Decentralized Finance (or DeFi) is known as one of the most promising movements at this moment. It concerns the ecosystem of financial applications that is being built with blockchain technology. This ecosystem promises a global and open alternative to every current financial service can be developed.

Invoicing is no exception. Invoices encompassed an estimated 550 billion annual volume^[1] of paper and electronic bills in 2019. Electronic invoices are expected to experience a growth of 400% in the coming years. Currently, most invoices are still paper documents, but e-invoicing is becoming more common. It is estimated that by 2030 e-invoicing will replace paper invoices as the predominant form of invoicing (see Figure 1). 

Figure 1 E-invoicing will take over paper invoices & receipts by 2035.   

The financing of invoices has been and still is growing at double digit rates, opening opportunities to parties who have cash available to make a return.

What is Invoice Market? 

Invoice market is a place where invoices can be traded as financial instruments. Invoices are financed by factoring companies, fintech companies, and banks. For now ,we will call those: Originators. At Invoice Market, Originators can sell invoices to Institutional investors. The Institutional Investors can make a return on the invoices and the Originators free capital by distributing the risk off their balance sheet.

Although this might sound complicated, the process is relatively straightforward. Imagine the following:

• Company A, the seller, sells a product or service to Company B, the debtor. 
• Company A creates an invoice to be sent to Company B with a payment term of 60 days.  
• However, Company A needs the money from the invoice to buy material to deliver to another project.  
• Company A can use a financier (usually a bank, factoring company, or fintech company) to get an advance on the payment of the invoice quickly.

This process goes as follows:

1. A seller (Company A) sells a good or service to a debtor (Company B). The seller creates an invoice. 
2. After verification of the invoice of the seller (Company A), the factoring company acquires the invoice in return for financing (usually around 80 to 95% of the total invoice). 
3. The financier now holds the risk of the invoice on their balance sheet and is required to hold capital for that risk. As these costs are high, financiers tend to look to distribute the risk to investors.   
4. Investors buy the invoice and take over the risk of the financier. 
5. When the payment term is due, and the invoice is paid by the debtor (Company B), the financier receives the total value of the invoice. 
6. The platform then distributes the remainder of the invoice to the investors.  

In an invoice market, the invoice plays a particularly significant role. Let’s have a closer look at the invoice.

What is an invoice? 

Although an invoice seems to be a simple document at first, there is more complexity to it than you would expect. An invoice is a so-called ‘document of title’. This means it is a written legal document that verifies ownership of an item. It may also be a written commercial document that allows for the transfer of ownership of products, goods, or another tangible item from one party to another in a transaction.

In other words, it is a document that records transactions between parties and specifies the terms of the deal and payment. It makes the obligations of the buyer clear and tells the buyer what the seller will supply or has supplied.    

The issues 

However, there are several issues with invoices and the way they function in an invoice market. 

First, there is no standard invoice format. Any document that tells what to pay when, to who, and how much, can be seen as an invoice. There is no global consensus on what data is supposed to be on an invoice. E-invoicing seems a promising opportunity for developing standardization, but also here, there is no defined standard. An e-invoice can be a PDF of any sort, formatted in EDI or XML, or via APIs. This makes securitizing non-standardised invoices a challenging job as it is likely that issues with the data and operational processes around the invoices occur.

Second, verification of invoices is cumbersome. Before an invoice can be considered as a secure title document, some verification needs to take place. The buyer needs to be able to fulfil its obligations, and the information on the invoice needs to be correct. If this does not happen securely, unverified invoices can be mistaken for secure titles.

A third issue is double spending. To use invoices as collateral, they are pledged or sold to financiers. As invoices are poorly or not registered in most jurisdictions, they can easily be offered as collateral to multiple parties. Of course, this can happen by accident, but it also increases the risk of fraud. Anyone can issue an invoice, and as this document is not regulated, detecting, and preventing fraud on invoices, is difficult.

Fourthly, manual payments are error prone. Incoming payments to sold invoices can accidentally be booked to the wrong owner of an invoice, mistakes in account numbers can be made, or other human errors can lead to wrongful payments.

The buyer can only fulfil his obligation of payment to the owner the invoice. To prevent operational risk, originators almost always require cash dominion. This means they take control of the payment stream.

Investors can run into various problems as well. Invoices might seem to be a good asset class, as they provide higher yields while being credit insured. But insurance only covers the invoice when the process around the invoice has been followed as agreed in the insurance policy. Factoring companies and Credit management agencies are particularly good at making sure these processes are executing according to policies.   

Benefits of a tokenized invoice market 

However, setting up a so-called ‘Special Purpose Vehicle’ to hold and manage the asset portfolio in a way that they are bankruptcy remote and transparently separated from other assets, is unwieldy. It requires a lot of negotiations and high one-off costs for the setup.

This is where a tokenized invoice market comes in. A tokenized invoice market aims to make invoices widely available to investors as a new asset class and overcome the previously mentioned issues . To accomplish this, invoices must be tokenized and put on a distributed ledger platform, creating a highly scalable and transparent platform. The platforms (such as banks, factoring companies, and fintech companies), are then able to sell invoices on the invoice market as a new asset class.

In short, this is how it works: 

After the platforms have acquired invoices which they want to distribute, the invoices are tokenized, put on a distributed ledger, and added to the wallet of the platform. This token can then be sold to an investor, either as a single asset or as a portfolio of tokens. This entire process is automated with software acting on predetermined criteria or by automated negotiations (via Smart Contracts, for instance).

Figure 2 Traditional securitization vs. tokenized invoices   

By tokenizing invoices on a distributed ledger, all parties can access the same data. Verification can easily be done, as the required information for verification is readily available. This also forces the invoices to adhere to a certain standard, as they are otherwise not accepted by the various parties. This standardization allows for high scalability and easy collaboration across any business network.

Furthermore, when a token moves from one wallet to another, ownership moves with it. This ensures that the previous owner of the token is completely bankruptcy free. It also eliminates the need for Special Purpose Vehicles, saving time and money.

In addition, the technology used in this system automatically keeps track of ownership and status by design. Therefore, it also prevents double-spending issues.

This use-case is developed by a varied group of companies and institutions, coming from legal, regulatory, technology and business sectors.

Figure 3 - ITSA, CMS, PwC, Digital Asset (Daml), Dusk Network, CGI, EuropeChain, Rotterdam School of Management, ABN AMRO 

Curious to learn more or want to participate in this use-case? Feel free to contact us via info@2tokens.org

[1] https://www.billentis.com/The_einvoicing_journey_2019-2025.pdf