on the credit endorsement of the core enterprise, enabling suppliers to access more favorable financing terms.

For example, buyer A places an order with supplier B to purchase goods. Typically, supplier B would ship the goods to buyer A and submit an invoice based on their payment terms, such as T/T 30, allowing buyer A 30 days to make the payment after receiving the goods.

However, if supplier B wants to receive funds more quickly (or if buyer A does not have available cash and prefers to retain cash for operational purposes, among other situations), they can utilize supply chain finance as a solution where a third party C (the funder or lender) immediately pays the invoice on behalf of buyer A and extends the payment period that buyer must repay, possibly extending it to 60 days.

This creates a win-win situation, as buyer A can delay the actual payment of the invoice without damaging the relationship with supplier B, thus increasing cash flow, while supplier B can receive the unpaid invoice amount in a shorter period.

During the recent COVID-19 pandemic, this flexibility of early receipt of funds and deferred payments has provided significant support for many suppliers and buyers. Many buyers and suppliers had to seek adjustments in payment terms and support from financial institutions to avoid supply chain disruptions caused by liquidity pressures.

Advantages and Disadvantages

Advantages

1. Supply chain finance helps maintain the mutual interests of both buyers and sellers and expand credit limits, providing suppliers and buyers with more available funds.
2. The injection of liquidity facilitates smoother operations across different links of the supply chain and strengthens cooperation among enterprises, which is conducive to the long-term development of the supply chain.
3. By extending financing criteria to the entire supply chain instead of focusing solely on individual companies, even SMEs can inherit the creditworthiness of the supply chain, gaining access to more diverse financing opportunities without being limited by their own credit ratings and financial conditions.
4. Supply chain finance disperses risks throughout the entire supply chain network, leading financial institutions to offer loans at lower interest rates, thereby enhancing financing efficiency for enterprises and reducing capital costs.

   Disadvantages

5. Supply chain finance relies on honest participants to operate sustainably. When financing providers come from financial entities other than banks, there is a higher risk of breach of trust, such as delayed payments to the seller or failure to fulfill contractual obligations.
6. Supply chain finance may be used for illegal money laundering transactions, involving a disconnect between logistics and funds flow. Buyers or sellers may exploit the time gap in payments to engage in illegal trading or financial crimes, making inherent risks relatively high.
7. It can only be used for financing finished products with immediate market value. Other objects like inventory, work-in-progress (WIP), and raw materials lack liquidity as they cannot be sold immediately and cannot gain the trust of financiers to provide financial services.
8. It requires high levels of system integration and technological requirements, necessitating cooperation, information sharing, and transaction validation among different participants in the supply chain to facilitate fund flow. Additional investments and efforts in technology are needed, and reliable cooperation relationships often require time to cultivate.
9. Assessing risk and creditworthiness is challenging as it extends from the credit rating and financial status of a single enterprise to the entire supply chain. The complexity grows exponentially, involving extensive data collection and analysis within the supply chain, especially when there is insufficient information or incomplete credit records of participants.

Application of Blockchain in Supply Chain Finance

Accounting

Blockchain technology can bring many benefits to the accounting of supply chain finance. It enables transparency and traceability of supply chain transactions, ensuring the accuracy and reliability of accounting data. The security and tamper-resistant features of blockchain also reduce the risk of human fraud and errors. Through automated real-time recording on the blockchain network, data recording efficiency and immediacy can be improved, and all participants in the supply chain can share the information, facilitating more efficient and even dynamic accounting and financial management. In addition to improving the accounting process of supply chain finance, it also helps save time costs.

Payment

Blockchain technology can be used for fast and instant payments, eliminating the need for the clearing and settlement processes of multiple intermediaries and banks. It is not subject to the limitations of non-working days, thus saving time. The peer-to-peer cash flow network removes unnecessary intermediary institutions and directly transfers funds from the payer to the payee, effectively reducing payment costs. Furthermore, the decentralization and encryption of blockchain ensure the security and trustworthiness of payment transactions, eliminating the risk of single-point failures and tampering by centralized institutions. In the context of cross-border trade, blockchain technology also provides convenient international payment solutions, overcoming issues such as time zones, currency conversions, and cross-border regulations, significantly streamlining the process of cross-border payments to enhance payment efficiency and convenience.

