International finance deals with monetary transactions between two or more countries. It includes trade finance which refers to the use of financial products and instruments to facilitate trade between parties. Trade finance includes activities such as issuing letters of credit, export credit, factoring and insurance. Since, trade finance includes domestic and international transactions related to trade receivables finance and global trade, they make up a major chunk of global trade.
Traditionally, trade finance was a manual process with excessive paper work and documentation. With the advent of the computer, electronic forms of the same documents were maintained independently by both the parties. The excessive paper work increased the cost and time of each transaction. Banks and payments services aimed to reduce these expenses by implementing a system which would reduce the paperwork and lower the time taken to process each trade transaction.
Blockchain uses cryptography to link blocks of information secured by a key. The blockchain technology is a secured network where trading partners meet to trade securely. This network is secured by a key and allows real time update of information on its platform. This increases the transparency between parties and reduces the cost and time involved in the transaction. Once two parties enter into a transaction on the blockchain network the documents are shared over the network and reconciled constantly.
The question arises as to how trade finance works with blockchain. The working has been explained in the following steps:
- Meet trading partners: The first step for any transaction is for the buyer and seller to meet on a common platform. The platform offered by the blockchain network allows trustable trading partners to meet each other.
Example: Company A (located in India) meets Company B (located in USA) on the blockchain network and decide to transact with each other.
- Form a smart contract: The next step in the process involves the buyer initiating a smart contract with certain defined rules.
Example: Company A decides to purchase 5000 computers from Company B through a smart contract with rules defined by the parties involved in the contract.
- Buyer’s undertaking for bank payment: The buyer promises to settle the amount due when the goods are delivered.
Example: The buyer has a bank account at State Bank of India and promises to pay the amount due on the delivery of goods.
- Receivable financing: The seller can ask for receivable financing from its bank, if required.
Example: Company B wishes to opt for receivable financing and requests for it from its bank (Bank of America). This is recorded on the blockchain network as well.
- Goods are shipped: The goods are shipped by the seller once the goods are ready for delivery.
Example: Company B ships the computers to Company A’s address so that Company A can begin operations in India. The documents related to the shipment are updated on the network.
- Buyer confirms the receipt of goods: Once the goods are received, the buyer confirms the receipt on the blockchain.
Example: Once Company A receives the computers, he confirms the receipt and updates the documents on the network.
- Buyer’s bank payment: The smart contract will automatically process the buyer’s payment to the seller once the goods are received.
Example: Once the update has been made the payment is processed automatically by State Bank of India (Buyer’s bank).
Thus, this is the main process of how blockchain and trade finance work in a real world situation. Blockchain if incorporated in trade finance has its own advantages which are as follows:
- Real-time review: The documents on the blockchain can be reviewed by any party involved in the transaction at any time.
- No intermediaries: The blockchain network is accessible by everyone involved in the transaction and no intermediary parties are involved.
- No paperwork: The documents are updated on the blockchain without any hassle of paperwork between the parties to the transaction.
- Regulations: Details regarding regulations imposed by the governing authorities are also maintained at one location.
- Lesser time: The whole trade finance process involves lesser time as there are real-time updates for the shipment.
- Secure: The network is secure as it allows only the parties involved to alter and view the documents for the transaction. No outside authority is allowed to access the documents. The network is also secure as the company can approve who can see their trade transactions.
- Distributed ledger: The data is uploaded on a distributed ledger where several parties to the transaction have control over the information uploaded. This would prevent data manipulation and increase the reliability of the network.
- Consensus mechanism: The concept of consensus mechanism involves all transactions to be approved by all the parties and then added to the ledger in order to prevent double spending and fraudulent activities.
These advantages would benefit the blockchain users and also their business as a whole. Few of the enterprise blockchains suitable for trade finance include Hyperledger, R3Corda, Ripple and others. These enterprise blockchains build blockchain-based distributed ledgers for usage across industries.
Several companies are exploring the use of blockchain in trade finance. The Society for Worldwide Interbank Financial Telecommunication (SWIFT) is one of the companies interested in blockchain for trade finance. The CEO, Gottfried Leibbrandt stated that SWIFT will incorporate the technology into their service if it helps them provide superior service to their banks.
Barclays, a financial services company is claimed to be the first bank to use blockchain for trade finance. They believe that blockchain is the “new operating system for the planet.” The bank used a platform called Wave to upload bills of lading and other documents required for global transactions.
The People’s Bank of China is working its way to setting up an efficient blockchain platform. Their aim is to create an ecosystem to trade across Hong Kong, Macau Bay Area and Guangdong. They believe that the network would reduce the cost of every transaction by at least 7-8%.
We.Trade a joint venture company founded by nine banks uses the Hyperledger blockchain framework to manage, protect and track trade transactions between Small and Medium Enterprises (SMEs). Their main goal is to provide easy access to trade finance and build strong trading relationships.
I personally feel that blockchain technology will be incorporated in almost every company that trades domestically and internationally. Blockchain is a boon and will speed up the trade process and documentation procedure. Companies may take their time to accept blockchain as the most efficient way for trade documentation but its benefits will slowly override the current fallacies.
Thus, trade finance and blockchain are hand in hand with each other. The issues of trade finance are resolved with the secure and transparent blockchain network developed and maintained by banks and joint ventures. Blockchain will eliminate human error and provide real time document review for the company. Further, the technology will reduce the time and effort involved to process a single trade transaction. It is expected that companies that trade domestically and internationally will incorporate the blockchain technology in their operations in spite of the news regarding security threats and the decentralized blockchain network. Hence, there will be a widespread use of the blockchain technology in trade finance.
References
https://www.americanexpress.com/us/foreign-exchange/articles/blockchain-technology-to-streamline-trade-finance/
https://101blockchains.com/trade-finance-blockchain/
https://www.tradefinanceglobal.com/blockchain/trade-finance-and-blockchain/
https://tradeix.com/benefits-of-blockchain-in-trade-finance/
https://coinrivet.com/the-benefits-of-blockchain-in-trade-finance/
