NFT's Real World Use Case Example: Supply Chain

With the emergence of digital technologies businesses started to heavily rely on databases to facilitate commercial activity. While the latter storage mechanism provides significant advantages over previous paper-based systems, databases also introduced new exposures to information stored in this way. The threat vectors to databases increased exponentially with the introduction of information exchange protocols, and consequent exposure of databases to electronic networks, including the internet.

New types of network architecture (more here) hold the promise of mitigating against these risks, while providing a host of other advantages. The following is a review of the benefits and risks of decentralized software solutions in general, and blockchain-based solutions - such as NFTs - in particular, portrait in the context of key performance indicators of supply chain management using the automotive industry as illustrative example.

Risk Management

The automotive supply chain is an integration of activities from the supplier’s supplier to the end customer through supplier, manufacturing, assembling operation, dealer (including logistics management activities), information and communication technology, and correlated flows of financial transactions. This is followed by coordination and communication among the internal (within organization) and external (outside organization) stakeholders. The commercial viability of each participant depends on its ability and efficiency to navigate and administer a complex network of business relations. Therefore it is necessary to understand supply chain not only as a relation between a supplier and customer, but as an interconnected system, where the quality, cost and risk of a product offered is a function of the performance of the entire network.

The following analysis of the application of decentralized software in general, and blockchain-based solutions (for brevity: BBS) in particular, is divided into four stages: procurement, production, transportation, and warehousing. Within each stage, the analysis will be applied to core KPIs: further divided into financial and technical benefits, identifying and prioritizing the most common risk factors. The following analysis will make use of the prioritization as much as BBS can mitigate against these factors. Of the risks presented, failure of suppliers, lack of information exchange in the chain, supplier does not deliver material, and alterations in production were tied for first place among those with the greatest negative impact on companies studied. Blockchain solves some of the challenges described above.

Blockchains

As with the open-source technologies that delivered the building blocks for the current internet architecture – such as network protocols (TCP/IP, SMTP, FTP, SIP), blockchains provide an ever-increasing list of new protocol-like network architecture designs. As such this outline is best understood as the current state of the technology.

Note: in the context of network technology, blockchains should not be classified as protocols but be understand as business logic engines, making use of network protocols (instructive here Nick Szabo's article The Idea of Smart Contracts).

The term blockchain technology refers to a cryptographic encryption method conceptualized in 1999 - and referenced in the Bitcoin Whitepaper - which links hashed data in a consecutive manner, albeit neither paper actually uses the term 'blockchain'.

By itself, the term blockchain refers to a decentralized, open, network that makes use of this cryptographic implementation to timestamp and secure computation results, syncing honest nodes for the purpose of creating Byzantine Fault Tolerance.

The latter implementation was introduced with the launch of the Bitcoin blockchain and is sometimes also referred to as public blockchain. The decentralization component of blockchains - the fact that anybody may download the open source software and operate a computational node - makes transactions executed in this way difficult to reverse. The necessary collusion by a majority of network participants is unlikely to occur as the resulting distrust in the network would erode the colluding parties’ investment in computing power and/or allocation of virtual assets (stakes) in the blockchain needed for the manipulation to begin with. Because of these features, blockchains are also referred to as "trustless networks," and the transactions (state changes) are considered immutable, a quality which enables peer-to-peer transactions of blockchain-native assets (coins) and digital assets created on a public blockchain via qualified/standardized smart contract (tokens).

Like the web itself, no single operator maintains a blockchain, and anybody is free to participate in the operation of the network. Unlike the internet, which facilitates information transfer, blockchains can also facilitate the transfer of value. Blockchain transactions are usually public and show network addresses which interact; however, they do not reveal any personal identifiable data, or any other information.

