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Web3 Deep-tier Financing

By May 9, 2022 No Comments

As decentralised trade financing becomes mainstream, the time has come to unlock affordable supply chain financing for all. In this blog, AMPLYFI’s co-founder Chris Ganje explores the current landscape of Web3 deep-tier financing.

Trade finance has been around for centuries. During brief breaks between wars and plague outbreaks, John would grow apples and sell them to Alice. Alice could not pay John immediately as she needed to arrange a cart to bring them to market. Instead, she issued John a note promising to pay him within 90 days. In the meantime, to make ends meet, John took the note to a local lender and, using it as collateral, secured a loan at an extortionate interest rate. Fast forward to modern times and little has changed except plague made way for COVID-19 and that note got rebranded as an “approved invoice.”

The problem with this conventional approach to trade finance is that only large suppliers can access financing at a reasonable cost. The smaller the supplier, the higher the risk to the lender, and so the higher the interest rate. In many industries, it has reached a point where many small and medium enterprises (SMEs) are excluded from trade financing. Lack of access to affordable financing leaves them vulnerable to many risks, from worldwide economic recessions to lengthy payment delays.

If our experience through catastrophic events such as Fukushima and the COVID-19 pandemic has taught us anything, it is that the health of supply chains is of utmost importance to survive and prosper when facing major disruption. In virtually any supply chain, sitting behind a few giant first-tier suppliers with global brands are hundreds if not thousands of smaller niche suppliers scattered throughout its deeper tiers. The time has come to unlock deep-tier affordable financing for all.

A few FinTech platforms, including Tallyx, Skuchain, and Centrifuge lead the web3 revolution and offer a range of blockchain-based financing solutions. Although implementation details vary, these FinTechs operate on similar principles. They tokenize a financial asset, such as an invoice, purchase order, inventory item etc, creating a non-fungible token (NFT). Then the supplier receives a fraction of the asset value (80~90% for invoices) in stable coins or platform native tokens. Once the buyer’s payment clears, the supplier gets the rest of the value less the platform fee. Some platforms also allow using finance to pay an upstream supplier instead of receiving the payment directly.

One could argue that the above process resembles typical factoring mechanisms and could operate perfectly well without a blockchain. Whilst this is true, blockchain technologies provide several key benefits. Firstly, the cost of operating a decentralised finance (DeFi) platform is substantially lower compared to traditional bank (or non-bank) lenders. A recent study by the International Monetary Fund (IMF) indicates that these costs could be 3 to 6 times lower, mainly due to lower labour and operational costs, resulting in a considerably lower interest rate or fee for suppliers. Secondly, buyers can benefit from real-time visibility within their deep-tier supply chains and detect potential supplier problems early to reduce risk and increase security. Thirdly, the whole process simply transacts faster and with less “friction.”

No doubt blockchain technologies will and, in some areas, are already changing the world of trade credit. Yet, there are still many questions to answer. As decentralised trade financing becomes mainstream, are we going to see the launch of Société Générale and Citi Bank trade coins? Will the likes of Airbus and Walmart launch their own? With the increased levels of security provided by blockchain and smart contracts, what role will traditional trade credit insurers such as Atradius, Coface, or Allianz Trade play?