For the past few years, the buzz around blockchain has grown to a crescendo. Long regarded as a technological novelty, blockchain is quickly evolving, and may soon become a viable financial tool on a global scale. One of the more interesting areas that blockchain is seeking to address is trade finance and global trade.
What Is Trade Finance?
Trade finance refers to financial transactions, both domestic and international, which relate to trade receivables finance and global trade. These 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, there is some form of trade finance involved. One of the difficulties involved with 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 flows.3
How Does Trade Finance Work?
As an example case, under the current system of trade finance, ABC Company in the United States seeks to import a shipment of goods from supplier XYZ Company in China. The importer needs to pay for those goods, but is hesitant to do so before making sure that the goods will arrive as ordered. The exporter is also hesitant to ship the goods, without being certain that the payment will arrive for the goods they supply.
Into this impasse steps the importer’s bank, who issues a letter of credit to the exporter via the exporter’s bank promising to pay the exporter’s bank once documents (such as a bill of lading) has been 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, and the banks take on the role of holding 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 between 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 paper work must be confirmed between various parties, ensuring its accuracy.
The Promise of Blockchain in Trade Finance
The promise of blockchain is that it may have ability to streamline the trade finance process. A blockchain is a data structure that allows the creation of a digital ledger of transactions that can be distributed amongst a digital network by using cryptography. This way, each participant on the network 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 of information 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 constantly reconciled against each other, 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.
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. Among the best of blockchain’s advantages are the speeding up of transaction settlement time (which currently takes days), increasing transparency between all parties, and unlocking capital that would otherwise be tied up waiting to be transferred between parties in the transaction.6
There are several companies that have already begun investing in, and developing test programs, which utilize blockchain in trade finance and receivables finance. The Society for Worldwide Interbank Financial Telecommunication (SWIFT) is exploring the use of blockchain in trade finance, with SWIFT CEO Gottfried Leibbrandt stating 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
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, and if it does, it could affect every business that conducts cross-border business or trade.