Blockchain's Killer App? Making Trade Wars Obsolete

Pindar Wong is the chairman of VeriFi (Hong Kong) Ltd and a member of CoinDesk's advisory board. An internet pioneer, he co­founded the first licensed Internet Service Provider in Hong Kong in 1993. 

The following article originally appeared in Consensus Magazine, distributed exclusively to attendees of CoinDesk's Consensus 2018 event.

On Hainan Island, China's Hawaii, in the shadow of sanctions, tit-for-tat tariffs and a looming trade war, China's paramount leader stood up for globalization last month by launching a surprise defense of world trade. Laudable though his position might be, Xi Jinping's bargaining position - and that of Donald Trump - may soon be irrelevant.

A confluence of technologies is poised to dramatically reshape the world of manufacturing and, in the process, render obsolete the existing international trade regime. A few get a lot attention: the rise of 3D printing, the application of internet-of-things (IoT) devices to shipping and logistics, the increasing prevalence of artificial intelligence and machine learning.

But it's blockchain technology, with the capacity it gives to non-trusting parties to transact with each other by relying on a common source of digital truth, that will facilitate this disruption. It provides the enabling platform on which a new dynamic, highly fluid global system for exchanging value will emerge, one that's far outside the purview of the World Trade Organization's current "rules of origin" model.

Trade warriors are fighting yesterday's battles. Instead of pitting their smokestack, 20th-century factories and armies of workers against each other, governments should apply blockchain's 'Don't Trust, Verify' approach to trade arrangements, using it to reduce trade friction and improve cross-border relations to the betterment of their societies.

What might the roadmap look like? That's what an ad hoc group of Hong Kong's leading strategists and business thinkers set out to define when they started meeting privately in late 2016  to explore how to fully digitize trade among the 65-plus countries involved in China's 'Belt and Road Initiative'.

The Belt and Road Blockchain Consortium, as our group came to be known, recognized that as supply chains evolve into highly automated, data-driven ecosystems, they will need the transparency, immutability and accountability that blockchains provide.

Already, large-scale enterprises like Walmart, IBM and Maersk are deep in blockchain-for-supply chain research and a clutch of exciting startups such as  Provenance and Skuchain are building blockchain-based tools for the supply-chain management industry.

But the consortium recognized two important barriers to the widespread adoption of a global blockchain-based trade architecture. The first concerned the desire for legal certainty, and independent verifiability, of unique blockchain identifiers, which are currently often represented as QR (Quick Response) codes. The second concerned the liability and validity of data written to an immutable blockchain, specifically what to do in the case of erroneous - let's call it #FakeData.

We felt the history of the Internet's development offers a useful framework for addressing the question of legal verifiability. We saw that verifying a blockchain address is conceptually similar to resolving cross-border accountability issues with Internet Domain Names, which identified a need for a Blockchain Naming Service (BNS), with common business identity standards to interface with sovereign company registries.

Under this model, if coindesk.com wanted to operate a bitcoin wallet, anyone should be able to verify that a bitcoin address was actually administered by CoinDesk LLC, the U.S. company, and not someone else.

As for the data validity issue, we found that it was useful to borrow some of the thinking behind traditional finance notions of security, specifically the KYC, or know-your-customer concept. The intersection of IoT with blockchains drives a need for hardware integrity, which we call KYM (know your machine).

The need for a mechanism for online dispute resolution (ODR), one that lies outside of the blockchain in question, also became apparent to us. In that case, the blockchain would provide initial evidence to lower the cost of establishing "matters of fact."

Any new, blockchain-based governance system for the Belt and Road community will need a reliable, trusted jurisdictional home. And for that, we highlighted a key role for Hong Kong, with its access to the free and open Internet, its common law heritage, and a business credo of "public governance/private business."

Thus we argued that resolving the 'verifiability and validity' issues could be addressed by developing open standards for online dispute resolution of blockchain identifiers under Hong Kong law, with legal certainty provided by its Electronic Transactions ordinance (Cap 553).

We adopted an open, bottom-up, opt-in approach inspired by the Internet Corporation for Assigned Names and Numbers (ICANN), which successfully managed a similar global policy endeavor for domain names.

Other standards will also need to emerge in related industries to ensure all parties have confidence in the data being shared in a blockchain environment.

Of particular value was the foundation last year of the Global Smart Container Alliance in Shenzhen to drive standards both for smart shipping containers that record and report the ambient state of their cargo and for "E-locks," which are used to electronically seal the container for faster customs and duty clearance.

Since March 2016, E-locks have been successfully used between the customs authorities of Hong Kong and Shenzhen, China's Silicon Valley. By combining legal certainty with cryptographic certainty, the Belt and Road Blockchain will not prevent trade disputes from occurring -  they will -  but when they do the cost and complexity of having them will be dramatically reduced. And that's good for business.

One exciting, highly disruptive outcome of blockchain integration into global manufacturing and trade is the prospect that businesses will move from "push" supply chains to "pull" demand chains.

This is the idea that production will be configured in response to - or pulled by - customer demand rather than pre-configured on anticipation of what customers want and then pushed onto them. More than anything, it is going to make trade spats like that of the U.S. and China redundant.

Blockchains' role in this is to help market participants break up long value chains into shorter ones, with financial exchanges acting as bridges between them. This should result in greater liquidity and enhanced price and market discovery.

I call this "packetizing risk" as the system can automatically dispense fine-grained rewards that can be traced back to the original rights holder based on the presence of appropriate cryptographic evidence.

A model like this could, for example, have allowed businesses waiting on the delivery of goods trapped on the creditor-seized ships of the bankrupt Hanjin Shipping Company in 2016 to liquidate their positions by selling tokenized rights to those immobilized goods.

