The role of blockchain in trade finance: what is in the future?
Trade finance which was developed during the Renaissance period is still existent and relevant in the present day world economy. The application of trade finance tools in inter-geographical exchanges is enormous, and hence, the World Trade Organization’s Director-General, Roberto Azevedo, noted that “About 80% of the world trade depends on 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: Every trade agreement includes a large amount of unstructured data.
- Document Volume: More than 400 to 500 transactions are made daily and each of them has more than 20 sub documents.
- Conformity Checks on a Huge Scale: In average, more than 32 compliance checks will be carried out in different documents.
- Eroding Manual Accuracy: A gradual increase in the frequency of mistakes results in low-risk compliance.
To this end, the banking sector is also exploring technology, which marked the beginning of a new era of innovation which is Blockchain.
Blockchain in trade finance is being explored in various ways to solve not only the above-mentioned micro-level issues but also the general issues of the sector. However, let us not forget that the current imbalance affects more than one company and, thus, turns to the function and consequences of blockchain and trade finance.
Risk in Geoeconomic Terms When There Is No Decentralization in Trade Finance
In developed countries where there is well-developed banking systems for both exporters and importers trade finance is not a big issue. Nevertheless, SMEs continue to struggle with the problem of inadequate funding due to the limited guarantees, credit history, and collateral as compared to large corporations.
For the SMEs in the developing countries, these challenges are even worse. They also face the same challenges as the banks in developed countries, but they have to operate in less developed financial markets and have to go the extra mile to prove their creditworthiness.
Another significant problem is that there is little or no access to the necessary experience that is needed to effectively address trade finance. One major problem that has always surrounded trade finance is that it is a very paper-intensive process. Another factor that has been noticed is that banks and their corporate clients still use manual methods to track their transactions and this results in a lack of transparency and increased costs.
To this end, trade finance needs blockchain technology and custom financial software development to improve efficiency, enhance transparency in the process, and decrease the dependency on paperwork. It is now high time that these technologies are adopted in order to revolutionize the future of trade finance.
The Potential of the Blockchain in Trade Finance: Concepts and Controversies
Today, blockchain is mainly connected with cryptocurrencies, however it has much wider application. Therefore, it is equally important to note that the traditional business can also use the blockchain to improve its operations. In its simplest definition, blockchain is a distributed ledger which provides a record of every transaction made in a certain process. These entries are open to all the concerned parties and cannot be edited or erased once made. This openness does not require the involvement of other parties and thus minimizes the costs associated with contract signing as well as the risk of fraud. Also, it enables real-time monitoring of processes which reduces on inspection time.
The banking sector was one of the first to embrace the innovation and it is easy to understand why. In regards to the concept of cryptocurrency transactions between wallets, this idea can easily be translated to the conventional bank transfers. Payment processes that are made across borders by using traditional systems such as SWIFT may take up to three business days especially where there is no a direct link between the banks. However, when it comes to blockchain-based money transfers, people can complete the process in minutes only. In the future, the same can be employed for customers’ verification and reporting to the authorities which will help in improving the adherence to the laws and regulations.
For instance, due to the new rules set by the European Union for banks to provide more information and do thorough background checks on clients and partners, several European banks which are headed by Swiss UBS have developed blockchain.
Hence, corporations that have a few verified counterparties can use blockchain, but those with hundreds or thousands of suppliers, customers, or franchisees will get the most benefits. There is one industry that can greatly benefit from the use of blockchain and that is logistics. In the traditional shipping processes, the accompanying documents are forwarded with the shipment and the documents have to be checked at different stages by the warehouse personnel and customs officials. This happens especially when shipping goods by sea where the cargo usually reaches before the necessary documents, thus creating delays.
This would be a revolutionary process if a blockchain-based delivery system were used in such a case. The sender transfers the required documents to the online storage where it can be accessed by a pointer on the distributed ledger. Each step in the supply chain is recorded by the application software and each participant can authenticate himself or herself with the help of private keys, thus guaranteeing the security of every transaction. The combination of the financial software solutions and the blockchain in the trade finance could also increase the effectiveness in documentation and payment.
The use of encrypted signatures in the blockchain prevents alteration of the cargo and guarantees that it gets to the right recipient hence minimizing on delays and fraud. This way of tracking and verifying is advantageous to all the parties involved, from the people working in the warehouse to the final recipient hence making blockchain ideal for trade finance and logistics.
Advantages of the Application of Blockchain in Trade Finance
However, the current world needs the application of blockchain technology in the trade finance sector as outlined below. Through the proper application of blockchain, the participants are able to minimize the time taken to process the transactions, at the same time as increasing transaction security, transparency and trust. Also, by eliminating the middlemen from the process, there is no one to manipulate the process and hence the system is more effective.
Here are some of the key benefits of blockchain in trade finance:
- Efficiency: The use of blockchain technology in trade finance has also been associated with the removal of intermediaries which is one of the gains. In this manner, the smart Contracts enable the parties to close deals without the intervention of other parties. It helps the businesses to automate the transactions and thereby, eliminate the need for manual interventions in trade finance process thereby saving time and resources.