Benefits of Blockchains, and Blockchain-based Solutions

Blockchains represent a technological paradigm shift that can best be compared with the emergence of the internet, and later world wide web. As such the benefits for operations, and supply chain can be understood as being derived not from the underlying new network architecture as utilized by blockchain-based solutions as such we will use this term, or its acronym BBS moving forward. The central innovation of blockchains – its decentralized software execution function – enables developers to create self-executing code, often referred to as “smart contracts”. While first generation blockchains such as Bitcoin, required programmers to interact with the complex code structure of the software, second generation networks, such as Ethereum, introduced a programming language and were specifically created to serve as smart contract platforms.

BBS address disadvantages inherent in legacy technology architectures, such as the siloed nature of databases under control of other entities a business may rely on for its operations. The latter dependency not only leads to an opaque flow of information, but will often carry time, policy, and cost constraints, imposed by the third party via inflated prices for services, products, or overt fees.

Frictions introduced by financial service providers into global commerce amount to 6% of global GDP.

Furthermore, as most business interactions are based on legal contracts that determine the deliverables, utilizing a smart contract platform can automate agreement functions without manual intervention by the parties.

Financial Benefits

Procurement and Streamlined Supplier Onboarding

BBS can increase efficiencies, and reduce costs incurred in the process of sourcing and acquiring the goods and services a company needs by
streamlining supplier onboarding. A recent study by Accenture showed that inaccurate supplier onboarding data, such as mistakes in product order forms, inaccurate measurements and quantities, and incomplete risk assessment costs businesses about $15 million every year. BBS enable all participants in the supply chain to access the same immutable record on the ledger reducing – and potentially eliminating discrepancies - in information flow between parties.

Chainyard, a blockchain consulting and tech firm, claims that blockchain’s trusted source of supplier information can: reduce administrative costs by 50%, eliminate up to 90% of repetition and redundancy, and make the process of onboarding new suppliers 70-90% faster. BBS can help decrease suppliers’ cycle time, and as a result decrease the total time it takes from receiving an order to delivering an item (lead time). Without BBS, new supplier onboarding is a time-consuming, manual experience for both buyers and sellers in a supply chain. Blockchain supply chain solutions can speed this process through an immutable record of new vendor details that business network participants can trust.

Production

BBS can drastically reduce production cost by reliably recording and pinpointing errors in production systems. While many manufacturers may turn out fungible products, new BBS standards enable tagging these physically interchangeable products with digitally non-fungible signatures reflected in simple real-world implementations – i.e. QR, and barcodes. Employing these solutions in automotive supply-chains will allow a manufacturer to single out specific car doors etc. with defects related to a
specified roll of sheet-metal. A study by AlixPartners estimates the cost of
recalling just one item at $8M. In 2018 alone, recalls cost the automotive
industry $22.1B. Downstream effects would include the recall of a limited number of vehicles in cases where non-BBS solutions might need to recall all vehicles of a certain built, potentially saving an entire product line from being unprofitable for the manufacturer.

Transportation

The average vehicle has around 30,000 individual parts. Each of those parts is either manufactured in-house or sourced from a third-party provider. A delay in just one section of the supply chain can slow down the
manufacture and distribution of critical components, resulting in the
production line getting shut down. As automobile builders and brands move towards just-in-time manufacturing, any impact on the smooth construction and distribution of vehicles means inventory shortages and revenue loss.

BBS can provide transparency into transportation related costs, and the correlations between them. Examples for these are mileage-based insurance products in which company owners may choose to pay mostly for the actual usage of a vehicle. This will enable more granular cost controls especially for vehicles employed for seasonal purposes.

BBS allows for the representation of real-world objects such as materials and products on the blockchain in a digital form such as a token and gives them a digital identity that can be thought of as the real-world object’s ‘digital twin’. The concept allows for the real-world metadata about the object, such as its identity, current physical location, responsible party, possession, container temperature, and other metrics, to be attached to this digital twin in order to yield useful insights about the condition of this objects in the real world, and updated as conditions change (via time-stamping to the geolocation of a transported good),which presents an accurate and timely view of the physical object to all involved parties helping the detection of lost, stolen, and counterfeit goods and materials. Hence, assigning responsibility indisputable to a party.

