What Is The Future Of Blockchain In Trading Finance?
The Renaissance gave rise to trade finance, which is now a significant component of the modern global economy. “Currently, up to 80 percent of global trade is facilitated by a kind of financing or credit insurance,” said Roberto Azevedo, Director-General of the World commerce Organization, demonstrating the extent of the reliance on trade finance tools for smooth inter-geographical exchanges.
Though the banking industry has shifted to a digital-first approach, trade finance is still a paper-heavy industry with several long-standing problems.
Unstructured Data: Vast amounts of unstructured data are collected in all trade agreements.
Document Volume: Each transaction has between 400 and 500 sub-documents, and each transaction is logged daily.
Large-Scale Conformity inspections: Typically, more than 32 compliance inspections will be carried out over several
- When Trade Finance Is Not Decentralized, What Is a Geoeconomic Concern?
- How Blockchain Can Be Used for Trade Finance?
- Benefits of Blockchain Technology in Trade Finance
- Applications of Blockchain in Trade Finance
- What Other Impacts Does Blockchain Technology Have on Trade Finance?
- Opportunities and Trends in Blockchain-based Trade Finance
When Trade Finance Is Not Decentralized, What Is a Geoeconomic Concern?
Trade finance is often taken for granted because the well-established banking systems in industrialized nations support both importers and exporters. Small and medium-sized enterprises (SMEs) in these areas continue to face challenges in securing funding because they own less guarantees, credit history, and collateral than larger organizations.
Small and medium-sized businesses in developing countries have the same challenges as their counterparts in developed countries, in addition to dealing with less advanced, more constrained local financial instruments and the requirement to establish their credibility.
Another key problem in many developing countries is the lack of access to the skills required to manage trade finance. The trade financing operation has been typified for over a century by an immense amount of paperwork. To make matters worse, trade transactions are still being tracked by banks and their business clients using manual methods, which leads to a lack of transparency and needless costs.
How Blockchain Can Be Used for Trade Finance?
The primary reason for the surge in interest in blockchain technology is the existence of cryptocurrencies. But established businesses could also benefit from new technology. Recall that every transaction that occurs between the participants in a process is recorded in a distributed database known as a blockchain. The entries from the register are visible to all participants in the process; they cannot be secretly altered or deleted. Technology makes it possible for businesses to operate without middlemen, which reduces costs related to things like contract execution and eliminates fraud. Blockchain technology allows for real-time process tracking and reduces the need for inspections.
The financial sector was the first to use blockchain technology. This is not surprising because it is easy to translate the idea of cryptocurrency transfers between wallets to traditional bank payments. Cross-border blockchain-based money transfers can be finished in minutes, whereas international payments via SWIFT can take up to three business days, particularly if there are no correspondent links between the sender and destination banks. In the long run, blockchain can be used for consumer verification and reporting to authorities.
A group of European banks led by Swiss UBS has introduced a blockchain platform in conformity with new EU banking regulations that went into force this year and require banks to disclose more information and do more thorough due diligence on clients and counterparties.
The company that stands to gain the most from blockchain technology is not a firm with a dozen certified counterparties, but rather an organization with several suppliers, customers, and franchisees that need constant supervision. One sector that meets this criteria is logistics. Every step of the delivery process involves warehouse staff and customs officers inspecting the forwarding papers that the supplier supplies with the package. It sometimes happens that the recipient of an item shipped by water has to wait for the products to arrive since the paperwork takes longer to process than the cargo.
What is the blockchain-based transport delivery system like? The sender uploads the documents to the online storage, the consignee establishes the criteria for the documents, and a pointer to the data storage URL appears in the distributed registry. All participants utilize specialized software that records each action taken in the supply chain at every stage of the item’s journey.
To confirm that the goods have been delivered, a warehouse or customs office employee signs beside the item’s recipient. Because each process participant has a private key, senders and recipients may be recognized. The signature, like the key, is encrypted. Blockchain rewrites cargo to a different party, preventing it from being captured.
Benefits of Blockchain Technology in Trade Finance
Today’s trade finance can greatly benefit from blockchain technology. By carefully deploying blockchain technology, trade finance stakeholders can decrease processing times while increasing transaction security, transparency, and confidence. Moreover, there are no instances of manipulation when the middlemen are removed from the system.
