The Value of Smart Contract in Trade Finance

Abstract

Problem Definition: Smart contract improves the supply chain efficiency by enabling the supplier’s commitment to post-shipment financing decisions, which mitigates the bank’s lending risk exposure and thereby reduces the financing cost. This paper investigates how smart contract adoption could facilitate trade finance activities and create value for supply chain firms.

Academic/Practical Relevance: As the emerging blockchain technology could potentially reshape the trade financing landscape, understanding the impact of smart contract adoption and its interaction with trade finance activities is practically relevant and of great importance.

Methodology: We develop a two-stage game-theoretic model and adopt supply chain finance theory to characterize the strategic interactions between supply chain firms in the presence of both operational risk (demand uncertainty) and financial risks (credit and liquidity risks).

Results: We find that the value of smart contract depends critically on the trade finance structures, including both pre-shipment and post-shipment financing schemes. Under the baseline trade finance model (with purchase order financing as pre-shipment financing and factoring as post-shipment financing), smart contract alleviates the supplier’s overpricing behavior caused by commitment frictions and helps restore the supply chain efficiency. When buyer direct financing serves as an alternative pre-shipment financing, smart contract might discourage the retailer from offering buyer direct financing, which significantly hurts the supplier and thus reduces the supply chain profit. When invoice trading serves as the alternative post-shipment financing, the supplier always chooses invoice trading over factoring due to its trading flexibility which, in turn, makes the commitment frictions ubiquitous and unresolvable (namely, commitment trap). As a result, invoice trading could unexpectedly lead to a lower supplier’s profit. Luckily, such an adoption dilemma can be resolved by smart contract adoption in conjunction with factoring.

Managerial Implications: Our findings provide guidelines for and insights into when smart contract should be adopted and its interactions with different trade finance schemes. In particular, smart contract adoption does not always benefit the supply chain.

Keywords: Trade finance, supply chain finance, FinTech, smart contract, invoice trading, purchase order financing, buyer direct financing, factoring