For those able to see beyond the scams and overpriced digital art, NFTs could end up playing a key role in supply chain finance for smaller organisations.
Non-fungible token or NFT technology can be seen as a cost efficient way to transform trade finance assets such as invoices or purchase orders into a tradable asset, allowing suppliers to reduce their working capital costs by accessing alternative sources of financing or by using the token to pay their own suppliers.
With the global trade finance gap running into trillions of dollars, many observers believe tokenising payment guarantees of large buyer invoices is key to ‘deep-tier finance’ or financing that reaches deep into the supply chain.
According to Jean-Baptiste Gaudemet, SVP Data & Analytics at Kyriba, there are three key elements to this process:
A blockchain network to securely issue a unique and identifiable NFT.
A financial mechanism to incentivise suppliers at each stage of the supply chain to pass the NFT on to their own suppliers, which could take the form of a spread coded into the NFT’s smart contract.
Effective KYC for all participants at each stage of the chain to ensure compliance with anti-money laundering and sanction screening regulations and reduce the risk of fraud.
Currently, only the direct supplier is financed at the risk of a large buyer, for example in the case of reverse factoring or dynamic discounting.
“Thanks to tokenisation, major buyers will be able to transfer their payment risk and finance rate along the supply chain,” explains Andrei Maklin, CEO of Russian trade finance platform Factorin. “This could drastically reduce funding costs for second and subsequent tiers of SME suppliers, making the supply chain more sustainable.”
Tokenising assets is clearly an efficient way of undertaking business and transactions. The funds are available to the borrower immediately and the credit lines can be fully collateralised – an important consideration for issuers. In the event of a default, the smart contract is hardcoded to take the collateral without any human intervention.
Rob Gaskell, Founder and Partner at Appold (an advisory and investment company in the digital assets sector), says it is important to distinguish the functionality of smart contracts from NFTs.
“A smart contract is an automated code that executes a programme or transaction on the blockchain based on a set of rules and agreements,” he explains. “In contrast, an NFT is code that can be embedded into a smart contract giving that transaction a specific authentication or proof of being genuine, as opposed to a copy.”
An NFT can be tied to a unique cargo crate or an individual consignment of wine, allowing for the creation of a perfect (and immutable) means of transferring ownership at different points of the delivery of the asset in a way that the use of smart contracts alone cannot achieve.
“This is because smart contracts are better suited for fungible assets or commodities, such as one barrel of oil out of a million identical barrels – where it does not matter whether a buyer gains ownership of a specific barrel – rather than a unique consignment, where ownership of that specific consignment is important,” says Jose Neif, Head of BCB Labs at crypto payment services provider BCB Group.
The complexity and legal difficulty of providing an optimal level of credit support to small companies is a major reason why many big companies don’t do it. But while tokenising the payment guarantee of the final buyer can make it easier to provide this support, there are some important caveats.
“Tokenising payment guarantees certainly could make it cheaper and easier to execute credit support, but there is no guarantee that these processes would then be used to extend supply chain financing through to the long tail of suppliers,” observes Alisa DiCaprio, Head of Trade at R3. “It needs to be adopted at the industry level as suppliers would need to pass the NFT onto their own suppliers in turn for the tokenisation of payment guarantees to truly be effective.”