Blockchain Arbitration for Modern Supply Chains
Written by Marianna Riabova, PhD student at Institute of Engineering and Management Univ. Grenoble Alpes
Not so long-ago Supply Chains (SC) were considered very basic linear systems that communicate through a network of binary relationships between suppliers and customers. Although this viewpoint was true in the past, modern supply chains are becoming increasingly complex and dynamic and act as a link between numerous network participants.
The increased complexity of supply networks entailed certain challenges for the Supply Chain Management , :
- Decreased SC transparency and traceability: As the number of supply chain participants increases, it gets harder to trace the products from suppliers to final customers and all the parties face significant visibility issues.
- Lack of SC security: In recent years Supply Chains are facing the increased number of cyberattacks and data frauds, which can cause cargo thefts and mass production of fake goods that can be dangerous for people’s health.
- Lack of trust among SC partners: The visibility and security problems inevitably reduce the level of trust among SC participants, which, in its turn, prevents the proper information sharing and negatively influences parties’ intention to collaborate.
- Increased number of disputes: Supply Chains are nowadays facing an ever-growing number of disputes that can arise at any point of the supply chain due to uncertainties in contract management, goods delivery not in-full or not in-time, damages of the products during transportation etc.
As Supply Chains are very competitive, SC specialists and researchers are always looking for the best solutionы to existing problems.
2. Blockchain and Smart Contracts in Supply Chains
One of the solutions that got particularly much attention in recent years is blockchain technology. Blockchains, which were introduced by Nakamoto in 2008, are decentralized ledgers that facilitate transactions’ recording and assets’ tracking in a business network. Blockchain technology can be defined by the following important characteristics , :
- Immutable: As soon as transactions are added to the blockchain, they cannot be modified.
- Open and transparent: As blockchains are distributed ledgers, all network participants have access to the same records.
- Consensus driven approach: Data is exchanged with all network participants. Each participant in the distributed network keeps a copy of the ledger, which is updated and approved at the same time.
- Safe: All blockchain additions are regulated by stable algorithms that employ public key encryption.
- Time stamped: All network transactions are time stamped, providing a built-in audit trail for all additions.
In addition, blockchain allows for Smart Contracts’ integration. Smart Contracts, that were first introduced by Nick Szabo in 1996, in contrast to conventional contracts, ignore the legal model. Instead of preparing complex legalese-filled documents, parties use technology to draft agreements in code. Parties do not need to be concerned about facing the ineffectiveness of a lawsuit or fighting for payments as soon as the conditions and enforcement are already predefined by computer code per “if/then” rules.
These technology features make blockchain and Smart Contracts a possible solution to modern Supply Chain challenges , :
- Blockchain enables SC visibility. Thanks to its distributed and decentralized nature, blockchains provide full information visibility. SC participants can easily verify the transactions recorded and follow how products move.
- Blockchain technology can become an answer to SC security challenge. Decentralization renders data manipulation impossible and cryptographic encryption assures data security and prevents data modifications without permission.
- Blockchain can add more trust to the Supply Chain: The visibility and security of the transaction guaranteed by blockchain increases trust among the network participants. So blockchain can literally create an ecosystem where parties fully trust each other and transact directly without any third parties.
- Blockchain can eliminate SC disputes: Blockchain technology can significantly lower the possibility of a dispute thanks to the ability to register transactions transparently and in real-time. In addition, a Smart Contract built on the top of blockchain can immediately cause penalties when pre-set terms are violated, making traditional dispute resolution a thing from the past.
3. Blockchain Arbitration as a dispute resolution method
Despite all these advantages blockchain and Smart Contracts are not flawless, and the adoption and usage of these technologies can still cause disputes. Disputes that arise in Supply Chains are usually dangerous for the participants as they negatively influence company’s profit, inventory, reputation, and goodwill. What is more, if not properly handled, Supply Chain disputes can destroy trust among partners, hinder future collaboration and jeopardize the overall continuous operation of the whole chain. Consequently, Supply Chain disputes must be addressed efficiently to avoid negative financial, operational and liability implications for all the parties involved .
As blockchain and Smart Contracts are innovative technologies, disputes related to these technologies are also a new phenomenon. Existing dispute resolution methods are not fully suitable for resolving disputes arising in a global decentralized environment, which creates a certain regulatory lacuna for blockchain and Smart Contract users .
Blockchain Arbitration appeared as an answer to the existing regulatory gap. As Smart Contracts cannot be fully independent in case a dispute arises, the parties can secure themselves and encode an arbitration clause into the Smart Contract. In case of a dispute, parties can trigger an arbitration clause and send the claim to the Blockchain Arbitration platform. Currently, there are several projects offering Blockchain Arbitration, but the 2 most promising are Kleros and Jur platforms.
