Today’s supply chains are often paper-based operations prone to human error and delays. Consequently, some companies are beginning to invest in digital infrastructure, including blockchain tools, to boost supply chain efficiency and visibility.
One of the benefits of using blockchain for supply chain management is that parties can cooperatively use smart contracts to make, track, and manage payments made in cryptocurrency (also colloquially referred to as ” crypto”). For example, a smart contract can record and log the acceptance of a shipment, triggering a warning message that payment is due to the supplier. A more advanced smart contract implementation allows the smart contract to go beyond sending a message and take the next step to automatically execute the crypto payment.
Use smart contracts to execute payment
Using smart contracts to manage the execution of supply chain contracts and associated payments offers several beneficial features:
Precision
Smart contracts automatically calculate payment amounts, eliminating errors that might otherwise occur. Additionally, a smart contract can calculate payment amounts due to multiple parties for a single transaction almost instantly, regardless of geographic locations or cross-border issues.
Autonomy
Because smart contracts live on the blockchain, they are highly resistant to tampering or manipulation, making them ideal for situations where the parties to a transaction do not know each other well or where one of the parties is operating in an unstable conventional economy.
Efficiency
Using smart contracts to execute payment automatically reduces the need for payment intermediaries and associated fees. This is especially true for cross-border transactions, as the parties making the payment through a smart contract usually use some form of cryptocurrency, which is borderless currency. Payments made by cryptocurrency eliminate the need for currency conversion, which can be costly in terms of fees and fiat currency fluctuation. However, cryptocurrency itself can be quite volatile; in 2021, the value of Bitcoin ranged from a low of $29,000 to a high of $69,000.00.1
Enforcement
Programmers can set up smart contracts to release payment to a vendor upon the occurrence of one or more events (such as verified acceptance of delivery of goods). The smart contract will hold the buyer’s payment until the scheduled release event occurs. If the release event does not occur, the smart contract will send the payment back to the buyer.
Security
The currency used to pay for products or services in a smart contract, whether cryptocurrency or fiat currency, can be included in the smart contract itself. In these cases, there is less opportunity for payment information to be “skimmed” and then misused. When fiat currency is included in the smart contract, the payer’s bank and the receiver’s bank must also be on the blockchain, which is a step avoided when the payment is made by cryptocurrency.
Non-repudiation
A smart contract can verify both the delivery of goods and services, as well as the acceptance of delivered goods and services. This reduces the risk of cancellations and chargebacks.
What is the difference between Crypto Coins and Tokens?
Payers typically make payments through a smart contract in one of two forms of cryptocurrency: coins (like Bitcoin) and tokens.
Blockchain-enabled supply chains can be implemented using coins or tokens and the choice has subtle implications for how smart contract payments work in the supply chain.
Scenario 1 – Parts-Based Supply Chain
In a coin-based supply chain scenario, the payer makes smart contract payments with a blockchain-defined coin. Since cryptocurrency coins have inherent value, a recipient can use the coins received in the same way they would use currency, including exchanging in fiat currency, such as US dollars. To facilitate fiat currency exchange, a coin-based payment structure can use a stablecoin, which is a cryptocoin tied to a selected form of fiat currency, such as the USD coin, which is guaranteed to have a ratio of 1:1 with US Dollars.
Scenario 2 – Token-Based Supply Chain
In a token-based supply chain scenario, the payer makes smart contract payments with a blockchain-defined token used in supply chain transactions. Since tokens have no inherent value, a recipient cannot use the received tokens in the same way as the recipient would use currency. Instead, the beneficiary must use the tokens to secure other services provided by the issuing blockchain ecosystem. For example, in a token-based supply chain, tokens may represent physical goods and possession of a token may entitle the bearer to a “tokenized” item.
Legal Considerations for Using Cryptocurrency
Although payment by cryptocurrency offers many advantages, payment by cryptocurrency also poses legal problems.
U.S. federal income tax treatment
The federal tax treatment of virtual currency is uncertain. In 2014, the IRS advised that for federal income tax purposes, virtual currency, like Bitcoin, is treated as property rather than currency.2 Under these guidelines, receiving virtual currency for payment is treated as receiving cash equal to the fair market value of the property upon receipt. Additionally, if virtual currency is held as a capital asset, the holder may realize capital gains or losses in the currency upon sale.
Securities Laws
William Hinman, Director of the SEC’s Corporate Finance Division, stated on June 14, 2018 that Bitcoin and Ethereum are specifically not securities.3 However, the SEC has not clearly defined when a cryptocurrency is considered “security”. It is therefore unclear whether US securities laws apply to any particular cryptocurrency.
Infrastructure Bill (Public Law No.: 117-58)
Despite strong opposition from the digital currency industry, the infrastructure package signed into law by President Joe Biden in late 2021 has resulted in a series of cryptocurrency tax reporting requirements that will take effect from 2023.4 One of these reporting requirements is that businesses that receive cryptocurrency payments of $10,000 or more must report the identity of the sender to the government, similar to the reporting requirement for cash transactions of the same amount.5
Smart Contracts and Blockchain
Since cryptocurrency transactions are conducted using smart contracts on a blockchain, parties should also be aware of issues related to the legal recognition of smart contracts and blockchain-related contractual terms. See article 6 in this series “Blockchain in Supply Chain” for more information on the legal implications of blockchain in the supply chain.
Despite these uncertainties, cryptocurrency payments via smart contracts could be the key to the success of the 21st supply chains of the century.
1 bitcoin price, Coinbase, (last retrieved November 16, 2021).
2 Notice 2014-21, IRS, (last retrieved November 16, 2021).
3 William Hinman, Digital Asset Transactions: When Howey Meets Gary (Plastic), United States Securities and Exchange Commission (June 14, 2018).
4 Pub. L.117-58; Davison, Laura How Crypto Taxation Was Changed By Biden’s Infrastructure Act, Bloomberg (November 17, 2021).
5 ID.