Trade finance, which was created in the Renaissance, is still an important part of today’s global economy. The dependence on trade finance tools for seamless inter-geographical exchanges is vast; so much so that the Director-General of the World Trade Organization, Roberto Azevedo, even remarked, “Currently, up to 80 percent of global trade is facilitated by a kind of financing or credit insurance”.
However, while the finance sector has turned digital-first, trade finance continues to be a paper-heavy business with certain deep-rooted issues:
- Unstructured Data: All trade agreements contain extensive unstructured data collections.
- Document Volume: 400 to 500 transactions are documented every day, each with more than 20 sub-documents.
- Conformity Checks on a Huge Scale: On average, over 32 compliance checks will be performed across numerous documents.
- Eroding Manual Accuracy: An ongoing rise in the frequency of mistakes leads to low-risk compliance.
To address this, the banking sector is additionally turning to technology, which ushered in a new period of innovation which is Blockchain.
Blockchain in trade finance is being investigated in a variety of ways to address not just the previously described microscopic concerns, but also the sector’s overall inadequacies. But, before we get into the function and outcomes of blockchain and trade finance, consider why the existing imbalance affects more than just one corporation.
What is Considered a Geoeconomics Concern When Trade Finance Lacks Decentralization?
Since industrialized nations’ well-established banking sectors assist exporters as well as importers, trade finance is typically taken for granted. Within these regions, small and medium-sized businesses (SMEs) still have difficulties obtaining financing since, in comparison to larger corporations, they have fewer guarantees, credit history, and collateral.
In addition to the same difficulties faced by their counterparts in industrialized nations, small and medium-sized enterprises in developing nations additionally have to deal with less sophisticated, more limited local financial instruments and the need to verify their creditworthiness.
Lack of access to the expertise needed to manage trade finance is another major issue in many developing nations. For more than a century, the trade finance operation has been characterized by an enormous volume of paperwork. To exacerbate the situation, banks and their corporate clients still track trade transactions using manual methods, which results in a lack of transparency and unnecessary expenses.
It’s time to put blockchain technology in trade finance and alter that.
How Blockchain Can Be Used for Trade Finance?
The rise in popularity of blockchain technology is mostly attributable to cryptocurrencies. However, traditional enterprises may also take advantage of new technology. Recall that a distributed database called a blockchain keeps track of every transaction that takes place between the people involved in a process. All participants in the procedure may see the entries from the register; they cannot be quietly changed or removed in the past. Technology makes it feasible to do away with middlemen in business, which lowers expenses associated with things like contract execution and gets rid of fraud. Blockchain technology saves inspections and enables real-time process tracking.
Blockchain technology was first applied in the banking industry. This is not shocking, as it is simple to convert the concept of crypto transactions between wallets to conventional bank transfers. While international payments via SWIFT can take up to three business days, especially when there are no correspondent relationships between the sender and destination banks, cross-border blockchain-based money transfers can be completed in minutes. Blockchain can be utilized in the long run for reporting to authorities as well as for consumer verification.
In compliance with new EU banking regulations that went into effect this year and mandate that banks disclose more information and perform more extensive due diligence on clients and counterparties, a group of European banks led by Swiss UBS has introduced a blockchain platforms.
Not a corporation with a dozen verified counterparties, but rather an organization with numerous suppliers, customers, and franchisees that require continuous oversight will reap the most benefits from blockchain technology. Logistics is one industry that fits this description. The supplier ships forwarding paperwork with the shipment, and warehouse employees and customs officers inspect them at every point of delivery. When shipping items by water, it frequently happens that the recipient must wait for the products to arrive since the paperwork takes longer to process than the cargo.
What is the transport delivery method based on blockchain like? A pointer to the data storage address appears in the distributed registry, the sender uploads the documents to the online storage, and the consignee determines the requirements for the documents. Everybody involved uses specialized software that logs every action in the supply chain at every point throughout the items’ journey.
Both the recipient of the items and a warehouse or customs office employee sign to attest to the fact that the products have been delivered. Senders and receivers may be identified because to the private keys that each process participant possesses. Similar to the key, the signature is encrypted. Blockchain prevents cargo from being captured by rewriting it to a different party.
Benefits of Blockchain Technology in Trade Finance
Blockchain technology has enormous benefits for trade finance today. Stakeholders in trade finance may reduce processing times and increase transaction security, transparency, and confidence by strategically implementing blockchain technology. Furthermore, when the middlemen are eliminated from the system, there are no instances of manipulation.
These are a few of the key benefits of blockchain in trade finance:
The method that becomes effective via the finalization of a transaction between the relevant parties without the involvement of a middleman is one of the primary benefits of blockchain technology in trade finance. Both parties may create contracts that can automatically start business transactions by utilizing the smart contract capability, which will streamline and expedite the industry as a whole.
Exporters and importers may view the real-time location of their products and assets with the incorporation of blockchain technology in trade finance. Additionally, owners may provide stakeholders with pertinent information so they can respond quickly. This results in a scenario that characterizes the ideal transaction result.
