POST Blockchains and supply chains

Listening to Manuela Saragosa's interesting BBC Business Daily episode about “fraud in the food chain” (I wouldn’t listen to it while you are eating, incidentally) I was reminded how long and complex the supply chains are in the food industry. That’s great for producers and consumers, but it has risks. How do you trust the food that ends up on your plate? How can you tell, to give one of the examples used in the episode (which included an interview with Jesse Baker of Provenance) that your tuna is sustainable?

Fortunately, the blockchain is going to fix this problem. As Michael Casey and his co-author Pindar Wong explained in their Harvard Business Review piece on this topic last year, blockchain technology allows computers from different organisations to collaborate and validate entries in a blockchain. This removes the need for error prone reconciliation between the different organisation’s internal records and therefore allows stakeholders better and timelier visibility of overall activity. The idea discussed in this HBR piece (and elsewhere) is that some combination of “smart contracts” and tagging and tracing will mean that supply chains become somehow more efficient and more cost-effective.

(I put “smart contracts” in quotes because, of course, they are not actually contracts. Or smart. Bill Maurer and DuPont nailed this long ago in their superb 2015 King’s Review article on Ledgers and Law in the Blockchain, where they note that smart contracts are actually computer programs and so strictly speaking just an “automaticity” on the ledger. Indeed, they go on to quote Ethereum architect Vitalik Buterin saying that “I now regret calling the objects in Ethereum ‘contracts’ as you’re meant to think of them as arbitrary programs and not smart contracts specifically”.) 

Anyway, using the blockchain and “smart contracts” to fix the problems of food chain fraud sounds like an excellent idea and there’s no doubt that supply chain participants are taking this line of thinking pretty seriously.

 

What’s in the Blocks? 

 

But while I was listening to the show, I couldn’t help but wonder exactly how the these exciting technologies will fix those problems. What, in other words, will be in the blocks? I tried to think this through a couple of years ago by applying the ideas to my favourite supply chain fraud, the famous case of the vegetable oil that almost bankrupted American Express (and went some way toward making Warren Buffet a multi-billionaire).

 

If you are not familiar with salad oil story, the essence is that a conman, Anthony “Tino” De Angelis, discovered that people would lend him money on the basis of commodities in the supply chain. His chosen commodity was vegetable oil (see How The Salad Oil Swindle Of 1963 Nearly Crippled The NYSE). Amex had a division that made loans to businesses using inventories as collateral. They gave De Angelis financing for vegetable oil and he took the Amex receipts to a broker who discounted them for cash. So he had tanks of vegetable oil and Amex had loaned him money against the value of the oil in those tanks, the idea being that they would get the money back with a bit extra when the oil was sold on. Now as it happened, the tanks didn’t much contain oil at all. Tino had filled them up with water and put a layer of oil on the top, so that when the inspectors opened the tanks and looked inside they saw oil and signed off whatever documentation was required. Eventually the whole scam blew up and nearly took Amex down, enabling the sage of Omaha to buy up their stock and make a fortune.

 

So. How would the blockchain have fixed this salad oil problem? Blockchain technology is only “trustless” insofar as it relate to assets on the blockchain itself. As soon as the blockchain has to be connected to some real-world asset, like vegetable oil, then it is inevitable that someone has to trust a third-party to make that connection, whether that third party is a Calcutta DNA laboratory or a New York salad oil inspector or an Indonesian tuna canning factory.

 

(This, incidentally, why I think that tokens linked to real-world assets by regulated institutions are the future of trading.)

 

This need for trust, however, takes us back to square one. As Manuela asks in the BBC programme, how can you trust the people entering the data? Consider another of my favourite scandals, the horsemeat scandal that swept Europe on the 50th anniversary of the salad oil scandal. Basically horsemeat was being mixed with beef in the supply chain and then sold on to the suppliers of major supermarkets in, for example, the UK. One of the traders involved was sentenced to jail for forging labels on 330 tonnes of meat as being 100% beef when they were not. Once again, I am curious to know how a blockchain would have helped the situation since the enterprising Eastern European equine entrepreneur would simply have digitally-signed that the consignment of donkey dongs were Polish dogs and no-one would have been any the wiser. It is not clear how a fintech solution based on blockchains and smart contracts would have helped, other than to make the frauds propagate more quickly.