An essential KPIs within transportation is Delivery in Full (DIF), Delivery-on-Time, and Damage-Free Delivery. Since BBS allows the recording of transportation related metadata visibly and auditable to all participants, including the potential recipient, incomplete delivery can be detected even before arrival. As such, it reduces receiving control procedures.

Warehousing

Warehousing is often one of the largest expenses a manufacturing company has. Because of this, inaccurate inventory can have the biggest impact on a company’s profitability. Unlike database solutions, BBS are not susceptible to common user-entry errors such as duplication or deletion of data. Inventory that is recorded as blockchain entry as moved in or out of the warehouse can only digitally exist in one place, and under control of the true owner of the item, as the digital record and access to it (“private key”) moves with the physical item.

The automotive industry could use a BBS to keep both an accurate record of inventory and trace/verify parts throughout their warehouses. For example, the BBS captures, stores, and updates information on vehicle parts including spare parts. Additionally, it removes the element of human error in activities like physical inventory counting/cycle counting.

Technical Benefits

Resiliency

As widely documented in the recent COVID pandemic, one unexpected event can cause a cascading array of supply chain disruptions. Automotive supply chains must be resilient to change, stress, criticism, and adversity as they digitally transform. The decentralized nature of BBS makes these networks more resilient than database solutions. The latter will frequently have a single point of failure potential, such as one company maintaining the software, or reliance on just one cloud provider. BBS also utilizes secure smart contracts that automatically trigger when pre-defined business conditions are met and are not dependent on a single source. This gives near real-time visibility into operations and the ability to act earlier, should there be an exception. Furthermore, these contracts are
structured through a computer program and can allow companies in the automobile industry to forgo the need of trusted intermediators, enforcements costs, fraud losses, and malicious and accidental exceptions. BBS can be another effective strategy to increase resiliency in addition to established strategies that involve risk pooling such as multi-sourcing, nearshoring, partnerships, inventory and capacity buffers, manufacturing network diversification, and platform, product, or plant harmonization.

Data Security

Not only is this data analyzed so that self-driving algorithms can be improved, but it also may contain information regarding privacy, ownership, cybersecurity, and public safety. Tesla has collected billions of miles of autopilot data, developed business processes to store this information, and created new supply chain relationships to obtain new components and services. However, their databases are highly vulnerable to security breaches due to their centralized nature with several points of entries – mainly manipulation of operators (“social engineering”). Eliminating the middleman and human error already reduces half of all reported data breaches. Public blockchains have a lower attack surface than database solutions, as all recorded data is continuously encrypted with ever increasing difficulty, and hacking a single user only enables the hacker to access the limited data under that user’s information (i.e. the risk
of a systemic catastrophe significantly decreases when data is distributed
through block hashes.) This means that nobody, neither an OEM nor a hacker, can tamper with such a set-up. Blockchain technology also satisfies the public’s overwhelming desire to not store unencrypted private data anywhere in the public domain. While this list is far from exhaustive, some of the more common database security vulnerabilities include deployment failures, broken databases, data leaks, stolen database backups, and abusing database features. Often, databases and business processes are not fully tested leading to opportunities for data to be stolen. Furthermore, the actual car may be hacked allowing hackers access to even more personal data. As a result, the automotive industry and/or its partners are exposed to high costs for repairing breaches, mass recalls, notifying customers, fines and penalties for non-compliance, and damage to brand reputation. In 2015, Chrysler issued a recall of 1.4 million vehicles to address the vulnerability to hackers and total automotive recalls in 2016, costing the company $22 billion.

Supply Chain Transparency

BBS can provide granular transparency to transactional data without the need to create complex user access systems (i.e. a supplier can instantly see that a payment was performed without the need to involve a financial service provider.) This type of “programmable money” is likely to become commonplace within the next ten years, as many countries are currently
experimenting with ‘central bank digital currencies’ which will have the same qualities as cash payment (i.e. instant settlement). All digital payment systems have the settlement risk priced in at a minimum of 1%. As such, at any given point in time billions within the economy can be exposed to a settlement risk. BBS can facilitate instant settlement.

