The noise around blockchain has grown to a crescendo, but is trade finance blockchain set to be a reality in the near future? Originally regarded as a technological novelty, blockchain is quickly evolving and may soon become a viable financial tool on a global scale. And trade finance and global trade are some of the more interesting areas it could have an impact.
What Is Trade Finance?
Before we talk about trade finance blockchain, we should define what we mean by trade finance. Trade finance refers to financial transactions, which can be domestic but are typically international, in support of B2B commerce. Trade finance transactions include lending, issuing letters of credit, factoring, export credit and insurance.1 These transactions make up an enormous portion of global trade – approximately 80-to-90 percent of world trade relies on trade finance.2 Essentially, almost any time goods or services are bought or sold across any border, some form of trade finance is involved. One of the difficulties of trade finance is the large volume of paper documents that still make up much of the information flow. Banks are seeking to reduce costs and increase efficiency by replacing the flow of paper for trade finance with digital data.3
How Does Trade Finance Work?
For example, under the current system of trade finance, ABC Company in the United Kingdom seeks to import a shipment of goods from supplier XYZ Company in China. The U.K. importer needs to pay for those goods, but is hesitant to do so before making sure that the goods will arrive as ordered. Likewise, the Chinese exporter is hesitant to ship the goods before being certain that payment will arrive. Into this impasse steps the importer’s bank, which issues a letter of credit to the exporter via the exporter’s bank promising to pay once documents (such as a bill of lading) are provided by the exporter proving that the goods have been loaded onto the cargo ship, truck or train. In this way, both the importer and exporter are protected while the banks hold the money for each party.4 This structure has been in place for hundreds of years, with fairly little change in the process and in the substantial amount of physical paperwork being shuffled back and forth amongst the importer, exporter, importer’s bank, exporter’s bank, shipping company, receiving company, local shippers, insurers and others. With each step of the process, all the paperwork must be confirmed between various parties, ensuring its accuracy.
The Promise of Blockchain in Trade Finance
The promise of blockchain is that it may streamline the trade finance process. A blockchain is a data structure that allows the creation of an encrypted digital ledger of transactions that can be distributed amongst members of a digital network. Each member can securely amend that ledger without the need for a central authority.5
Because a blockchain is updated quickly by each participant on the network to reflect the most recent transaction, it removes the need for multiple copies of the same document to be stored on numerous databases across various entities. For example, with a traditional trade finance system, the importer, exporter, shipper, banks, etc., must all maintain their own database for all the documents related to a transaction (the letter of credit, bill of lading, invoices, etc.). Each of these databases must be continuously reconciled against the others, and if there is an error in one document, corrective steps must then be taken to determine which (if any) copy of the document is correct.
Conversely, a single blockchain can embody all of the necessary information in one digital document, which is updated nearly instantly and viewable by all members on the network at the same time. Blockchain’s potential advantages include the speeding up of transaction settlement time (which currently takes days), increasing transparency amongst all parties and unlocking capital that would otherwise be tied up waiting to be transferred.6
Several companies and financial industry consortia have already begun investing in and developing test programs utilising blockchain in trade finance and receivables finance. The Society for Worldwide Interbank Financial Telecommunication (SWIFT) is exploring the use of blockchain in trade finance. SWIFT CEO Gottfried Leibbrandt has said that “[SWIFT is] looking at the blockchain technology, keeping a very close eye on it. If there is a way to improve the service we provide to the banks with that new technology, then we will use it. We are absolutely on it.”7
The Takeaway:
Although full implementation of blockchain-based trade finance solutions may still be some time away, it is worth keeping an eye towards the very rapid developments occurring in the space. Blockchain is poised to effect positive change in trade finance. If it does, it could affect every business that conducts cross-border business or trade.
Sources
- “Bank of America Merrill Lynch explores using a blockchain for trade finance”, ”, BraveNewCoin Digital Currency Insights; http://bravenewcoin.com/news/bank-of-america-merrill-lynch-explores-using-a-blockchain-for-trade-finance/.
- “Trade Finance”, World Trade Organization; https://www.wto.org/english/thewto_e/coher_e/tr_finance_e.htm.
- “Bank of America Merrill Lynch explores using a blockchain for trade finance”, BraveNewCoin Digital Currency Insights; http://bravenewcoin.com/news/bank-of-america-merrill-lynch-explores-using-a-blockchain-for-trade-finance/
- “What is Trade Finance?”, Euromoney Institutional Investor; https://tradefinanceanalytics.com/what-is-trade-finance
- “CIO Explainer: What Is Blockchain?”, The Wall Street Journal; http://blogs.wsj.com/cio/2016/02/02/cio-explainer-what-is-blockchain/
- “Blockchain Will Change Trade and Finance in Our Lifetime, Perseus” http://perseus.co/blockchain/
- “SWIFT explores solving the correspondent banking problem with the blockchain”, BraveNewCoin Digital Currency Insights; http://bravenewcoin.com/news/swift-explores-solving-the-correspondent-banking-problem-with-the-blockchain/