Financing

The application of Decentralized Finance (DeFi) offers many interesting ideas about financing. For example, companies can achieve more flexible fundraising and decentralized financing by issuing digitized tokens, such as security tokens, governance tokens, yield bearing assets, and real-world assets, to attract more potential fund providers.

Mortgage lending protocols open up further possibilities. Companies can use tokenized assets as collateral for loans or mint stablecoins, which preserves assets while releasing liquidity. This significantly reduces the threshold for obtaining funds.

The functionality of smart contracts enables the automation of financing terms and payments and the executions of businesses on the blockchain network, which can reduce the possibility of human errors and disputes and effectively improve the efficiency and security of financing processes.

Risk Control and Credit Assessment

Traditional risk control and credit assessment for enterprises usually rely on factors such as financial conditions, credit history, industry environment, management team, business model, market outlook, etc., putting small and medium-sized companies at a disadvantage in this regard. With the development of Web3, the metaverse, DAOs, micro-enterprises, and studios, risk control and credit assessment mechanisms based on non-fungible tokens (NFTs), decentralized identity (DID), and soulbound tokens (SBT) can bring a more flexible framework to supply chain finance.

For example, every entity in the supply chain network has an on-chain wallet and gains basic trust based on proof of work related to their economic activities (e.g., purchases, manufacturing, distribution, services, etc.). A reputation system is established through evaluations from upstream and downstream enterprises and end consumers, dynamically tracking participants’ behaviors and commitments. Malicious companies engaging in fraudulent activities will be punished, while positive participants will be trusted and rewarded.

Extending the concept of social finance (SocialFi) from the individual side to the business domain can allow the supply chain to expand from one-way bilateral trade to triangular trade and multi-party trade, evolving into a globally interconnected network. By leveraging the power of blockchain technology, it becomes possible to comprehensively integrate and decentralize logistics, information flow, fund flow, and business flow, enabling any capable individual or entity to participate in any business within the supply chain or assume multiple roles simultaneously.

Yield Farming

Yield farming in decentralized finance (DeFi) is like a set of Lego bricks, unlocking unprecedented profit potential for supply chain finance. Debt financing, commodity financing, and credit guarantees can all be tokenized and traded on decentralized exchanges, allowing companies to choose to become liquidity providers and earn yields based on their inventory management and financial planning.

With the rise of emerging markets for goods and services, many supply chains face increasingly complex and riskier industrial environments, leading to a growing number of transactions being handled through credit sales. The development of DeFi derivatives can break free from the limitations of traditional finance and various national regulations, offering innovative tools to actively enhance the utilization of funds, production capacity, and inventory within supply chains. Participants at any stage can act as financial institutions, providing liquidity to other enterprises, earning rewards, and accelerating the overall flow of the supply chain, thereby generating more added value.

Challenges in Technology, Organization, and Regulations

Digital Integration

Although blockchain technology has obvious advantages, its development and application still face many challenges, making the aforementioned supply chain finance applications difficult to realize. The development and deployment of new systems can be time-consuming and resource-intensive. Integrating private blockchains, consortium blockchains, and public blockchains is also an issue, as the systems built by institutional supply chains may be difficult to adapt to the blockchain environment.

Furthermore, transforming enterprise infrastructure and business processes would be a major undertaking, likely disrupting normal business operations and consuming resources from other projects. Top-level executives may hesitate to approve such investments unless they see widespread adoption of the technology among other major players in the industry.

Enterprise Collaboration

The effectiveness of a new system relies on other partners in the supply chain also being willing to use blockchain technology and making certain compromises regarding enterprise privacy to achieve more efficient collaboration. Institutions may choose to use blockchain technology to cover only a part of their business processes, but doing so would limit the full benefits of on-chain integration. The barrel principle will determine the growth potential of the supply chain network’s synergy, and not all companies may be willing to embrace the transparency of a blockchain network, as one malicious actor can significantly undermine the efforts of other participants.

Management Changes

Once a blockchain-based system is deployed, the enterprise needs to promote its adoption among employees. This requires significant investment in time and money for employee training and redesigning business processes. The company will also face changes in organizational culture and structure, including explaining and educating about blockchain technology, how it improves job responsibilities, how to use the new system with blockchain networks, and plans for subsequent technology applications and training. This may encounter considerable internal resistance and require consensus and cooperation from multiple stakeholders, with establishing cross-organizational consensus being an extremely challenging task.