BBS would play an integral role in and be an integral component of emerging supply chain solutions. A shared distributed ledger, track-and-trace accuracy and scale are more robust, optimizing automotive supply chain functionality. In every supply chain, there are inbound logistics and outbound distribution. Specifically, in the automotive supply chain,
manufacturers must coordinate with multiple suppliers and third-party logistics and transportation companies to source parts. A BBS will facilitate access to a transparent network. Using this network, all parties will have an end-to-end view of a parts location, quantity, and other useful information. This arrangement will afford manufacturers more significant insight into their production schedules, while also improving part traceability and inventory requirements. Suppliers will also be able to optimize their inventory levels resulting in lower warehousing costs and fewer erroneous orders.

To ship completed vehicles, manufacturers must also work effectively with several third-party logistics, rail, shipping, and trucking companies to ensure the timely delivery of new cars to global importers and dealer groups. A BBS will establish a transparent, permissioned network for manufacturers, importers, and dealer groups. This network will facilitate
access to crucial information such as the vehicle’s location and status,
inherently improving logistical oversight while reducing the potential for
losses or damage. As a result, importers, dealer groups, and other bulk vehicle purchasers will see shorter lead times for build-to-stock and build-to-order vehicles. These savings can then be passed on to end consumers, lowering the upfront cost of car ownership.

In implementing a BBS, all stakeholders will extract greater value. From parts suppliers to end consumers, blockchain provides a level of insights
never before seen. With a robust growth forecast to continue well into the
future, producers can assume that even greater application innovation is on the horizon.

Blockchain will support the global movement and tracking of $2 trillion of goods and services every year.

Data Integrity

Data integrity is one of the largest problems in current day database architecture. Frequently, companies must incur costs and time delays related to ‘deduplication’, and ‘parsing’ of legacy database exports. BBS ensures data integrity via tamperproof, time-stamped records with strict permission management.

BBS function of connecting multiple chains to digitized products or parts used in manufacturing helps to resolve supply-chain integrity issues, such as backdoor goods, counterfeit goods, parallel imports. By storing data across a BBS network, the blockchain eliminates the risks that come with
data being held centrally. Ultimately, BBS technology can enhance overall
cybersecurity for vehicles, validate software bills of materials, enable secure micropayments, strengthen identity management, and improve data validation.

Risks in implementing blockchain-based solutions

Untested

As with all new technologies, BBS are still in early development stages, and as such have inherent risks related to risks yet unknown to providers of the solution.

Transaction Speed

While several BBS promises performances equaling those of databases, public blockchains are inherently a shared resource, and several blockchains, such as Ethereum, continue to show congestion when popular applications are being launched on the network.

Interoperability

There are a number of different blockchain developments using various forms of programming languages and standards. While Ethereum, in particular, is supported by the largest developer base, these do not necessarily support enterprise developments such as developments by IBM and R3.

Smart Contracts Risks

Smart contracts can potentially encode complex business, financial, and legal arrangements on the blockchain, and could result in the risk associated with the one-to-one mapping of these arrangements from the physical to the digital framework.

Conclusion

BBS addresses many of the challenges introduced into the supply chain by utilization of legacy technologies, specifically database architecture. The secure sharing of data between parties operating in concert within a given supply chain enables one “single-source of truth” and mitigates against duplication or deletion of records which historically have been the source of delays and miscommunication between parties interacting within the
supply chain network. Furthermore, blockchain based smart contracts enable the automated execution of business processes increasing efficiencies of commercial coordination. Lastly, emerging blockchain based standardization protocols allow for the first time to create digitally non fungible items which can be correlated to physical world items, enabling targeted addressing of faulty products and/or responsible parties.

Note: some of the data was derived from this Gartner Report.