Researchers have demonstrated a new tool to improve the security of small-scale business transactions with the goal of helping ensure that businesses are paid and customers get what they pay for. The tool, which relies on blockchain-powered smart contracts, essentially serves the same function that letters of credit provide for large companies.
A key idea here is the “letter of credit,” which is a letter from a financial institution guaranteeing that a seller will receive payment from the buyer in full and at a specific time, provided that the seller meets the contract specifications. The financial institution effectively backs the transaction, so that the seller can feel secure in making the transaction. Letters of credit are widely used in international transactions between large organizations, but are not generally available to small businesses or the public.
“The service provided by letters of credit would also be tremendously valuable for small businesses and everyday people who don’t currently have access to that type of financial service,” says Brandon McConnell, co-author of two papers on the work and an associate research professor in North Carolina State University’s Edward P. Fitts Department of Industrial and Systems Engineering. “For example, if a contractor takes a job from a homeowner, it would be useful for there to be an established way – outside of the courts – for the contractor to ensure they are paid and for the homeowner to ensure the work is done.
“Our goal here was to develop and demonstrate a proof of concept for how blockchain technology could be used in the same capacity as a letter of credit for transactions on a small scale. People have explored this idea for large-scale, international transactions; we wanted to make something that would work at a practical level for everyday people.”
The new tool relies on smart contracts, which make use of blockchain technologies and execute the terms of a specific agreement when a defined set of conditions are met. Specifically, the new tool consists of multiple smart contracts, each of which oversees a different aspect of the client-contractor agreement. At a baseline, the tool would include smart contracts that cover the scope of the work to be done, payment for the work and completion of every milestone of the job. But additional smart contracts can be incorporated into the tool depending on the complexity of the work, whether arbitration is necessary, and so on.
Here’s how it works.
“If a client wants a service performed for an agreed-upon price, the client would have to demonstrate that they have the funds to pay that price,” McConnell says. “The tool may also require that contractors meet requirements, such as proof of licensure, proof of insurance, etc. Once both parties have signed on to the agreement, it would be recorded on the blockchain – meaning there would be a clear record of what both parties agreed to, and that both parties had the wherewithal to meet the obligations of the contract. Then, if the contractor performs the service, the terms of the relevant smart contracts would be met and the funds would be released to the contractor.
“This example is pretty straightforward, but we also outline mechanisms that can be used to address situations where either the client or the contractor does not meet the terms of the agreement. For example, how can smart contract technology help a client who is dealing with an unresponsive contractor who has not completed all work milestones to standard?”
The researchers conducted proof-of-concept testing to demonstrate that the tool works and is capable of handling unexpected challenges.
“We think this technology has practical utility for a host of small businesses and other users, and we are open to working with interested parties who would like to develop it further,” says McConnell.
“This concept is ideal for something like a small-scale general contracting job, where lack of previous information and distrust may provide opportunities for one party to take advantage of the other,” says Lieutenant Colonel Mat Fukuzawa, who is lead author on both papers. “While services like Angi and Frontdoor already exist, they do not guarantee that all parties honor their commitments.
“Litigation and forced arbitration remain the standards for settling civil issues such as this one in a general contracting scenario, which tend to add significant costs external to the job itself,” says Fukuzawa, a former Ph.D. student at NC State who is now an assistant professor of mathematical sciences at the U.S. Military Academy at West Point. “Our idea proposes that this scenario can be captured in one tool or process and at a lower cost.”
The two papers, “Implementing A Letter of Credit Style Business Process for Small-Scale Contracting Using Smart Contracts” and “Mechanisms for Dealing With the Unexpected in Small-Scale Contracting Using Smart Contracts,” are both published open access in the journal Transactions on Computer Science and Applications. The papers were co-authored by Michael Kay, an associate professor in the Edward P. Fitts Department of Industrial and Systems Engineering; Kristin Thoney-Barletta, a professor of textile and apparel, technology and management in NC State’s Wilson College of Textiles; and Donald Warsing, an associate professor of operations and supply chain management in NC State’s Poole College of Management.