- Traceability: Blockchain technology helps the exporters and importers to know the location of their goods and assets at any given time. It will also allow owners to share key information with the stakeholders which will enable them to respond to the situations in the most efficient manner. This improved traceability means that transaction are well accounted for and gives the best possible outcome for all concerned.
- Auditability: Trade finance through the use of Blockchain applications involves the creation of an audit trail of each transaction as it takes place, in sequence and cannot be altered. This leads to a strong and secure tracking of all the transferred items that cannot be tampered with decreasing the compliance costs for every transferred item.
- Transparency: Blockchain-based trade finance makes it possible to record transaction data which complies with contractual agreements safely. The use of a decentralized network where data cannot be altered makes it easier for participants to share information hence decreasing the possibility of data manipulation and increasing the transparency of the network.
Knowing the potential of blockchain in trade finance, it is evident that the integration of custom financial software development and the financial services software solutions will enhance these advantages and enhance the trade finance processes.
Let’s look at how blockchain is applied in some of the most common trade finance instruments.
Blockchain in Trade Finance – An Analysis
Blockchain technology is revolutionalising the trade finance by improving the efficiency of many instruments. Some of the trade finance instruments have already been affected while others are in the process of being developed. Now, let us see how blockchain is disrupting the trade finance.
1. The Concept of The Letter of Credit (LC) in Relation to Blockchain.
Letter of credit (LC) is a document used in bank to bank dealings especially in international trade as a means of providing assurance to the seller for payment. The traditional process is highly document-intensive, but blockchain technology is revolutionizing the workflow:
- The Applicant and Beneficiary enter into a trade agreement and the trade agreement is then registered in a blockchain network.
- With the help of the billing system, the Applicant generates a purchase order for the Beneficiary which is equivalent to the LC contract.
- The Applicant’s system on the blockchain network pulls LC application data and then contact the Issuing Bank to issue LC. All the necessary information that is needed for the completion of the order is given to the bank; this includes a copy of the purchase order in a digital format.
- The Issuing Bank opens and transfers LC to the advising bank.
- The Advising Bank gives advice to the Beneficiary in the digital form through the use of the blockchain network.
- The Beneficiary accepts or declines the terms by the same blockchain network.
This process allows safe and transparent dealings between the importers and exporters through eliminating the use of the conventional paper works hence cutting down on costs. Thus, the use of banking software solutions can even advance these blockchain-based processes in trade finance.
2. Blockchain and Forfaiting
Forfaiting is a technique by which exporters can sell their medium to long-term international receivables at a discount in order to obtain cash now and Blockchain is critical to this process. The technology makes the process easier and faster as in the case of the transaction between HSBC and the Bank of Communications that was done on the China Trade Finance Union blockchain platform.
In this transaction the buyer’s bank committed to pay a client of the Bank of Communications in 180 days for the goods sold. The Bank of Communications shifted the payment liability to HSBC through the use of blockchain, all the paperwork-including the offer letter and rights transfer were automated and transmitted. This application shows how faster and more secure forfeiting is through the help of blockchain technology.
3. Blockchain and Factoring Invoices
Factoring is a financial tool which enables the company to sell its receivables in order to get cash for its needs. Conventionally, this is done through the financial institutions such as banks that charge high-interest rates and require collateral in form of valuable assets.
In the proposed blockchain model, invoices are converted into NFTs thus allowing for easy storage and transfer of invoices. Smart contracts allow businesses to make payments for these tokenized invoices and all the transactions are stored in the block chain. This is because the use of blockchain in trade finance makes it possible to stop the domination of a few players in the trade financing space.
To add on this, firms can incorporate fintech app development services that incorporate blockchain with factoring systems that allow real-time tracking and reduced transaction costs.
Through the application of blockchain in trade finance, the traditional models are being altered by embracing aspects such as transparency, minimization of fraud and provision of better and more sustainable systems. This is because the integration of banking software development services and blockchain technology will keep on creating new avenues in the global trade.
What other impacts does the Blockchain have on the Trade Finance Industry?
This paper aims at identifying how the application of blockchain technology has enhanced the trade finance industry by changing several aspects and positively impacting all the stakeholders. So here are some of the major changes that have been brought by blockchain in the sector:
Automated Payment Options
A letter of credit (LC) is in its classical sense an instrument that is employed to support the transfer of goods and to channel the trading activities through banks. Nevertheless, the process is rather expensive, time-consuming and vulnerable to congestion since it is based on the documentation rather than the shipment of the goods. This is because it creates inefficiencies within the system hence products are delivered and remain unclaimed in certain locations.
Therefore, combining blockchain with financial software development services, the whole LC process can be reinvented to minimize its risks. Smart contracts enable exporters to be paid on delivery and the compliance certification process is done electronically. Further, corporate blockchain solutions can identify errors and problems before they become problems, thus solving them fast.