Among the main advantages of blockchain in trade finance are the following:
Efficiency
One of the main advantages of blockchain technology in trade finance is the way that becomes effective via the completion of a transaction between the relevant parties without the need for an intermediary. By using the smart contract feature, both parties can build contracts that will initiate commercial transactions automatically, speeding up and streamlining the sector as a whole.
The ability to trace
With the use of blockchain technology in trade finance, exporters and importers may see the current location of their goods and assets. In order for stakeholders to react promptly, owners may also give them relevant information. This leads to a situation that epitomizes the perfect transaction outcome.
Accountability
The usage of blockchain technology applications in trade finance enables auditing every transaction in a sequential, infinite form possible and even easier. The technology lowers overall compliance costs, enhances asset identification, and offers a permanent audit record of the transferred item.
Openness
Trade finance based on blockchain makes it possible to document a wealth of transaction data in compliance with business contracts. In a decentralized network, data can be easily shared among participants while maintaining immutability. As a result, there is almost little chance of data manipulation.
Now that you have a general understanding of how blockchain is used in trade finance, let’s look at how some of the most well-known trade finance products use it.
Applications of Blockchain in Trade Finance
Blockchain may have an impact on most trade finance instruments in supply chain and trade finance; for the rest, we are sure that applications are being developed. Let’s limit the analysis to how different instruments are impacted by blockchain technology in trade finance.
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The Letter of Credit (LC) and Blockchain
A letter of credit is a document that a bank issues to another bank, usually one that is located overseas, as assurance that payments would be made to a specific person under specific conditions.
The blockchain-based trade finance procedure follows this workflow; otherwise, it is a document-heavy process.
The Applicant and the Beneficiary sign a trade agreement, which is then registered on the blockchain network.
The application then creates a “purchase order” for The Beneficiary, which functions as LC’s contract, utilizing their billing system.
Subsequently, the Applicant accesses the data of the LC Application through their system, which is also on the Blockchain Network. Subsequently, the system initiates communication with “The Issuing Bank” and requests that it send an LC. “The Applicant” gives the bank all the data required for the LC, together with an electronic copy of the purchase order.
The bank processes the LC data after receiving it and sends it on to the advising bank.
After obtaining the LC, “The Advising Bank” makes use of the blockchain network to give “The Beneficiary” digital advice.
The Beneficiary provides “The Advising Bank’s” digital approval or rejection via the blockchain network.
Following the completion of these six procedures, an agreement is made between the importer and the exporter, which states that the exporter will supply the goods as specified and that the importer will pay the exporter for the commodities in accordance with the terms of the LC.
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Forfaiting and Blockchain
The next application of blockchain in trade finance is the role it plays in forfeiting. Exporters can offer their medium- and long-term foreign accounts receivable on a “without recourse” basis at a discounted rate and receive cash by using this instrument.
An example of how banks are actually using blockchain technology for trade finance through forfeiting can be found in the transaction that happened between HSBC and the Bank of Communications on the blockchain infrastructure of the China Trade Finance Union.
A Bank of Communications client that supplied paper goods was given a payment promise by the buyer’s bank in the contract, with a 180-day payment period. After obtaining the customer’s payment obligation, the Bank of Communications transferred the agreement to HSBC via the trade finance platform powered by blockchain technology. All of the documents, including the confirmation letter, offer letter, and rights transfer, were created and emailed digitally in a matter of hours.
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Invoice factoring and blockchain
Companies can use a type of financing known as factoring to sell their accounts payable (invoices) to a third party in order to meet their short-term liquidity needs. In this transaction, the factor withholds their commission and fees from the money owing to the invoices.
This arrangement has a problem because it relies on traditional lenders, such banks or private businesses, who only ask for high interest rates in return for the guarantee of more collateral. In the context of trade finance and blockchain, the invoices are tokenized within a non-fungible concept, which facilitates their storage and mobility. These tokens are currently purchased via smart contracts that display invoices on the front of NFTs. A distributed ledger technology, which records each transaction between participants, can also be used by businesses to swap bills.
