Published on October 28th, 2018 | by Michael Barnard0
Smart Contract Business Drivers: Multiplying Parties, Default Costs, & Penalty Clauses (Blockchain Report Excerpt)
October 28th, 2018 by Michael Barnard
Along with our regular daily clean tech news coverage, CleanTechnica also produces in-depth reports on various aspects of clean energy and clean transport. One of the emerging technologies we cover that isn’t directly a clean tech innovation is blockchain, which promises to be a catalyst for innovation in the green economy in the very near future. Blockchain is probably most widely known to the public as “having something to do with cryptocurrency and Bitcoin, right?,” which is partially correct, but the technology itself has a wide range of applications, some of which will be crucial in the fields of distributed renewable energy, grid management and energy storage, and smart contracts, among others.
The full report Blockchain – An Innovation Enabler for Clean Technology, which was published in July, is a deep dive into blockchain and its potential, and we will be posting more excerpts from the report over the coming weeks. (Read the last installment here.)
1. Herstatt risk due to currency volatility
2. Time value of money
3. Speed of transactions
4. Cost of transactions
5. Accounts receivable and default costs
6. Penalty clauses
7. Multiplying parties
8. Trusted contract writers
9. Bad contracts
This article is the latest in a series which digs into each of these 9 factors.
One of the purported advantages of smart contracts, including a third party such as a delivery organization in a contract, is actually an added complexity. Anything which involves multiplying parties to a contract increases its complexity, as is true with any solution to a problem. One of the original English formulations of Occam’s Razor was do not multiply entities without necessity. Three-party arrangements today typically involve one contract between two of the parties and a different contract between two of the other parties, not one contract between the three parties. One organization takes on the costs and risks of one of the parties, such as the delivery organization, and includes them in their price either explicitly or implicitly.
Every services contract I’ve negotiated has included only a service organization and a customer, and those contracts have often been worth millions of dollars. This is the most common pattern, and the value proposition of adding additional entities is unclear in most cases.
Tri-party agreements are relatively common in the construction industry, but less common elsewhere, and those tri-party agreements are in aid of financing and not escrow agreements with virtual currencies.
Accounts receivable and default costs
Accounts receivable and default costs are a strong advantage of smart contracts for the seller and no direct advantage to the buyer.
Net 30 contracts involve an invoice being generated by seller and being sent to the buyer. If the buyer doesn’t pay, the seller has to dun them for the money. If they continue not to pay, the seller has to take the buyer to small claims or civil court to try to exact payment.
Escrow contracts by definition protect the seller, not the buyer. All of the buyer’s money is in escrow, not the seller’s. The seller is guaranteed payment and the buyer has no ability to default except in the case of the seller not meeting the smart contract’s conditions. There is no need for any civil action by the seller against the buyer with any decently structured smart contract.
Penalty clauses are one place the buyer starts to see an advantage. If a buyer needs a good or service at a particular time in a particular location or its value starts going down, a smart contract can be very useful for them. The obvious analogy is to many pizza parlors’ promise of 30 minutes or free. Pizzas that can be free if late, of course, are likely to be too inexpensive to warrant the contracting costs. But imagine a supply chain smart contract requiring delivery of a product to a construction or manufacturing site on a just-in-time basis.
The buyer of just-in-time goods has distinct downsides to late and early delivery. They have to put early deliveries into inventory and then take them out again, incurring costs which impact profits. They have to slow or halt their construction or manufacturing if the goods they need are late, which in turn impacts their delivery and their cash flow.
A smart contract which had clauses that penalized either early or late delivery automatically would be advantageous. No need to worry about adjustments or negotiations of penalties or getting into lawsuits. The penalties would be automatically incurred upon delivery. In some business models, this factor alone could make it worth a buyer’s time. And since so many of the benefits are in the seller’s interest, they’ll be amenable too.
Stay tuned for more excerpts from Blockchain – An Innovation Enabler for Clean Technology, or view the summary and request the full report at https://products.cleantechnica.com/reports/