Introducing Blockchain in Trade Finance for Significant Transformations

• Mudit Kumar
• May 07, 2020
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Trade financing facilitates financial institutions to provide credit facilities to ensure the guarantee of exchanging goods. It is a centuries-old industry that has not experienced a significant transformation with the growth of global trade flows. In 2015 alone, the trade finance market capitalization was more than USD 10 trillion. However, it is time to revamp the way trade finance operates by incorporating blockchain based solutions to boost efficiencies, lower cost base, and create new revenue opportunities, such as forming new models of credit and funding guarantees to back the trade. Let’s assess the challenges the trade finance industry faces today and how blockchain will redefine its future.

The Trade Finance Landscape 

Trade finance by financial institutions like banks is a crucial function in international commerce. It provides delivery and payment guarantees to buyers and sellers involved in a trade while closing the trade cycle funding gap for these parties.

The growth and sustenance of the international trade market rely on financing mechanisms’ easy availability and robustness. However, trade participants can be vulnerable to business risks and uncertainties stemming from several factors. Those factors include process inefficiencies, variation in trade regulations and requirements across geographies, and the operational and logistical complexities arising due to the involvement of numerous entities. In a recent survey by the International Chamber of Commerce, reports showed an increasing trend in litigation and fraud related to trade financing over the last few years. Other pain points include:

• Payment and delivery delays due to process overheads and intermediaries.
• A lack of insight and traceability into the movement of goods.
• Manual contract creation for counterparty due diligence and compliance processes
• Manual AML review conduct using the financials
• Multiple platforms use by each party and thus causing miscommunication and fraud
• Duplicative bills of lading due to the inability of banks to verify their authenticity
• Multiple versions of the truth and version control challenges

For banks as well as buyers and sellers involved in the process, these obstacles can increase both risk and costs, leading to unfavorable financing terms, especially for small businesses.

Also, Read | Digitizing AML/KYC Compliance with Blockchain

The Promise of Blockchain in Trade Finance

Blockchain applications have the potential to streamline various trade finance processes. A blockchain is a data structure that enables the creation of a digital ledger storing all transactions. It is distributed across a digital network with cryptographic mechanisms. As a result, it enables each participant in the network to securely update that ledger without the need for a central authority. A blockchain ledger gets updated in real-time by each participant on the network to reflect the most recent transaction. Thereby, it eliminates the need for multiple copies of the information document stored on numerous databases across various entities.

For instance, in a traditional trade finance system, importers, exporters, shippers, banks, etc., maintain their separate databases for all the documents related to a transaction such as the letter of credit, bills of lading, invoices, etc. It requires each of these databases to be constantly reconciled against each other. In case if there is an error in one document, it gets difficult to take corrective steps to determine which copy document copy is falsified.

Blockchain Advantages

A blockchain trade finance can encompass all the necessary information in one digital chain of blocks consisting of information documents. The chain is updated almost in real-time, and accessible by all members on the network at the same time. Blockchain solutions’ advantages include speeding up transaction settlement time, establishing transparency across all parties, unlocking capital opportunities, and more.

Regulatory Compliance and transparency

Regulators get a real-time view of essential documents and information for enforcement and AML activities.

Automatic settlement processes and lower transaction fees

Blockchain smart contract solutions execute contract terms between parties automatically with accuracy and efficiency. As blockchain underpins the smart contract technology, there’s no need for correspondent banks or additional transaction fees.

Real-time review

Stakeholders can review and approve financial documents linked and accessible through Blockchain in real-time. It reduces the time to initiate shipment. Transparent factoring: Stakeholders get a real-time and transparent view into subsequent short-term financing by accessing invoices on Blockchain.

Disintermediation

Banks facilitating trade finance through Blockchain can eliminate the need to have a trusted intermediary in place to assume the risk.

Reduced counterparty risk

They can access and track bills of lading through Blockchain and thus, eliminate double spending risks.

Decentralized smart contract execution

As parties meet the specified terms in a smart contract powered by the blockchain technology, its status gets updated on Blockchain in real-time. It reduces the time and headcount needed to track and monitor the delivery of shipments.

Also, Read | Use Case: Simplifying Financial Post-Trade Processing with Blockchain

Blockchain in Trade Finance | A Hypothetical Use Case Scenario 

• Using a smart contract solution on the Blockchain, the import bank gets access to the agreement of sale between the importer and exporter.
• In real-time, the import bank reviews purchase agreement, drafts terms of credit, and asserts payment obligation to the export bank.
• The export bank reviews the provided payment obligation and verifies it. Upon approval, a smart contract is generated on the Blockchain that covers terms and conditions and lock-in obligations between involved parties.
• Further, after getting the obligations, the exporter digitally signs a Blockchain-equivalent letter of credit within the smart contract to commence a shipment.
• 3rd parties and the customs agent in the exporting country inspect the received goods and provide their respective digital signature of approval on the Blockchain smart contract.
• Upon delivery, importer digitally acknowledges the receipt of goods and trigger payment using the same smart contract solution
• With provided acknowledgment by the importer, Blockchain automates payment to exporters via a smart contract.

Also, Read | Blockchain Smart Contract Solutions for Efficient Contract Management

Looking Forward

Blockchain-enabled trade networks can prove beneficial for all stakeholders. Blockchain can significantly reduce friction from the logistical and operational inefficiencies and streamline them across the entire trade finance value chain. In the short term, it can prove to be instrumental in augmenting business processes by reducing redundancies, establishing transparency, and increasing efficiencies. The longer-term application of blockchain technology in trade finance can be more profound. They can lead to essential changes in or complete redesigning of existing processes. Though blockchain’s potential for disruption is immense, multiple obstacles need to be overcome. At Oodles, we help you realize the promise of blockchain in trade finance can be realized. We develop applications with careful strategic considerations and design decisions for production deployment. We make use of the most suitable blockchain platforms to address challenges of platform applicability, scalability, and interoperability.