Smart BoL - Reducing Contractual Enforcement Costs

The shipping industry has to address excess administration. Bills of Lading are paper based and fraught with forgery/fraud. Going digital is not feasible as the digital world is duplicable and the industry has to be able to accept the culture change. Bitcoin however creates the first unique digital file that is non duplicable. Blockchain combined with bills of lading could therefore provide the security needed for the industry to go digital. 

But changing the practices of an industry is hard. In finance, bitcoin presents a existential threat and that innovation by banks using blockchain is possibly a plight for self-preservation. Why? Not because bitcoin is efficient but because it is a working alternative financial system. What of the shipping industry? Will it innovate proactively or react to potentially inevitable disruption?

What else can blockchain do for shipping? We take the view that the biggest value it brings is to automate the enforcement of contractual terms. It is expensive to enforce contracts, it adds bulk to the shipping industry that is passed on to the users. Sometimes contracts are simply unenforceable because it does not make economic sense to expend resources to enforce them. At CoT we see that the role of blockchain combined with IoT can reduce the general cost of shipping contract enforcement. We give a few examples below of how that would work with Smart Contracts. See video here to watch the full speech. 

Bills of lading are legal documents.

They consist of:

 1.    Document of Title to the goods: possession of the Bill of Lading is equal to having title in the referenced goods.
 2.    Receipt: evidence that the Carrier has received the goods of a certain quality in compliance with the Commercial Contract between the parties
 3.    Shipping contract (terms of the carriage): stipulation on how the product be shipped. 

Problems with the current system:

 •    Theft/fraud. Particular issue as BoL is a title document. Possession of the document - prima facie - equals ownership (in the same manner that possession of cash equals ownership from the point of view of bona fide third parties). This incentivises theft of the BoL. Also forgery of a Bill of Lading is a recognised problem.
 •   Excessive administration. Bills of Lading are paper based. For instance BoL is usually presented in triplicate (three physical originals).

If the cause of the problem of excessive administration relates to paper based documents it is logical to say we need to remove the paper. 

Naturally one would think about digitisation as a way to improving administrative efficiency.

However there are a few issues with digitisation: 1) duplication of digital files/ 2) you need the buy-in of the whole industry to go digital.

On duplication we know that the digital world has made copyright enforcement almost impossible. There is nothing actually - apart from the law - stopping from copying or tampering with a digital file.

So if you go digital and end up with increased falsification then you are not remedying the problem of paper based processes - you may be but you creating a different challenge of guaranteeing digital integrity.

One innovation that came with blockchain is the ability to create a digital file that cannot be duplicated or changed.

If you take the words of Eric Schmidt, he said: “Bitcoin is a remarkable cryptographic achievement and the ability to create something that is not duplicable in the digital world has enormous value

So if you were to fuse blockchain technology and Bills of Lading you would expect that a blockchain based BoL would have a non-duplicable characteristic and yet be digital. 

This should surely lead to efficiency gains and maybe potentially a tipping point to help the industry go digital and alleviate itself from these paper based processes.

However we should not underestimate existing industry conventions. The Shipping Industry is not a young industry. It not because a technology is particularly good or efficient that necessarily it will be adopted. 

It takes an industry to come together to decide if it wants to change its ways and conventions.

Oftentimes industries change because of regulation. Other times it comes from the threat of disruption.

With bitcoin - the legacy financial system recognised the threat of a decentralised payment system. 


Not because bitcoin is particularly efficient.

No but because bitcoin operates without the need for a banking system or a card network or for that matter any central administrator for the payment system. 

And it actually works.

Because bitcoin exists and is a real alternative it remains a thorn in the side of the financial system.

This got the financial ecosystem thinking. I suspect part of the innovation and investment by financial institutions into blockchain technology is partly a reaction to the fact that there is now an alternative that doesn’t involve them.

Threat based innovation is hardly a conducive way of innovating.  

But it is having a fantastic effect. 

Who would have thought that over 70 banks have come together to explore how blockchain technology could be used across the whole of the financial industry. 

The question is whether the same will occur within the shipping industry? Let's defer that question till later.

So let’s look more at what blockchain can do.

You see it is not only about creating non-falsifiable digital bills of lading.

That is just the beginning and the tip of the iceberg. 

The real potential for blockchain technology in shipping is to automate contractual obligations. 

To identify how that might be possible we need to acknowledge a new technological trend in shipping which is happening in parallel: IoT.

IoT unquestionably is going to revolutionise shipping. 

