Smart contract and invoice finance: the blockchain

Thursday 6th January 2022

There’s no question that finance is changing. The traditional use of banks, currency and the way in which transactions happen is evolving at a rapid pace to serve all parties.

One of the most interesting developments of recent years is of course the idea of smart contracts. These promise to make transactions faster, easier, cheaper and more secure, and in this article we’re going to take a look at how they do this, particularly in respect to invoice finance.

Despite the mystery that surrounds these kinds of innovations, smart contracts are actually fairly straightforward to understand at a top level. The way they work technically is of course quite complex, but you don’t need to understand coding to understand how they work, or how they might be able to benefit you in the future.

In short, smart contracts are contracts whereby all of the terms between the two parties are written into code, and they execute themselves automatically when those terms are met, or in practice, updated in the code. What’s more is that the code and thus details of the contract are stored across a network of multiple computers and servers.

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What is Blockchain?

Blockchain is essentially the technology that underpins all of this. Blockchain is the ledger that records transactions, by recording specific information in a block, and then chronologically ordering this information as new blocks are added. It’s a wholly decentralized and open way of doing things (though supported by initiatives such as Hyperledger). This kind of transaction recording can carry many benefits.

The advantages of smart contracts

1. No need for a middleman

The upshot of all this is that firstly, there is no middleman. There’s no need for any kind of central authority to manage or mediate all of the contract as currently happens, because the details of the contract are accessible from anywhere, and can be seen by anyone (though parties are anonymous) and updated by the relevant parties. No single entity is responsible for holding the contract while either party fulfills its obligations.

2. High security

Blockchain technology is particularly attractive because of its security too. The way in which it records data chronologically and stores it across multiple nodes means that it cannot be changed and is therefore very difficult to abuse. Should a malicious entity, whether a piece of software or a person, attempt to change the blockchain, it would be instantly found to be incongruous with the blockchain as recorded elsewhere in the network.

Blockchain Impacting Invoices

Naturally, this potential evolution for contracts will transfer over to invoicing. It will firstly be much easier to establish where in the process an invoice is, because much of the process is automated, and in theory it should be unarguable as to whether it is due. The more people in the entire supply chain that choose to use smart contracts, the faster and cheaper the whole process becomes.

Impact of blockchain on invoice finance

Advantages of blockchain

The implications for invoice finance products are very interesting. On the one hand, companies should find it much quicker to realise their invoices and therefore release the cash that’s owed to them, if everything is recorded in a smart contract. This is especially true for certain digital transactions and agreements where literally every part of the process can be automated once two parties have agreed.

Disadvantages of blockchain

On the other hand however, there are still going to be a great many instances in which it isn’t possible for a contract to automatically execute payment, even if it deals with the rest of the transaction. If you sell physical products for instance, the moving of those cannot necessarily trigger the smart contract.

In this instance, invoice finance is still going to be a hugely desirable facility for a lot of businesses, but smart contracts can in fact help there too. Given the clarity and security that smart contracts afford, they are likely to make any invoice as an asset itself, more valuable. This means that businesses may well be able to receive better terms on their invoice finance. And indeed, it’s already the case that marketplaces have been established online that allow almost anyone to take advantage of smart contracts by lending against or purchasing invoices from businesses across the world.