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Trade Finance towards Blockchain

Blockchain – the BUZZ word that’s been going around for a few years now, but what exactly is it? Blockchain is just one form of the “Distributed Ledger” technology. To rephrase, “All Blockchain platforms are based on the Distributed Ledger technology but not all Distributed Ledger platforms can be termed as Blockchain”.

Let's start from the Ledgers, the most common concept in the financial sector with a history of being maintained by a third party who is to be trusted. For example, the Banks are the third party who would maintain and update all the transactions on the Ledger. One Ledger and one party maintaining it – Do we sense some single point of failure? Distributed Ledger Technology or DLT is the one that comes very close in revolutionizing this most fundamental concept in the Financial sector.

Technically, DLT refers to the databases distributed across various nodes/parties or computing devices. Every node in the network will have the replicated copy of the ledger. If a node/party wants to have a new transaction in the Ledger, it must go through a process called Group Consensus. During this process, every party in the network or group of dedicated parties must agree to the transaction that is to be created in the Ledger. Once the approval is in, all the Ledgers across the network will be updated automatically with this transaction.

So, what is DLT/Blockchain helping us to resolve or helping us to achieve? In a nut shell, it digitizes trust and maintain the transactions immutable on the Ledger. It also keeps up the Ledger decentralized and transparent.

Let us travel through this article exploring today’s most engaged field in Enterprise Blockchain – Trade Finance.

What can DLT/Blockchain offer Trade Finance?

Trade Finance, a majorly paper and trust based multi trillion Dollar industry, with complex processes and for the very same reason has been holding back the digitization for a reason. Blockchain/DLT could help build a digitized trust among the corporate, banks, service providers, regulators and other involved financial parties. Compliance costs and processes in Trade Finance could be shrunk to bare minimum. Few of the prominent factors that a DLT/Blockchain could handle in Trade Finance are listed below

Reducing the transaction process time: The delays in process during the data sharing among the parties is one of the pain points that could be resolved using DLT/Blockchain.

Disintermediation: The role played by all intermediaries will be redefined and reduced, as they will be part of the network themselves.

Transparency for all involved parties: All the involved parties including the insurance companies and shipping companies will get a real time view on the necessary documents over the life-cycle of a transaction and beyond. Even the regulators will be completely aware on every transaction happening on the network and will be able to validate and run through audits any time.

Real-time review: Financial documents when associated through Blockchain, could be subject to a real time review and approval.

Reduced risk: The bill of lading could be tracked throughout the transaction and hence reducing the risk of double spending.

 

How are the Banks involved?

Banks are playing a major role in reducing the reliability on the cumbersome manual processes in Trade Finance and digitizing the key trade products like Letter of Credits. DLT is the key technology that is being eyed by the Banks on the long-term vision for the better transparency, security and accessibility of the Digitized trade documents. With DLT, the trade transactions and the processes can be made accessible only to a defined group of trusted parties. Banks are inclining towards a closed Blockchain environment, where along with the Corporates are implementing Blockchain/DLT in a Federated way. Several major banks like ING, HSBC, Commerzbank and Standard Chartered belong to a range of Trade Finance Blockchain Consortia. These consortia are aiming at streamlining the traditional Trade Finance processes and operations and implementing them on a Blockchain/DLT platforms.

Apart from the banks the key technology players like TradeIX, R3, Corda, CryptoBLK, IBM, Hyperledger and Ethereum are involved in building these Consortia.

Let us analyze the major Trade Finance Blockchain Consortia built based on the Distributed Ledger Technology

Voltron: This consortium backed by R3 and CryptoBLK is formed by 12 major banks including HSBC and ING. The main objective of this consortium is to digitize the Letter of Credit and the process involved in it.

MarcoPolo: Backed by TradeIX and R3 Corda’s technology on Distributed Ledger, this consortium aims in developing an end-to-end open account Trade Finance network. The major banks involved this consortium are ING, Commerzbank and Barclays along with other prominent banks.

Komgo SA: With Komgo SA, along with the banks, trading companies, inspection and energy trading companies play a role of partners in this consortium. This consortium will be working on the commodity Trade Finance sector. This Blockchain/DLT application will be built based on Ethereum.

We.Trade and Batavia: We.Trade platform based on Ethereum, offers suppliers partial invoice financing and Batavia based on Hyperledger Fabric helps all participants to track their open transactions in cross-border trade. These two smaller consortia are backed by IBM and the talks had already begun in merging these two Consortia.

Following the trend, can few more mergers happen that could build a healthier venture handling the complete Trade Finance business?

 

How will a basic Trade Finance transaction look in Blockchain/DLT?  

Assuming all involved parties in a trade finance transaction like importer, exporter, banks, third-parties/customs and logistical companies are part of the Blockchain/DLT network. Each party will be a node in the Blockchain network.

1.      A sale agreement between the importer and the exporter will be shared to the Importer’s bank on the Blockchain/DLT network.

2.      Importer’s Bank will have the capability to review the agreement and draft the terms and conditions on the real time and submit it to the exporter’s bank on the Blockchain network.

3.      Exporter’s Bank will review the obligations and a smart contract will be generated on Blockchain covering the conditions.

4.      The exporters will digitally sign the LoC equivalent within the Smart contract and initiate the shipments.

5.      The Goods will be inspected by the third parties and the customs and will digitally sign it in the Blockchain network within the Smart contract.

6.      Once the arrival of the goods, the importer will digitally sign and acknowledge the receival of the goods.

7.      With the acknowledgement from the importer, the Blockchain/DLT will automate the payment from importer to the exporter.

 

Peeking into the future, DLT could be the layer on top of which the Trade Finance business would run. There are few key challenges like regulation and security that are to be addressed elaborately. But the recent successes on the Trade Finance pilots are more encouraging in taking this journey to the next level.

 

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Sriram Krishnamoorthi

Sriram Krishnamoorthi

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