Regulatory Constraints

Due to the restrictions and uncertainties of regulations in different countries, there is virtually no practical application of blockchain in supply chain finance. The regulatory differences regarding blockchain and related applications among countries will pose significant challenges in cross-border trade scenarios.

Regulatory authorities are well aware that providing financing for asynchronous logistics, fund flow, and trade before delivery requires extra caution, as it could potentially become a breeding ground for financial crimes like trade-based money laundering. This could lead to upstream and downstream participants in the supply chain concealing illegal money flow through fraudulent B2B transactions. Typically, most regulatory agencies have well-defined guidelines for extensive inspections by trade financing banks to avoid loopholes. However, implementing anti-money laundering measures in decentralized on-chain transactions remains a challenging problem.

Many countries and regions have not kept pace with the timely development of blockchain technology in terms of regulations, and this uncertainty hinders businesses from actively adopting blockchain technology.

Conclusion

In this course, we have explored the potential applications of supply chain finance and blockchain technology. Supply chain finance, as an important financial service and solution, offers significant assistance in reducing financing costs, improving business efficiency, promoting fund flow, trade financing, and risk management. However, its reliance on the traditional financial system has inadvertently become a ceiling limiting the expansion of supply chain networks.

According to Little’s Law, compressing process time can reduce inventory costs in the supply chain. Its underlying implication is that “information, if sufficiently abundant, can replace inventory, capacity, and even fund flow.” The degree of predictability of future events will determine the operational costs of the supply chain. A fully transparent information network like blockchain can maximize the output efficiency of the supply chain.

We have also explored potential scenarios for decentralized credit assessment, financing, yield farming, and payments. Although it currently seems impossible to see organizations like a decentralized iPhone assembly factory or decentralized agricultural and aquaculture farming, if future technological advancements empower anyone with high production possibilities, consumers will not care whether their products or services originate from anonymous on-chain wallets.

Anyone who can produce products, provide services, and has sufficient funding will be qualified participants. The supply chain will possibly evolve into a supply web, using distributed production and distribution to meet the overall supply and demand of the human society. This is a seemingly almost impossible vision that requires overcoming numerous challenges in development, integration, education, regulations, and policies. However, with the rapid development of technology and the widespread use of AI, perhaps the magical world of fantasy may one day become a reality.

Takeaways

1. Supply chain finance is a financial service and solution that aims to reduce financing costs, enhance business efficiency, and facilitate fund flow, trade financing, and risk management. It plays a crucial role in the modern business environment.
2. In traditional business operations, various links in the supply chain often face different challenges, such as funding shortages, payment delays, and risk exposure. Supply chain finance provides effective financial support and risk management mechanisms to achieve mutual economic benefits for stakeholders.
3. Blockchain technology facilitates innovative applications in supply chain finance, optimizing solutions for enterprise credit assessment, financing, and payments, enhancing the efficiency of fund flow. It leverages transparency and traceability to improve risk management.
4. Businesses face challenges in fund flow and fund risk management, which may include pressures on cash flow, various risks and uncertainties, delayed payments, and difficulties in obtaining financing during their business operations.
5. Financial institutions (such as banks) play a significant role in supply chain finance by enhancing the commercial credit of small and medium-sized companies through core enterprise guarantees and commitments. They provide financial support and security to all participants in the supply chain, enabling smoother implementation of their businesses.
6. Common practices in supply chain finance include factoring and reverse factoring, where suppliers sell their accounts receivables to financial institutions, and factoring companies provide immediate payment and handle the collection on behalf of the suppliers.
7. The advantages of supply chain finance include maintaining common interests, promoting smooth business operations, relaxing financing standards, and dispersing default risks.
8. The disadvantages of supply chain finance include reliance on honest participants, potential misuse as a tool for illegal money laundering, challenges in system integration, and difficulties in risk assessment and credit rating.
9. In supply chain finance, there is potential for the application of blockchain technology in various aspects such as accounting, payment, financing, risk control and credit assessment, and yield farming.
10. Due to factors like digital integration, enterprise cooperation, management changes, and regulatory limitations, blockchain technology still faces numerous challenges in its application in supply chain finance.