In trade finance, the use of blockchain technology applications makes it feasible and even simpler to audit each and every transaction in a sequential, endless fashion. The system not only provides a permanent audit record of the transferred item but also improves asset authentication and reduces overall compliance costs.
Blockchain-based trade finance enables the recording of numerous transaction information in accordance with company agreements. It is simple to share data across members in a decentralized network with the guarantee of immutability. Consequently, the likelihood of data manipulation is nearly eliminated.
After gaining an overview of blockchain’s application in trade finance, let’s see how it is incorporated into some of the most popular trade finance products.
Applications of Blockchain in Trade Finance
The majority of trade finance instruments may be impacted by blockchain in trade finance and supply chain; for the remaining ones, we are certain that applications are being developed. Let’s confine the examination of how blockchain technology in trade finance affects various instruments.
1. Blockchain and The Letter of Credit (LC)
A letter of credit is a document that a bank issues to another bank, particularly one abroad, guaranteeing payments to be made to a certain individual under particular circumstances.
This is the workflow for the blockchain-based trade finance procedure, which is otherwise quite document-heavy.
- A trade agreement is signed by the Applicant and the Beneficiary and is recorded on the blockchain network.
- Then, using their billing system, the applicant produces a “purchase order” for The Beneficiary, which serves as LC’s contract.
- Next, using their system that is also on the Blockchain Network, the Applicant obtains the data of the LC Application. After that, the system communicates with “The Issuing Bank” and asks it to issue an LC. “The Applicant” provides the bank with all the information needed for the LC, including a digital copy of the purchase order.
- After receiving the LC information, the bank processes them and forwards them to the advising bank.
- “The Advising Bank” obtains the LC and uses the blockchain network to provide “The Beneficiary” with digital advice.
- Via the blockchain network, the Beneficiary offers “The Advising Bank’s” digital approval or rejection.
After completing these six steps, a contract is created between the importer and the exporter, stipulating that the importer will pay the exporter for the commodities according to the terms of the LC and that the exporter will supply the items as stipulated.
2. Blockchain and Forfaiting
The function that blockchain plays in forfeiting is the next use of blockchain technology in trade finance. With the use of this instrument, exporters may market their medium- and long-term international accounts receivable on a “without recourse” basis at a reduced rate and get cash.
The transaction that took place between HSBC and the Bank of Communications on the China Trade Finance Union blockchain platform provides an example of how banks are really utilizing blockchain technology for trade finance through the process of forfeiting.
In the deal, the buyer’s bank gave a Bank of Communications client that sold paper goods a commitment to pay in 180 days. Utilizing the blockchain technology trade finance platform, the Bank of Communications transferred the agreement to HSBC after acquiring the payment obligation from the customer. In a couple of hours, every document—including the offer letter, confirmation letter, and transfer of rights—was generated and sent digitally.
3. Blockchain and Factoring Invoices
Businesses can fulfill their short-term liquidity needs by selling their accounts payable (invoices) to a third party through a sort of financing called factoring. In this transaction, the factor deducts their fees and commission before paying the invoices the amount owed.
The issue with this arrangement is that it depends on conventional lending institutions, such as banks or private companies, that only demand high-interest rates in exchange for the assurance of additional collateral. The invoices are tokenized within a non-fungible concept in the context of trade finance and blockchain, making them simple to move and store. Currently, smart contracts with invoices on the face of NFTs are used to pay for these tokens. Businesses may also exchange their bills using a distributed ledger platform, which keeps track of every transaction that takes place between parties.
The potential of a platform that links businesses and investors in order to challenge the monopoly of a small number of firms in the trade financing instrument is highlighted by this specific use case of blockchain in trade finance. You can intend to incorporate a robust KYC model and a credit-scoring system to further enhance the platform’s capability and make sure it becomes genuinely helpful on a mass adoption level.
What Other Effects Does the Blockchain Have on the Trade Finance Industry?
The trade finance sector has advanced in a number of ways as a result of the blockchain. Here, we’ll discuss the main effects that have drastically transformed the corporate landscape while benefiting both sides.
Automated Payment Options
A letter of credit is the best way to guarantee the delivery of the goods. It facilitates the regulation of trade flows and the entire banking intermediary procedure. However, in addition to the contractual delays, the entire procedure is costly and complex. Because the whole LC process is based on document assessment rather than the delivery of the actual item, there are a lot of system problems that lead to unclaimed products at the delivery location.
Thus, the entire idea is redesigned using blockchain in order to reduce the associated risks with the LC. because the exporters receive prompt payments and the compliance certification procedure is automated thanks to smart contracts. The corporate blockchain development solutions may also identify mistakes and problems before inefficiencies are seen, so they can be fixed quickly.
Asset Tokenization To Guarantee The Importers’ Delivery
In order to reduce potential hazards and future harm, buyers demand fast information on the items throughout shipment transit. The purchasers are unable to observe the damages that occur while the items are in route and are also unable to forecast shipping delays and the potential causes, which might include inclement weather, technical issues, port traffic, or other factors.