Kleros is an Ethereum-based arbitration platform that combines “crowdsourcing, blockchain technologies and game theory”. To trigger the Kleros procedure, the parties have to pre-select Kleros as a conflict resolution platform in their smart contract. Arbitrators (jurors) are selected randomly, but the likelihood of being drawn as an arbitrator is proportional to the number of tokens an arbitrator stakes. Jurors evaluate the evidence presented by the parties and then decide based on the options offered by the smart contract. Jurors’ behavior is coordinated by the game theory, more precisely Schelling Point mechanism, so that coherent voting with others is a desired behavior. If parties are dissatisfied with the decision made, they can appeal .
Jur functions very similarly to Kleros. Jur focuses on enterprise use cases and aims at covering a wide range of disputes through three different dispute resolution layers. The first is the Court Layer which is comparable to a standard ODR system with traditional arbitrators and can generate decisions that are legally binding. The second layer is the Open Layer that proposes a collective intelligence decision-making solution. The last layer is Community Layer which provides a sort of a private court with certain rules that were determined by the creators .
4. Advantages and challenges of Blockchain Arbitration
Blockchain technology can bring certain advantages to the arbitration process , :
- Dispute initiation: Disputes can be sent to Blockchain Arbitration platforms fully automatically via triggering an arbitration clause encoded into the Smart Contract.
- Arbitrators’ selection. In most Blockchain Arbitration platforms this process is automated, eliminating manual labor and bribery attempts. Arbitrators stay anonymous for parties.
- Evidence disclosure: Thanks to secure blockchain technology parties can disclose the evidence promptly and be sure that the facts were never altered. Such evidence disclosure process is characterized by high data reliability.
- Arbitration process: Arbitration process is carried in the decentralized environment and is highly secure and protected from cyberattacks, which is valuable for Supply Chain dispute resolution, where data leakages can cause damages to company’s reputation.
- Decision enforcement: Arbitrators’ decisions can be automatically enforced via Smart Contracts. This is a substantial breakthrough compared to conventional litigation and arbitration, where parties must rely on state judicial systems.
Blockchain Arbitration is, therefore, a time- and cost-efficient solution which can decrease cash-to cash cycle time and increase SC profitability. Moreover, flexible Blockchain Arbitration resolution process can positively contribute to the overall SC flexibility. Finally, automatic jurors’ selection, usage of reliable evidence and process security add trust to the SC stakeholders’ relationship. Trust is a competitive advantage that can increase SC responsiveness, improve such KPIs as integration with partners’ and partners’ satisfaction and positively impact consumers’ loyalty, commitment, and product acceptance.
Despite many advantages, Blockchain Arbitration implies certain challenges , :
- Legal: Blockchain Arbitration is not yet fully recognized in the legal community. First, arbitration clauses encoded into Smart Contracts cannot comply with New York Convention on the written form of arbitration agreements. In addition, Blockchain Arbitration does not offer any predictability about dispute outcomes, as arbitrators rely on common sense and their experience rather than specific norms. Another issue that is widely discussed in the legal research is the morality of jurors participating in Blockchain Arbitration. As mentioned by Jinzhe Tan, the research assistant at the Cyberjustice Laboratory, “using game theory to replace the moral sense of jurors is a disruptive innovation”, that can raise questions about fairness of decisions provided by Blockchain Arbitration . Finally, Blockchain Arbitration platforms can only enforce the decisions regarding crypto assets. A SC dispute can, however, involve assets beyond the blockchain ecosystem.
- Technical: Existing BA platforms are now restricted to binary outcomes. SC disputes, however, usually need a more complex resolution. Moreover, blockchain lacks speed and scalability and Smart Contracts can contain a big number of errors, which can hinder the correct enforcement of arbitrators’ decisions.
- Educational: Companies that want to implement Blockchain Arbitration must invest much time, efforts, and money to educate its staff on functionalities of the platforms.
Blockchain technology along with Smart Contracts are progressively adopted by SC companies because of the advantages they can offer. However, these technologies can still cause disputes. Blockchain Arbitration is a dispute resolution method for blockchain and Smart Contract disputes that, despite existing challenges, still has a lot of potential for agri-food and pharmaceutical supply chains that were among the first to implement blockchain and have always been exposed to many disputes, pooled warehousing services, where numerous disputes occur due to high degree of space and resources sharing and for logistics services, where it is difficult to build and maintain trust with partners.
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This content has been updated on 06/05/2023 at 11 h 05 min.