I understand that Walmart have carried out some sort of pilot with IBM to try to track pork from China to the US. But if someone has signed a certificate to say that the ethically-reared pork is actually tuna, or whatever, how is the shared ledger going to know any different? A smart contract that pays the Chinese supplier when the refrigerated pork arrives in a US warehouse, as detected by RFID tags and such like, has no idea whether the slabs in the freezer are pork or platypus.

If you do discover platypus in your chow mein, then I suppose you could argue that the blockchain provides an immutable record that will enable you to track back along the supply chain to find out where it came from. But how will you know when or where the switcheroo took place? Some of the representations of the blockchain’s powers are frankly incredible but, as Jesse notes in the show, the blockchain is stupid. It doesn’t know who switched it and it can’t tell you.

So if the blockchain is so dumb, why bother with it?

So is there any point in considering a form of shared ledger technology for this kind of supply chain application? Let’s go back to the first example, the great vegetable oil swindle.  Had American Express and other stakeholders had access to a shared ledger that recorded the volumes of vegetable oil being used as collateral then, as it happens, fraud would have been easily discovered. 

“If American Express had done their homework, they would have realized that De Angelis’s reported vegetable oil ‘holdings’ were greater than the inventories of the entire United States as reported by the Department of Agriculture. “

via How The Salad Oil Swindle Of 1963 Nearly Crippled The NYSE

Interesting. So if the amounts of vegetable oil had been gathered together in one place, the fraud would have been noticed. What could that one place be? A federation of credit provider’s databases? A shared service operated by the regulator? Some utility funded by industry stakeholders? How would they work?

 

Now we can see where the shared ledger might come in. What if the stakeholders instead of paying some third party to run such a utility used a shared ledger? It would be as if each market participant and regulator had a gateway computer to a central utility except that there would be no central utility. The gateways would talk to each other and if one of them failed for any reason it would have no impact on the others. That sounds like an idea to explore further.

How might such a ledger might operate? Would American Express want a rival to know how much vegetable oil it had on its books? Would it want anyone to know? The Bank of Canada, in their discussion of lessons learned from their first blockchain project, said that “in an actual production system, trade-offs will need to be resolved between how widely data and transactions are verified by members of the system, and how widely information is shared”. In other words, we have to think very carefully about what information we put in a shared ledger and who is allowed to say whether that information is valid or not.

It is clear from this description that a workable solution rests on what Casey and Wong call “partial transparency”. I agree, and I borrowed the term translucency from Peter Wagner for the concept, as set in the paper that I co-authored with my then-colleague Salome Parulava and the R3 CTO Richard Brown -- Towards ambient accountability in financial services: shared ledgers, translucent transactions and the legacy of the great financial crisis. Journal of Payment Strategy and Systems 10(2): 118-131 (2016).

As you might deduce from the title of that paper, we co-opted the architectural term “ambient accountability” to describe the combination of practical Byazantine fault tolerance consensus protocols and replicated incorruptible data structures (together forming “shared ledger” technology) to deliver a transactional environment with translucency.  As Anthony Lewis, also from R3, described in an insightful piece on this new environment, it is much simpler to operate and regulate markets that are built from such structures because the cross-sector reconciliation comes as part of the fact recording; not after. Organisations can “confirm as they go“, rather than recording something, then checking it afterwards or having auditors check it downstream.

Luckily, there are cryptographic techniques such homomorphic encryption and “Zero Knowledge Proofs” (ZKPs) that can deliver the apparently paradoxical functionality of allowing observers to check that ledger entries are correct without revealing their contents and these, together with other well-known cryptographic techniques, are what allow us to create a whole new and surprising solution to the problem of the integrity of private information in a public space.

In this way the traditional disciplines of accounting and auditing are dissolved, re-combined and embedded in the environment. Smart contracts wouldn’t have disrupted Tino’s business, but ambient accountability would have uncovered his plot at a much earlier stage, when the near real-time computation of encrypted vegetable oil inventories would have delivered the data to end his dastardly plot.

It is far from clear to me whether “blockchain” solutions to the supply chain problem, or any other problem for that matter, will be cheaper or quicker than than the database alternatives. On the other hand, the introduction of new (and in some cases counterintuitive) forms of transparency may well improve the operation of complex supply chains to the great benefit of society as whole.