- What Makes a Lack of Decentralization in Trade Finance a Geoeconomics Issue?
- Performing Trade Finance Using Blockchain: The Core Outcomes
- Applications of Blockchain-Based Trade Finance - A Look at Instruments
- Blockchain and Letter of Credit (LC)
- Blockchain and Forfaiting
- Blockchain and Invoice Factoring
- Blockchain and Trade Credit Insurance
- How Can Appinventiv Help You Adopt Blockchain in Trade Finance?
Trade finance, invented in the Renaissance era, remains a cornerstone of the modern-day global economy. The reliance on trade finance instruments for easy inter-geographical transfers is massive; so much so that the Director-General of the World Trade Organization, Roberto Azevêdo, even stated, “Today, up to 80 percent of global trade is supported by some sort of financing or credit insurance”.
However, while on one hand, the finance industry is becoming digital-first, trade finance remains a paper-heavy domain with some deep-rooted issues:
- Unstructured Data: All the trade documents come with huge unstructured data collections.
- Document Volume: 400 to 500 transactions are recorded every day, each with over 20 sub-documents.
- Compliance Checks on a Massive Scale: On average, more than 32 compliance checks are to be done across multiple documents.
- Eroding Manual Accuracy: Consistent increase in the number of errors resulting in low-risk compliance.
To solve this, the finance sector is once again turning towards the technology that brought in a new era of revolution. Blockchain.
Blockchain in trade finance is being explored in multiple capacities to solve not just the above-mentioned microscopic issues but also the gaps present in the sector as a whole.
But before we dive into the role and outcome of blockchain and trade finance, let us look at why the current gap is more than one company’s problem.
What Makes a Lack of Decentralization in Trade Finance a Geoeconomics Issue?
Trade financing is usually taken for granted by developed countries since both importers and exporters are supported by mature financial industries. Still, even in these geographies, small and medium-sized enterprises (SMEs) face challenges in getting financed because they come with less collateral, credit history, and guarantees, compared to large companies.
The SMEs of developing countries also face similar obstacles as their counterparts in the developed countries, such as verification of creditworthiness, but they also face other challenges, like smaller, selective, and less advanced local financial instruments. A key challenge in many developing countries is also a lack of access to the knowledge required for handling trade finance.
Here’s a graph representing the challenges US manufacturing SMEs face when engaging in global trade.
For over a century, the trade finance process has been run on a massive amount of paperwork and to make matters worse, banks and their corporate clients continue to use manual systems for tracking the trade activities – leading to an absence of transparency and excess expenditures.
It’s time to change that by bringing trade finance on blockchain.
Performing Trade Finance Using Blockchain: The Core Outcomes
Modern-day trade finance can benefit immensely from the utilization of blockchain. Through a strategic implementation of blockchain technology in trade finance, the stakeholders can cut down processing time and heighten security, transparency, and trust in the transactions. Moreover, there are zero instances of manipulation when the intermediaries get removed from the system.
Here are some key benefits of blockchain-based trade finance.
One of the primary trade finance blockchain use cases can be seen in the process of becoming efficient through the completion of a transaction between the appropriate parties without the presence of an intermediary. Using the smart contract functionality, both parties can build contracts that can automatically initiate commercial transactions, leading to the entire industry becoming streamlined and speedy.
Through the integration of blockchain technology in trade finance, both exporters and importers can see the location of their assets and goods in real-time. Moreover, owners can pass down relevant information to the stakeholders for timely action. This leads to a situation that defines a perfect transaction outcome.
Blockchain technology in trade finance makes it possible, and even easier, to audit every single transaction sequentially, indefinitely. On top of giving a permanent audit trail of the traded asset, the technology also lowers the overall compliance expenses and betters the capability to authenticate the assets.
Trade finance on blockchain makes it possible to record multiple transaction details in sync with the business agreements. When placed in a decentralized network, it becomes easy to share the data between the participants with the assurance of immutability. As a result, the change of data tampering gets reduced to almost null.
Now that we have had a high-level view of blockchain in trade finance, let us look into its use cases by studying its inclusion across some of the most used trade finance instruments.
Applications of Blockchain-Based Trade Finance – A Look at Instruments
Blockchain in trade finance and supply chain can have an impact across most of the trade finance instruments, as for the rest, we are sure that an application is underway. For this article, let us keep the discussion of how blockchain technology in trade finance leaves an impact across different instruments limited to three.
Blockchain and Letter of Credit (LC)
A letter of credit can be defined as a letter issued by a bank to another bank (especially one in a different country) that serves as a guarantee of payments that will be made to a specific person under specific conditions.
Here’s how this otherwise document-heavy process works on blockchain-based trade finance.
- The Applicant and Beneficiary enter into a trade agreement stored on the blockchain network.
- The Applicant then issues a ‘purchase order’ for The Beneficiary in their Billing System, which acts as the contract for LC.
- The Applicant, next, gathers the LC Application details through their system, which is also on the Blockchain Network. The system then interacts with ‘The Issuing Bank’ and requests his bank to issue an LC. ‘The Applicant’ gives all the information for LC, consisting of the purchase order in digitized form to the bank.
- The LC details are received by the bank and it processes the same before sending it to the Advising Bank.
- ‘The Advising Bank’ gets the LC and advises it to ‘The Beneficiary’ in digital form – all through the blockchain network.