It's a demonstration of how finance can be unfrozen at intermediate stages along the chain, breaking them up, and facilitating more flexible and efficient means of aggregating the kinds of suppliers that operate in the 'pull-based' Demand Chains used in e-commerce.

Demand chains optimize "made-to-order" manufacturing, and customer fulfillment, to maximize product "variety not volume." To get an idea of how this alters the current logic of trade rules, imagine we are fully immersed in the era of 3D-printing and IoT-driven manufacturing and a footwear maker gets a Request for Quotation (RFQ) for a batch of customized cleats for Brazil's national soccer team that must be rushed in time for next month's World Cup. The cleats might be "Designed In China" - the home of the intellectual property - but "Made in Brazil" by a trustworthy 3D printer somewhere in Rio to produce the product and fulfill this order.

Demand chains are particularly useful when accurate sales forecasts are unavailable and demand is variable. Unfortunately, they are fragile; any unexpected supply disruption risks stopping the whole manufacturing process, leading to dreaded "stock-outs."

By packetizing risk and increasing a  pool of potential KYM-ed suppliers, blockchain may finally enable demand chains to scale beyond their traditional trust limits and challenge traditional long-standing trust relationships.

Demand chains exploit that fact that digital trade dramatically changes cost equations and economics. A key reason why e-commerce thrives is because it is relatively inexpensive to stock digital bits on computers compared with stocking analog atoms in warehouses.

As such, it makes sense to offer an overwhelming variety of products. The assumption is that any logistic complexity can be managed through computerized automation, throwing in more computers and software as needed to scale. More importantly,  products offered can be "pulled" into production only after they have been sold.

There are several commercial benefits to this approach. For suppliers, there's an immediate gain in that they get the money up front. Secondly, because they now know real-time sales demand, they avoid the common "bullwhip effect" problem encountered in traditional "made-to-stock" supply chains. This occurs when errors in forecasting demand are amplified up the supply chain, leading to increased waste the higher upstream you go. With demand chains, suppliers see  "effective demand," not forecasted demand.

One can view demand chains with packetized risk as an evolution of "just-in-time" manufacturing, as they add in the important element of automated "just-in-time" financing. This wouldn't be possible without a blockchain, since it can automatically reward participants without the risk of funds being stolen or unduly withheld.

Another potential benefit: saving the environment. This stems from a rather non-obvious feature of "pull" demand chains and the exchange markets that power them: the concept of "reverse logistics," which covers all operations involved in the return or reuse of products and materials.

One might create an exchange for a product's reuse, recycling or upcycling. Doing so might incentivize the creation of the "circular economy," greatly improving the resource usage with potentially huge environmental benefits. In this model, products are not optimally priced for the point of sale, but for one step beyond the sale -- the point of  reuse.

Taking this idea further, manufacturers might be encouraged to make a market in their own products where it is cheaper to design a product for durability, and buy it back, rather than design for planned obsolescence that externalize the environmental costs.

Since 2017, the Europeans have had a bold plan to kill "planned obsolescence" and encourage products that are end-user serviceable. A blockchain-based model of demand chains, with the added kicker of tokenized incentives, could help them get there.

Cryptocurrency exchanges, which now cover more than 10,000 unique digital assets, can be thought of as providing a market mechanism for pricing intangible property (IP). (Note: I am deliberately applying the acronym "IP" to a wider definition of assets beyond "intellectual property" since most cryptocurrency technology is based on open-source software).

We now have an opportunity to extend this approach to on-demand Industry 4.0 manufacturing technologies such as 3D-printing. Here, the only element that is "shipped" is a digital design, whose provenance can be tracked to the original author of the work using a blockchain (e.g. ascribe.io).

A blockchain might also act as a market, one that functions like an efficient collecting society since the monetization event occurs long after the original creation was made.  With a  blockchain, we can now trace and cascade back any royalties to the appropriate beneficiaries, forging a powerful new way to reward the creative process. MIT researcher Prema Shrikrishna calls this  "IP over IP" (Intellectual Property over the Internet Protocol), where manufacturing "supply" moves adjacent to market "demand."

Thus the very nature of trade changes from shipping tangible property in containers (atoms) to intangible property in packets (bits). This has huge ramifications for the international trade policy regime.

It's unclear how the existing trade rules under the World Trade Organisation's Rules of Origin will apply in such cases or whether countries will strategically hoard raw materials such as rare earth elements.

Given the glacial rate of WTO negotiation rounds, measured in multiple years, it is hard to see how the existing regulatory regime will adapt to a world where manufacturing, trade and retail are "all digital," even less so to a world where smart containers and packages automatically route themselves to their most profitable market.

This emerging paradigm suggests that divergences in manufacturing processes and costs - and the nation-state-led trade wars they trigger - will have decreasing economic relevance, relative to the impact of digital innovation. Already the root cause of labor disruption worldwide, digital automation will have an accelerating impact on people's lives and livelihoods.

The real danger for policymakers lies in not recognizing when a technical innovation is fundamentally changing the underlying architectural assumptions, and brings with it changes in market structure and competitive landscape. Rarely does a bell ring to tell you it's underway. That's what the onset of blockchain technology portends. Governments must have their eyes and ears open.

As for the immediate future, there is certainly a risk of a US-China trade war, with Hong Kong possibly caught in any crossfire. Yet there is also an opportunity for leadership and for a grand bargain between the world's two great trading powers to identify a common interest in establishing new rules for trading in Intangible Property using a global blockchain-based trade architecture.

Of the two outcomes, it's clear to me that a trade war is not only powerless in the face of a dramatically changing economic architecture but even more dangerous than ever to common wellbeing.

So to all you trade warriors ... "Ding Dong!"

Trade war concept image via Shutterstock

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