Blockchain: Evolution Not Revolution
Blockchain—more precisely, distributed ledger technology—seems to be the talk of the town. Best-known as the process underpinning the virtual currency Bitcoin, there is no doubt that it holds promise for global trade. Specifically, banks could use it to mitigate payment risk for their corporate clients, improve liquidity, and prevent fraud.
Yet it is important that, despite the buzz, we take a realistic approach to its potential. Banks must work together with technology companies and other financial institutions to overcome technical hurdles and, in the short term, focus on using blockchain for specific elements of the value chain.
How does it work?
Blockchain technology works as a distributed ledger—a record of data that is shared among all users of a certain computer network. Once completed, a trade or transaction is recorded as a block of digital information (see stage 2 below). Once announced to all participants (stage 3) and verified (stage 4), the transaction is tied as a block to the previous data (stage 5).
This creates a secure record or chain of information that is extremely difficult to alter. If someone wants to initiate a new transaction—creating a new block in the chain—all parties on the network must first accept its validity.
How can blockchain be applied to trade?
Trade transactions involve multiple players: from buyers, sellers and banks to shipping companies, forwarders, insurance companies, customs officers, inspection bureaus, and regulators. A ledger that is accessible by all these parties could satisfy the industry’s need for improved transparency and security—providing an authenticated stream of data, recording everything from the initial purchase order, to production, inventory, delivery of goods, and payment.
Banks, in turn, gain a clear and immediate overview of the complete supply chain. By removing the need for manual processing and matching of data, this could save resources and speed up the process of providing financing. Not only could this reduce the chance of non-payment and make supply chains more resilient, but it could also enable funds to be released quicker, improving companies’ liquidity.
Another promising opportunity is “smart contracts.” Underpinned by blockchain technology, these contracts automatically execute trade financing operations when triggered by an event. For example, once an importer has received its goods, a smart contract could enable automatic release of funds to the exporter.
The fight against fraud could also benefit from blockchain. A major risk in trade finance is double-financing—which occurs when an invoice presented for financing is already being used as collateral in another transaction, or the receivable has already been assigned to another bank. But blockchain’s clear and permanent record would make such deception much more difficult to achieve.
Challenges remain, however, and implementing blockchain-based solutions for trade finance will take time. From a technical perspective, the trade finance industry will need to agree on certain standards when it comes to upholding data security, as well as applying blockchain software interfaces to legacy systems.
Frameworks will also need to be harmonized across the industry. Were hundreds of different banks and trading counterparties to use different distributed ledgers based on different systems, the innovation’s main selling point—its interconnectivity—would be lost.
Banks must also work out exactly how blockchain can improve their corporate customers’ experience. Instead of replacing existing instruments and solutions with a blockchain-based alternative, it will be crucial to raise new potentials by identifying and testing use cases that support new business possibilities with blockchain technology—whether that is to improve liquidity and working capital, speed up provision of finance, or mitigate risk.
For example, the concept of a smart contract has already been applied with the Bank Payment Obligation (BPO). A hybrid instrument between the letter of credit and open account, the BPO uses automated data matching processes to provide companies with assurance of payment at the due date, faster handling of goods, and earlier receipt of trade documents.
Yet progress in blockchain also depends on partner banks and companies being educated on these innovations, investing in their development, and taking time to adopt them.
And development of the technology requires collaboration. Together, banks and financial technology providers must identify and develop specific use cases for trade, on a global level. R3, an association of over 70 players in the financial industry, is dedicated to exchanging ideas on blockchain, sharing experiences, and assessing the potential benefits to customers. The Euro Banking Authority Working Group for Cryptotechnology for Trade Finance is also working in this area.
Applying blockchain to trade finance could transform the industry. But it will likely be a process of evolution rather than revolution.
Petra Burckhardt is Global Head, Product Management Trade Services, Transaction Services & Financial Institutions at Commerzbank.