This particular use case of blockchain in trade finance highlights the potential of a platform that connects investors and businesses to challenge the monopoly of a few organizations in the trade financing instrument. To ensure that the platform becomes truly beneficial to a large number of users, you can plan to integrate a credit-scoring system and a strong KYC approach.
What Other Impacts Does Blockchain Technology Have on Trade Finance?
The blockchain has improved the trade finance industry in a variety of ways. Here, we’ll talk about the key factors that have positively impacted both parties and fundamentally changed the corporate landscape.
Options for Automated Payments
The best way to ensure that the products are delivered is with a letter of credit. It makes the whole banking intermediary process and trade flow control easier. But aside from the delays caused by the contracts, the process itself is expensive and complicated. There are numerous system issues that result in unclaimed merchandise at the delivery location since the entire LC procedure is predicated on document assessment rather than the delivery of the real thing.
Because exporters receive timely payments and smart contracts automate the compliance certification procedure, the entire concept is reinvented using blockchain to decrease the related risks with the LC. Corporate blockchain development solutions have the potential to detect errors and issues early on, allowing for prompt correction.
Tokenization of Assets To Ensure The Delivery To The Importers
Customers want quick updates on the products during shipment transit to minimize risks and possible damage. The buyers are not only unable to predict delivery delays and their possible causes—which could include bad weather, technical difficulties, port traffic, or other factors—but they are also unable to witness any damages that occur while the items are in transit.
The trade documentation moves separately from the products, which is the main cause. The buyer cannot claim that the goods have reached their destination until they receive the genuine documentation. Moreover, it is possible for the documents to be forged or destroyed, which would put the recipients in a challenging position. Blockchain technology in trade finance enables digital transformation by converting tangible assets into cryptocurrency. It also demonstrates how fast the concerned parties may check the blockchain network for transaction paperwork and the bearer of the item’s ownership. Adoption of blockchain technology also simplifies the distribution of insurance and risk management procedures.
Increased Bank Revenue via Digitized Payment Process
Trade receivables and financial instruments like drafts and exchange bills are linked by the banks. These tradable entities are received by the third party. All of this allows the suppliers to keep their money through the use of techniques like factoring and discounting.
Banks face a number of difficulties while managing the combined activities under the current conventional approach. It also happens because of the high bearing cost, the dearth of easily accessible information, and the unreliability of trade papers. These mistakes also give rise to other difficulties, such as costly legal disputes, financial fraud that harms reputations, and duplicate transactions. These difficulties might be solved by incorporating blockchain technology into the trade finance processing procedure and making the payment instruments available on the blockchain network. It also ensures that the receivables are handled efficiently.
Opportunities and Trends in Blockchain-based Trade Finance
Even if blockchain technology has already had a big impact on the global trade finance industry, there are still a lot of trends and developments in this process to watch in 2024.
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Unification of Blockchain
There are differences in the ecosystem that surrounds blockchain technology. One major barrier to the general adoption of blockchain technology in trade finance may be the abundance of incompatible blockchains and networks where users transact in isolation. Blockchain consolidation and interoperability advancements are therefore essential future developments that will allow system users to transact without risk or trouble.
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Adoption by Institutions
Although it is unknown whether widespread adoption will occur, institutional entities, such banks and international financial institutions, are actively researching blockchain technology. Thus, the extent to which blockchain technology is incorporated into trade finance procedures will depend on how widely banks adopt it.
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Computerized Recordkeeping
It would be oversimplifying the situation to claim that blockchain technology is the solution to every issue the trade finance industry is currently facing. On the other hand, it offers a substantial chance for the digitization of documentation, enabling the elimination of redundant paperwork, human labor, and other forms of red tape in the trade finance transaction process. These kinds of automation provide faster and more efficient operations, even in trade finance where blockchain adoption is not as widespread.
Conclusion
blockchain technology is poised to revolutionize trading finance by introducing decentralized exchanges, smart contracts, and enhanced security measures. This future promises transparent, secure, and efficient financial markets, democratizing access and transforming the way trading is conducted globally. Embracing blockchain in trading finance opens up new opportunities for innovation, transparency, and accessibility in the financial industry.
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