The primary reason is that the trade documentation moves independently of the products. Without getting the actual paperwork, the buyer is unable to assert that the items have arrived at their destination. Furthermore, the documents may be falsified or destroyed, leaving the recipients in a difficult situation. Digital transformation is made feasible by blockchain technology in trade finance, which transforms physical assets into cryptocurrency. Additionally, it shows that the parties involved may quickly verify the ownership of the items bearer and the transaction documentation on the blockchain network. Additionally, the adoption of blockchain technology streamlines the risk management and insurance distribution processes.
Bank Revenue Growth Through Digitized Payment Process
The banks serve as a link between trading receivables and financial instruments such as drafts and exchange bills. The third-party receives these tradable entities. With the use of methods like factoring and discounting, all of this enables the suppliers to keep their money.
There are several challenges that banks have while handling the compiled operations under the existing traditional system. It also occurs as a result of the high bearing cost, the little amount of information that is readily available, and the trade papers’ poor trustworthiness. Additional challenges that result from these errors include duplicate transactions, financial fraud that damages reputations, and costly legal battles. By releasing the payment instruments on the blockchain network, these challenges may be overcome by integrating blockchain technology into the trade finance processing process. Additionally, it guarantees that the receivables are managed effectively.
Opportunities and Trends in Blockchain-based Trade Finance
Even if the global trade finance business has already made a significant shift to blockchain technology, there are still a lot of trends and changes in this process to look out for in 2024.
1. Blockchain Unification
The ecology surrounding blockchain technology is not uniform. The fact that there are currently a lot of incompatible blockchains and networks where users transact in isolation might be a significant obstacle to the widespread adoption of blockchain technology in trade finance. Because of this, blockchain consolidation and interoperability improvements are crucial future trends that will enable participants in the system to trade without danger or difficulty.
2. Institutional Adoption
Institutional actors, such as banks and international financial institutions, are aggressively investigating blockchain technology, although it is unclear when widespread adoption will occur. The degree to which blockchain technology is adopted by banks will thus determine how far it can be integrated into trade finance processes.
3. Automated Documentation
Saying that blockchain is the answer to every problem facing the trade finance sector today would be oversimplifying the situation. However, it presents a significant opportunity for the digitalization of paperwork, allowing for the reduction of human labor, duplicate documents, and other types of red tape in the trade finance deal procedure. Even in the case of trade finance with limited blockchain implementation, these types of automation offer increased speed and efficiency.
Blockchain technology represents decentralization—the handing over of power over data to customers so they may dispose of it as they see fit. In light of a rising user base that won’t put up with having its data owned by someone else, IT executives need to reconsider their blockchain approach.
We have discussed in this article how blockchain technology might transform this industry. It is evident that blockchain technology is not flawless. Still, it is far superior to older systems. We can only expect a better experience with international commerce when we have the appropriate trade finance blockchain.
Blockchain is a potential advancement in the much-needed speed, efficiency, and transparency of trade finance, even if it is not perfect, and should be used with prudence and risk awareness.
For those firms in trade finance that are eager to take their business to the next level or are thinking about breaking into the market with an advanced blockchain resource, SoluLab, a blockchain development company, would be delighted to work with you as a reliable development partner on this project. With our skilled and knowledgeable team of blockchain experts, we can develop an advanced technology trade finance platform that meets your requirements both technically and strategically. Get in touch with us right now to begin putting your exciting, highly marketable company concept into action.
1. What is the role of blockchain in trade finance?
Blockchain in trade finance acts as a decentralized and secure digital ledger that records and verifies transactions across multiple parties in a transparent and tamper-resistant manner. It helps streamline processes, reduce fraud, and enhance the efficiency of trade finance operations.
2. How does blockchain improve transparency in trade finance?
Blockchain ensures transparency by providing a single, immutable record of transactions that is accessible to all authorized parties. This eliminates discrepancies, reduces the risk of fraud, and enhances trust among participants in the trade finance ecosystem.
3. What challenges does blockchain solve in trade finance?
Blockchain addresses challenges such as lengthy document processing, manual errors, and the risk of fraud in trade finance. By automating and digitizing processes, it reduces the time and cost associated with traditional trade finance methods.
4. How does blockchain enhance security in trade finance transactions?
Blockchain employs cryptographic techniques and decentralization to enhance security in trade finance. Each transaction is securely recorded in blocks, and once added, it becomes practically impossible to alter previous transactions, ensuring the integrity and security of the trade finance data.
5. Can blockchain reduce the time and costs involved in trade finance processes?
Yes, blockchain significantly reduces the time and costs of trade finance. By automating manual processes, minimizing paperwork, and providing real-time visibility into transactions, blockchain streamlines operations, accelerates settlement times, and lowers overall transaction costs.
6. How does SoluLab contribute to implementing blockchain in trade finance?
SoluLab leverages its expertise in blockchain technology to design and implement solutions tailored to the trade finance industry. Their team specializes in developing decentralized applications (dApps) and smart contracts that streamline processes, enhance security, and improve the overall efficiency of trade finance operations. SoluLab’s comprehensive approach includes consulting, development, and ongoing support to ensure the successful integration of blockchain in trade finance ecosystems.