The blockchain has received a huge amount of press over the past few years, and with good reason. It’s not hyperbole to say this digital tool has the potential to transform financial transactions around the world. Much of the attention so far has been focused on how blockchain technology stands to revolutionize the financial services industry. But the innovations don’t end there. Many companies are working on blockchain technology along their supply chain, to control sourcing together with their business partners.
First, let’s step back and address the questions of what the blockchain is and what makes this technology so appealing for facilitating financial transactions. The blockchain is a type of database that records digital events between parties. It acts, essentially, like a sequential spreadsheet of transactions that gets updated on a global network of computers, in a way that is auditable. This global network is a distributed ledger in which data is encrypted as it’s being written so that the transactions it contains can be safely verified by legions of other computers across the network.
The blockchain’s distributed nature is an advantage. When financial transactions are made, new blocks are added to the globally stored chain, and each block is assigned a unique “hash,” a seemingly random sequence of letters and numbers that represents a set of data. The hash makes a blockchain very secure because it’s extremely difficult to adjust a well-designed hash back into its original text. The blockchain essentially produces a loophole-proof audit trail.
Moreover, because blockchain-based transactions are being monitored in real time, this technology makes fraud extremely difficult to commit. Instead of just being able to pull up the current version of the ledger, as in most of today’s general ledger systems, a blockchain transaction enables all users to see exactly how updates to the transaction register were formulated. Thus, it is easier to spot fraudulent activity as it happens, which tends to be managed by compliance experts within each department.
Blockchain technologies can also reduce the risks associated with a singular point of failure. If an asset under the control of a single administrator is compromised—for example, a corporate ERP system—that individual has the power to cause devastation to the business. But with a blockchain structure, the ledger is distributed across networks around the world. Consequently, there is no one administrator who can be compromised, resulting in significantly less risk to the entire system.
The World Economic Forum predicts that blockchain technologies will store 10 percent of the world’s GDP within the next decade.That prediction dovetails with Gartner’s 2016 Hype Cycle for Emerging Technologies report, in which that firm estimates mainstream adoption of blockchain technologies won’t happen for another 5 to 10 years. Nevertheless, leading organizations have already gotten started.
Blockchain Increases Supply Chain Efficiency
While the technology is still relatively new, corporate finance professionals are increasingly integrating blockchain technology into business networks to provide their users with more flexibility and trust.
In the supply chain, for example, the blockchain can enable smarter, faster, and more transparent processes. One software application based on blockchain technology can store a company’s strategic sourcing information all the way up and down the value chain, from raw materials through the production process to the customer. Companies can distinguish the access privileges of different users of the information. But for executives with the right permissions, the software can provide a custom analytics dashboard that shows the status of operational activities from sourcing all the way to settlement.
This functionality enables finance executives to track and trace a product to its roots to guarantee its quality before, during, and after shipment. It also provides buyers and sellers with a level of visibility and control—from shipment to receipt—that they’ve never had before.
The underlying blockchain makes this transparency, up and down the supply chain, possible by reducing the risk of fraud. In addition to gathering from the blockchain the information about specific transactions that customers, suppliers, and others need to see, blockchain-based applications also capture the defining characteristics of the data assets through digital thumbprints of the assets that are stored on the blockchain. This information—including history, transport, events, and ownership of the data—enables multiple stakeholders across a global supply chain to verify the authenticity of the information.
Blockchain in Practice in Corporate Finance
This example represents the tip of the iceberg for blockchain in corporate finance. In addition to the ramifications for transactional security, the blockchain may significantly increase CFOs’ operational efficiency.
Where transactions are traditionally regulated by a central governing financial institution, the blockchain may be able to remove the need for third parties to guarantee a transaction. Because the technology coordinates agreements among all parties with a transparent, shared architecture, payment transactions no longer need “trusted third parties” (e.g., a clearing bank). This, in turn, means the blockchain has the potential to substantially reduce the time and resources required to send and receive payments.
Think about it this way: If a bank tells a business that its customer will pay for a service, then the selling business trusts that it will be paid. But the parties to a transaction pay the bank for this trust provision. With blockchain technology, this could change, as the trust is provided by the community. Moreover, the blockchain might be able to process a transaction in just a few seconds, which could obviously lead to further efficiency gains.
