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The Basics of Blockchain

May/June 2019

BLOCKCHAIN is often hyped as the future technological backbone of everything. This article is intended to ignore the hype and to serve as a starting point in thinking about how blockchain might impact equipment finance.

The Five Principles of Blockchain

To be called a blockchain, a solution needs to have five characteristics:

  1. Distributed database. Each party to a blockchain has access to the whole database and its complete history.

  2. Peer-to-peer transmission. Communication occurs directly between users. Each user stores and forwards information to all other users of the chain.

  3. Transparency with pseudonymity. Every transaction and its respective value are visible to anyone with access to the chain. Each user has an alphanumeric address that identifies it. Users can choose to remain anonymous or provide proof of their identity to others.

  4. Irreversibility of records and the Agreed Truth. Once transactions or parts of those transactions are put in the database, the records cannot be changed, because they are linked to every transaction record that came before them. Algorithms ensure that records on the database are permanent, chronologically ordered, and available to all others on the network. However, no single party regulates the data or the information. Every party can validate the records of its transaction partners directly. A transaction becomes part of the database only when a majority of users agree. This means the parties to the blockchain are agreeing what is the “truth.” (Note that agreement can be automated. If the input meets pre-defined criteria, the blockchain can be programmed in advance to recognize such input as automatically agreed to.)

  5. Computational logic. Users can set up algorithms and rules that automatically trigger transactions between users. This is sometimes, and confusingly, called a “smart contract.” In reality, it is just software code saying if X happens, then Y happens.


Blocks
You can build your own blockchain using software code to do whatever you want your blockchain to do.




Two Caveats

First, it is important to remember that bitcoin and blockchain are NOT synonymous. Bitcoin uses a blockchain to work. But you can build your own blockchain using software code to do whatever you want your blockchain to do.

Second, it is easy to get lost in the technology. Do you know how email works? Probably not. But it does. Same thing with blockchain. Leave the technology to the experts and focus on how it can help your business.

A Spring-Fed Stream

Blockchain got its name because transactions on it are put into blocks and each block is chained together with other blocks. But I think a more helpful metaphor for equipment finance is a spring-fed stream; the bubbling spring is the decision to acquire equipment, and where the stream empties into a lake is the acquisition of the finance contract by a funder.

As the spring water moves, it starts to collect water from other ground sources. The customer adds some information in the form of financial statements. The credit team adds some details with its analysis and decision. Operations adds some structure with documentation. More is added by the equipment manufacturer. And on it goes until we have our stream.

So now we come to the point where the equipment financier wants to sell the stream. In many situations, the stream has become muddied. The funding source, unable to see the stream bed clearly, discounts what it will pay to cover the uncertainty.

Fortunately, blockchain can prevent the stream from becoming opaque by allowing only approved sources to add only clear water. Let’s talk about how.

Blockchain’s Clear Waters

Let’s go back to the Five Principles and apply them to our metaphor.

  1. Distributed database. In our stream, all the parties involved have access to the stream, just like each party to a blockchain has access to the database. Note that not all parties can necessarily see all parts of the stream. The stream can be designed so that a party only sees what that party needs to see. Also, the stream can be designed so that only clear water (i.e., clear information) can be added.

  2. Peer-to-peer transmission. In a traditional lease stream, the customer would give their financials to the financier, who would then turn them over to the funder if requested. In our metaphor, once the customer’s financials became part of the stream, the funder could see them without the financier needing to forward them. This feature would apply to equipment appraisals, credit analysis or to any input.

  3. Transparency with pseudonymity. While the transparency from per-to-peer transmission would be an important feature of our stream, pseudonymity would likely not be allowed. However, a party’s identity could be masked for blind assignments or if otherwise needed.

  4. Irreversibility of records. A key feature of our equipment finance stream is that once water is added to the stream, that water cannot be altered or removed. When combined with the clear water restriction noted above, it is easy to see how the cloudiness and the resulting uncertainty can be avoided.

  5. Computational logic. This principle is likely the most important feature of our stream. The stream can be designed so that most events can trigger a follow-on event. For example: Completion of a credit review can automatically trigger documentation being sent to the customer; a customer’s electronic execution of the documents can result in setting up an auto-debit from the customer’s bank account; the booking of the transaction can result in it automatically being sold to a funding bank (or automatically put into a pool of other transactions and sold auction-style to the highest bidder). Of course, the above could be achieved without blockchain. We call that process automation. But the difference is that because of all the other principles, the stream will not become muddy and the funders should be willing to offer more for the stream since there is less risk.

Like Anything Else…

Making a blockchain successful in the equipment finance industry will not be easy. Like anything else worthwhile, it will take an investment of time and money. Hopefully, this article has piqued your interest in examining the cost/benefit of such an investment.

Related Resources

For more on blockchain, access these resources:

Blockchain 101 – This article from the Nov/Dec 2018 Equipment Leasing & Finance magazine reports on ELFA members’ awareness of, opinions about and current involvement with blockchain, based on a recent survey. http://bit.ly/2Qy1pgu

New Technologies Video – A comprehensive visualization from the Equipment Leasing & Finance Foundation for how artificial intelligence, blockchain and smart contracts will impact the equipment finance model over the next five years.
http://bit.ly/2PcoZ1i

Three New Technologies Whose Time Has Come in Equipment Finance – This article from the Foundation’s Winter 2018 Journal of Equipment Lease Financing illustrates how both equipment finance companies and their customers will benefit from early adoption of artificial intelligence, blockchain and smart contracts. http://bit.ly/2DSj6FB

Blockchain: Staying Ahead of Tomorrow – This article from the Foundation’s Spring 2017 Journal of Equipment Lease Financing offers an overview of how blockchain works, implementation hurdles, the implications for smart contracts and more. http://bit.ly/2Ni41wm

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  • OPERATIONS & TECHNOLOGY
  • LEGAL RESOURCES