In a Cisco/DHL IoT report they mention “end consumers [..] asking for detailed shipment tracking to have transparency in real time” and that business customers are “asking for integrity control especially for sensitive goods”. 

According to Cisco/DHL they “expect IoT to provide the next generation of track and trace: faster, more accurate and predictive”.

We can say that the drivers for IoT and shipping come from the need for increasing monitoring of the shipment and the quality of the goods in transit. 

But what use is there for improving monitoring if there no enforcement?

But what happens when an issue is identified? For instance the shipment is delayed or that it is not stored at a certain temperature. 

That would surely be an indication of breach of contract.

So while you have identified this breach early you can only enforce using the traditional mechanisms for enforcement. 

If you are seeking restitution that has to go through the legal/courts system. 

This means more administration and expense.

Because enforcing your rights costs money people have to make an economic decision when considering enforcement. 

If it costs hundreds of thousands in legal fees, delays, uncertainties on the outcome to enforce a ten thousand dollar shipment - would you enforce your rights? Probably not. 

So part of the inefficiency in shipping is the lack of cost effective enforcement mechanisms.

However, in the same way that IoT makes early detection of contractual breaches easier to spot, blockchain can reduce the cost of enforcing contracts.

We actually postulate that today there is a role for blockchain and IoT combined in shipping contracts: in particular where the costs of enforcement are higher in value than the goods themselves. So low value shipments might be a perfect area to begin experimenting with blockchain and IoT.

Let’s look at how blockchain technology can reduce those costs of enforcement.

Blockchain technology offers the ability to draft what is known as smart contracts.

Smart contracts were invented in the 90’s by Nick Szabo. He referred to them as: a “computerized transaction protocol that executes the terms of a contract.

In essence it is a contract with teeth.

This means that there is no need to rely on the ability of a person to enforce the terms of a contract. The computer code will do it.

If the computer code enforces the terms of the contract then there is not need for the parties in a shipping transaction to trust one another. 

That is why people refer to blockchains as being ‘trustless environments’. There is no need for trust for the system to function. 

That is all well and good but what is available today.

With blockchain technology the tools are available today to write smart contracts.

Now with bitcoin it is designed as a payment system so it has fairly restricted functions. Bitcoin was not initially designed with complex smart contracts in mind.

However, Ethereum (as an example) a newer protocol allows for what is known as Turing Complete coding. It is like going from trying to program a calculator to programming on a computer. 

In other words you can code just about anything as a smart contract. In relation to shipping it is perfectly feasible today in Ethereum to have a smart shipping contract.

Let’s look at an example.

A Carrier would deposit with the contract on Ethereum an amount of cryptocurrency and both parties would agree if the temperature of the container goes above 30 degrees then the smart contract will transfer the amount deposited by the Carrier as a penalty payable to the Seller of the goods. 

When you combine that with IoT the parties would agree that the container would have a sensor device that records temperature. That sensor device relays information to the Smart Shipping contract. 

If the temperature goes above 30 degrees then that would automatically and irreversibly initiate a state change in the Smart Contract. 

The state change would result in the terms of carriage being set to ‘Unacceptable’ (as a status) and the requisite penalty would go to Seller.

In this instance the terms of the contract self-execute.

Just in that example there would be no need for an arbitrator, no need for a court system. Just a piece of computer code signed by the parties, an IoT sensor device, with a cryptocurrency deposit.

Another way of designing the smart contract is to have a Smart Contract where the Smart Contract itself signs the penalty payment to the Seller due to the temperature breach but that an auditor has to countersign before the payment is released. 

In any event these are just simple examples.

As said we expect this technology to be deployed initially for low value contracts where the cost of enforcement of the contract terms is higher than the value of the goods.

But to unleash the potential of blockchain in shipping in the mainstream, it requires the experience, the know-how and the infrastructure of the shipping industry itself to come together to lead these innovations. 

The alternative is to present the opportunity for a real alternative blockchain protocol to emerge -  like bitcoin is a thorn in the side of the financial industry - that will displace a lot of the intermediaries in the existing shipping industry. This would be innovation as a reaction to disruption not a conducive form of innovation. 

In conclusion, we saw above bitcoin shows that a unique file (asset) can be created in a digital world. Taking a bill of lading and combining it with blockchain should imbue a bill of lading with the same untamperable/unduplicable characteristics as bitcoin. This is a good start for completing the digitisation of shipping documents. However, deeper innovation will come from tackling the costs of enforcement of legal contracts in shipping using blockchain based smart contracts. We hope to see the Shipping industry come together to explore these opportunities further.