Because everyone who’s party to a blockchain-based transaction has a synchronized record of transaction-related activities, you can also think of these technologies as the vending machine of business-to-business transactions. Instead of going to a lawyer or a notary, paying them, and waiting a long time for the document you need, you might simply drop bitcoin into the vending machine (i.e., the blockchain ledger), and your escrow, driver’s license, or whatever you share with the network will drop into your account.
To further streamline transactions, blockchain technology enables “smart contracts,” which simplify the financial reconciliation process. Smart contracts are special rules that can be built into a transaction to create automatic responses to certain outcomes. They can not only define the rules and penalties around an agreement in the same way that a traditional contract does, but also automatically enforce those obligations. Their provisions are converted into bits of code in the blockchain, allowing collateral to be held within the ledger and exchanged automatically between parties upon verification by the appropriate party that the contract’s been executed.
Smart contracts ensure that transactions are carried out correctly in accordance with specified provisions, particularly those involving multiple systems, departments, or companies. Thus, a blockchain-based smart contract can help facilitate negotiations, verify the agreement, and enforce compliance with terms.
For example, consider an options contract that is translated into code in the blockchain. The contract is in the public ledger, although the general public cannot see identifying information on the individual parties nor the details of the contract. When the expiration date and the strike price (the so-called “triggers”) are hit, the contract will execute according to the terms included in the blockchain code. Participants can see and understand the activities in the transactions, while maintaining their privacy.
A blockchain-based transfer has the potential to decrease some fees, saving businesses money. The additional services that third-party organizations often contribute to a transaction can be streamlined or even automated, cutting down on administrative fees.
In addition to improvements in efficiency, the blockchain can boost finance executives’ decision-making. That’s partly because transactions can be posted in minutes, rather than days. Everyone has instant access to information about posted transactions. In addition, CFOs can access a real-time, end-to-end view of transactions through the ledger in a blockchain-based system. This means decision-makers have access to the necessary data every step of the way, allowing them to see and track every liquid movement of capital.
Blockchain technology also streamlines the reporting process, recording transactions simultaneously across all copies of the ledger and eliminating redundancies in recordkeeping. Imagine that all transactions are streamed into the ERP system, with recordkeeping of all transactions in the blockchain. If further analysis is needed, the details get streamed in to reflect the history of the transactions’ audit trail.
This gives finance professionals back some time to focus more on forward-thinking and strategic activities. More strategic and better-informed decision-making might be the ultimate legacy of corporate finance’s shift toward the blockchain.
By integrating the blockchain into a company’s existing automation tools and ERP systems, finance teams can manage transactions under a single umbrella. This connectivity provides the opportunity to analyze the forces behind market trends, enabling CFOs to leverage a variety of advanced analytical capabilities based on truly “big data.” In the treasury function in particular, this helps tremendously to optimize working capital with full insights and foresights into a company’s value chain.
The true potential of blockchain technology lies in its ability to merge with other transformative digital technologies. The blockchain is still in its early stages, but its rudiments—security and transparency, shared with automation—will one day support the digital finance ecosystem through the Internet of Things (IoT), application programming interfaces (APIs), advanced analytics, and more. In fact, many vendors of finance software are now testing the integration of machine learning, big data, analytics, and the blockchain to help companies build a more practical workflow that makes use of the data available to them.
What’s Next for Blockchain Technology
A new survey by Oxford Economics indicates that only 7 percent of finance executives see the blockchain as important to the finance function. While adoption is still in early stages, as with any new technology, early adopters will enjoy first-mover advantages. For example, many early adopters are focusing on the “mass transactions” that currently need a central instance, like payments, contracts, and other areas.
With a framework that allows for the creation of a trusted, publicly available registry to securely log information, blockchain technology provides CFOs the opportunity to tap into the full potential of their digital investments. As the corporate finance function continues to evolve, it is crucial that CFOs gain a strong understanding of the concepts behind blockchain so that they are prepared to embrace it, when the time is right, or risk falling behind their peers.
Henner Schliebs is vice president at SAP. He heads SAP’s Global Finance Audience Marketing as well as S/4HANA and HANA Enterprise Cloud. In this capacity, he is responsible for the success of the full suite of SAP solutions for the office of the CFO and other corporate functions.