Blockchain technology has emerged as a transformative force within the realm of trade finance, offering a paradigm shift that promises increased efficiency, security, and transparency. In an era where global trade is the lifeblood of economies and businesses worldwide, the potential impact of blockchain is nothing short of revolutionary. This article delves into the intricacies of how blockchain can reshape the landscape of trade finance, providing a glimpse into the future of secure and seamless cross-border transactions. Join us on this journey as we explore the compelling ways in which blockchain is poised to disrupt and elevate the world of international trade.
The market for global trade finance is predicted to reach an astounding figure of just over $11.6 trillion by the end of 2028.
The figures look impressive, but what is trade finance? Companies frequently engage in and support international commerce and trade. The products and financial instruments that they leverage to this end are known as trade finance.
In simpler words, trade finance facilitates international trade amongst businesses with suitable means. Given that the pandemic impacted the supply chains by a large margin, the situation of trade finance across the globe hasn’t been as well as expected. However, modern technology has come to the rescue yet again with robust and reliable solutions like blockchains. Especially since trade finance involves monetary transactions happening (predominantly digitally) today, blockchains can transform the operational aspect of this industry. In a trade survey by the International Chamber of Commerce, it was found that 54% of banks said they had begun to prioritize transformative technologies to improve the situation. Let’s understand how decentralized trade finance is better than the traditional version.
Global Trade Finance: Current Landscape
“Trade finance does not work as well as it could, particularly for the millions of smaller businesses that help fuel the global economy.”
McKinsey studied the current landscape of the global trade finance ecosystem; the findings were quite surprising, to say the least.
Global trade is an ecosystem fueled by its participants – a diverse mix of all sorts of institutions, corporates, entities, etc. – most of which are MSMEs.
However, attributing some of the challenges to the pandemic, MSMEs face a finance rejection rate of as high as 40%. The highest contributors to global trade, quite ironically, have the hardest time getting access to finances.
A few of the other key challenges identified constituted of:
The complexity of the transactions involved in trade financing
Limited or difficult access to historical data of an enterprise
Failure to meet risk assessment criteria
Access to liquidity
The hindrance to the evolution and progress of the trade finance industry can be attributed to age-old, traditional approaches and technology that is still in use.
For example, the LoC (Letter of Credit) that banks issue to exporters through underwriting today is issued through the Electronic Data Exchange. While this is still a paperless, electronic document, the traceability, authenticity, and security of the same can’t be ascertained fully.
However, recent technological innovations like blockchain, natural language processing, and optical character recognition hold immense promise to help improve how trade finance operates.
Operational Mechanics of Trade Finance
Trade Finance in the global market begins with two or more entities with mutual benefit meeting in a global marketplace:
One party is in search of funds for trade, the “Seller”
One party is in search of products, the “Buyer”
When these parties meet, the terms of trade finance can be negotiated. Before the trade can happen, though, the trade finance department steps in to perform due diligence on both parties to determine that everything occurs within legal boundaries.
In trade finance, “Investors” are also involved – parties with excessive liquidity who invest in the trade assets. This creates an ecosystem of trade goods and finances that goes around the global economy.
Challenges in Trade Finance
Being an industry that is centuries old, trade finance has evolved every which way over time. However, with the pandemic and global economy today, certain challenges have come to light that needs to be mitigated:
Transaction management seems to be the top challenge the industry faces today, riddled with redundancies, poor traceability, and data loss
Scaling up the transaction volume while maintaining resource deployment at an optimum level
Risks and compliance
These issues can be easily solved by adopting blockchains into the trading finance ecosystem. Let’s understand how.
Blockchains in Trade Finance: How Transformative Blockchain Features Help?
Blockchains are distributed ledgers of immutable information that can address the major pain points of global trade finance. Here is how:
Traceability and Transparency in Transactions
Blockchain's distributed ledger system helps improve the visibility of the assets involved in a trade and provides high tracking capabilities.
By setting up letters of credit using blockchains, contractual obligations can be automated by implementing smart contract protocols. The exchange of LCs would become completely digital, eliminating the risks associated with physical documents.
Network Consensus for Fraud Prevention
Blockchains run on the network consensus mechanism, making the transactions fault-tolerant. The issue of the existence of multiple letters of credit is eliminated since only one letter of credit can exist on a blockchain network for each transaction. It also helps mitigate the risk of fraud, since those with authorization can only access the document.
Security of the Blockchain Structure
Any record stored on a blockchain is inherently impossible to tamper with. This makes this new technology highly secure, traceable, and useful today.
Even if there are changes to be made to the LC stored on blockchains, a multi signatory mechanism exists that ensures all the parties involved consent to it through signature before the terms therein can be changed.
In short, the blockchain mechanism described below works brilliantly for LCs:
Smart contracts on blockchains govern the LCs and ensure the T&Cs are being met
The transparent blockchain system ensures end-to-end visibility and traceability of LCs in case there is an audit
There is no ambiguity in verifying the LCs by the issuing bank
The multi signatory modification mechanism keeps everyone involved in the LC in the loop, mitigating the risk of fraud
In a landscape where trade finance has already transitioned into the digital realm, the imperative to fortify security and bolster data validation capabilities has never been more pronounced. The specter of cybercrime looms large, necessitating the adoption of technologies that not only digitize documents but also provide an immutable ledger system, rendering the data impervious to tampering or unauthorized access. Blockchain technology emerges as a beacon of hope, seamlessly aligning with this essential need for heightened security and trust. By leveraging blockchain's inherent attributes, such as decentralization, encryption, and consensus mechanisms, trade finance can elevate itself to a plane of unparalleled security and integrity. The fusion of electronic trade finance and blockchain fortifies the foundation upon which global trade operates, instilling confidence and resilience into every transaction. Embracing this amalgamation is not merely an option but a strategic imperative to secure the future of trade in an era plagued by evolving cyber threats.
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