The Value of Smart Contract in Trade Finance
46 Pages Posted: 18 Feb 2021 Last revised: 16 May 2022
Date Written: December 31, 2021
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
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