Asset Tokenization for the benefit of Importers Delivery
Therefore, buyers in the trade finance industry need timely information regarding their goods during the transit process to avoid risks. They can, however, struggle with regards to estimating shipping time or even detecting incidents such as damage that may happen mid-transit owing to factors like weather or port traffic congestion.
A key problem is that trade documentation is transported independently from the goods, which results in the fact that buyers cannot track the shipment without the corresponding documentation. There is also a possibility that the documents could be forged or even totally eliminated out from the system. The use of blockchain can therefore support digitalization process through tokenization of physical assets to cryptocurrency. Through the use of the custom financial software development, this process enables all the stakeholders to prove ownership of the goods and also access transaction information from the blockchain network. Risk management and insurance also benefit from blockchain as it optimizes the processes, increases the level of transparency and decreases the likelihood of risks.
How Banks can generate more Revenues via Digital Payments
Banks also have a very important role in the relation between trading receivables and other financial instruments like drafts and exchange bills. These tradable entities are sold to other entities and to this end, the suppliers employ factors such as factoring and discounting to ensure they have adequate cash flow.
Banks struggle with several issues in handling these operations under the conventional systems because these operations are costly, there is limited information available, and trade documents are unreliable. Other challenges that add to the difficulties include duplicate transactions, financial fraud, and legal cases among others. Thus, using blockchain technology and financial services applications in the trade finance, banks can move the payment instruments to the digital form and overcome these difficulties. This also means that it enhances the management of receivables and at the same time increases bank revenue through increased efficiency.
In conclusion, the use of blockchain in trade finance through the application of new ideas has revolutionised the sector through the streamlining of payments, increasing transparency in the system and most importantly, real time risk management.
Challenges and prospects of the blockchain application in the trade finance
Global trade finance has already moved towards blockchain technology and there is still much to look for in 2024. The following are the emerging opportunities that are defining the future of blockchain-based trade finance.
1. Blockchain Unification
It is today a rather decentralized and fragmented ecosystem with numerous distinct blockchains and networks which are not interoperable. This lack of interoperability is a current massive challenge to the adoption of blockchain in trade finance. One of the major developments that will be witnessed in 2024 will be the integration of blockchain which will enable participants to trade across different systems with ease thus lowering risk and maximizing on efficiency. The banking software solutions will be critical in the integration of these blockchain networks in a way that will facilitate easy transitions and the ease of transacting across these platforms.
2. Institutional Adoption
Many financial institutions including banks and other international financial organizations have begun to consider using blockchain technology, but mass application is not yet a reality. The above analysis shows that the extent to which these Institutions will adopt the blockchain will to a large extent determine the extent to which blockchain will be integrated into trade finance process. More and more banks begin to utilize blockchain, it will lead to a rise in the use of the financial services software development with the purpose of implementing unique solutions adhering to the legal standards and expanding the capabilities of the blockchain-based trade finance platforms.
3. Automated Documentation
Although, blockchain is not a panacea to solve all trade finance problems, it presents a significant way of enhancing documentation functions. Through automation of processes, elimination of the duplicate documentation and unwinding of bureaucracy, blockchain accelerates the process of trade finance transactions. With the current low levels of blockchain implementation, other automation tools such as fintech app development services can result in an immediate improvement of the speed and efficiency of trade finance operations.
Thus, the analysis of the current state and trends in the development of trade finance, it is possible to conclude that blockchain technology remains an active and promising field for growth and innovation. Some of the most significant trends that will likely define the future of the industry include the merging of blockchain networks, institutional investors’ interest, and the use of automation in documentation.
Final Words
The application of blockchain technology is decentralization which empowers the consumer with their data. While users increasingly demand their right to data ownership, more and more IT executives need to reconsider their approach to blockchain.
In its current form, blockchain is not perfect but has numerous advantages over the traditional systems especially the speed and efficiency in the trade finance processes. If well implemented, it has the potential of creating a revolution in the world trade.
For companies that want to incorporate blockchain into their model, teaming up with a fintech software development company such as Idealogic could prove to be very beneficial. We provide custom made solutions in the area of financial services software to meet your specific requirements. If you have any exciting ideas you would wish to implement, contact us.
Idealogic—Your Dedicated Blockchain Development Partner
In the blockchain development industry, you can rely on Idealogic to become a reliable partner focused on transforming your visions into sustainable, protected, and efficient applications.
Idealogic has proved to be abreast of blockchain technology and has worked hard to develop a number of excellent projects to boost businesses around the world. Whether you are focusing on optimizing your business processes, increasing transparency, or interested in entering the blockchain sphere, Idealogic has all the knowledge and commitment to accompany you through the entire journey.
For your blockchain project, do not go for a below-average experience—go with Idealogic and bring your ideas to life. Get in touch with us now or book a quick free call with our CTO to build the future that is based on the blockchain.