- The Beneficiary provides the digital acceptance/rejection of ‘The Advising Bank’ through the blockchain network.
At the end of this six-stage process, a contract is built between the exporter and importer, stating that the exporter will give goods as specified in the LC, and the importer will make payment against the goods received as per the LC terms.
Blockchain and Forfaiting
The next application of blockchain and trade finance can be seen in the role it plays in forfaiting. The instrument allows exporters to get cash by selling their medium and long-term foreign accounts receivable at a discounted rate on a “without recourse” basis.
A real-world application of banks using blockchain for trade finance through the way of forfaiting can be seen through the transaction between HSBC and the Bank of Communications on the China Trade Finance Union blockchain platform.
Under the transaction, a Bank of Communications client selling paper products received an undertaking to pay in 180 days from their buyer’s bank. The Bank of Communications after purchasing the payment obligation from the client sold the undertaking to HSBC through the blockchain technology trade finance platform. Every document from confirmation letter, offer letter, and transfer of rights was created and transmitted digitally only in a matter of a few hours.
Blockchain and Invoice Factoring
Factoring is a finance type where businesses sell their accounts receivable (invoices) to a third party to meet their short-term liquidity requirements. Under this transaction, the factor pays the invoices’ due amount after deducting their fees and commission.
The problem with this setup is that the process is dependent on traditional lending organizations like private entities or banks, who in turn, charge expensive interest rates that too only when they are given the guarantee of additional collateral.
In a blockchain and trade finance world, the invoices are tokenized under a non-fungible model, which makes them easy to transfer and store. Now the payment of these tokens is usually performed through smart contracts having invoices in the face of NFTs. Additionally, companies can also trade their invoices through a distributed ledger platform which records all the transactions between parties.
This particular use case of blockchain in trade finance highlights the scope of a platform that would connect companies and investors in a way to counter the monopoly of a few entities in the trade financing instrument. To make the platform even more powerful, you can plan on adding a credit-scoring algorithm and a strong KYC model to ensure that the platform becomes truly useful on a mass adoption level.
Blockchain and Trade Credit Insurance
Several commercial buyers ask for credit to make large purchases, but lending them puts the supplier at risk that it will not get repaid. This is especially true for unsecured debts, where creditors do not have collateral for the loan.
Trade credit insurance eliminates the risk by compensating the policyholders for unpaid debt as allowed by their applicable coverage limits.
Where does a blockchain trade finance platform fit into this? Through the technology, companies can build an immutable record of the policy by first generating a cryptographic hash of the signed contract and then recording it on the blockchain to then be checked again as immutable evidence.
In addition to playing a role in all the major trade finance instruments that companies opt for when doing international transactions, blockchain impacts some other areas as well.
- Trade chain – This is where all the trade-related events starting with the issuing of the letter of credit to the final delivery of all trade documents happen over blockchain DLT. The benefits of this approach can be seen in shorter trade documents’ delivery time, reduction of efforts needed to create and share documents, and increased transparency.
A real-world example of this can be seen in the trade transaction that Japanese conglomerate Marubeni Corporation and Sompo Japan Nipponkoa were involved in.
- Supply chain – Many companies are exploring blockchain’s capabilities to digitize the supply chain for their network of freight forwarders, shippers, ports, ocean carriers, and customs authorities. With the technology’s help, they are aiming to lower errors and frauds, reduce transit and shipping time, improve inventory management, and bring transparency to the goods authentication process.
Now that we have looked into the multi-faceted role of blockchain and trade finance, it is time to address a situation that is rarely vocalized by the technology’s enthusiasts – several platforms that were pushing trade finance on blockchain never moved beyond the pilot stage.
Based on our observations of Marco Polo Network, MonetaGo, and Komgo, especially their failures, we found that business models and less corporate uptake were the biggest hurdles. With a majority of these and other platforms, the issue was that they were made with banks in focus, instead of creating a new class of users. The issue with banks is that they are not willing to digitalize and the moment a nationwide or global instance like COVID-19 or the Ukraine war happens, they shift their entire focus to them.
How Can Appinventiv Help You Adopt Blockchain in Trade Finance?
At Appinventiv, we make market research and analysis a continued activity – one that doesn’t start with a project. And we have ideas on how to make your trade finance blockchain use case click.
Our strong portfolio of blockchain and fintech software development projects in our nearly decade long experience, along with a competent team of over 1,200 professionals further make us the ideal fit for your blockchain and trade finance needs.
Q. How does blockchain impact trade and finance?
A. Blockchain technology in trade finance makes inter-geography transactions and goods movement a streamlined, simplified, and secure journey with its decentralization capabilities. By bringing the entire sector on an immutable platform using the powers of smart contracts, DLT, NFTs, etc., blockchain makes it easy for inter-country businesses to work with the confidence of assured payments and delivery.
Q. What are the benefits of blockchain in trade finance?
A. The advantages of combining blockchain and trade finance range from high efficiency and auditability to secure transparency and immutable traceability.
Q. What are some of the banks performing trade finance on blockchain?
A. According to Trade Finance Global, several banks are exploring the applications of blockchain technology in trade finance. Some of the top names include – Bangkok Bank, BNP Paribas, CTBC, Citi, ING, HSBC, SEB, and Standard Chartered.