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In addition to the many sectors where blockchain technology is already in use — from manufacturing and healthcare to real estate and government — trade finance is one of the most intriguing.
The phrase “Trade Finance” will be unfamiliar to individuals outside of the financial industry. I’ll do my best to make it as simple as possible. Simply put, trade finance can be defined as the financial transactions of both domestic and international commerce that are enabled by third parties such as financial institutions like banks. Lending, giving letters of credit, factoring, providing export credit, and insurance are common forms of trade finance.
Trade finance accounts for 80–90 % of all current trade between countries, making up a significant percentage of global trade. Trade finance is engaged in every import or export of products across borders. A wide range of activities and challenges are involved. One of the most difficult aspects of trade finance transactions is dealing with a high volume of paper documentation. As a result of dealing with these documents, the supply chain becomes even more convoluted.
So what is the current condition of Trade Finance?
To better understand the current state of trade finance, consider the following example. Imagine that an Indian firm called CSX is looking for supplies from an American supplier and that company wishes to import a particular number of those supplies into India. So, let’s call this company DGI. In order to import the items, CSX must pay for the commodities, but it is hesitant to do so since it wants to ensure that the goods arrive as intended. At the same time, exporters are wary of shipping goods unless they are confident in the timely receipt of payment.
At this point, the banks become involved to help the importer and exporter company resolve its problems. The importer’s bank offers a letter of credit to the exporter and agrees to pay the required amount if and when the exporter bank delivers appropriate papers indicating that ordered products have been loaded onto the ship or other means of transportation. As a result, the banks participating in the transaction ensure that the trust between the parties is being developed by holding the money for each party.
But what’s wrong with this system?
For more than a century, the above process has required a massive amount of physical paperwork. Banks and their corporate clients currently employ manual systems to keep track of trade activities, which results in a lack of transparency and additional expenditures.
- Unstructured data: All Trade Documents contain huge unstructured data collections.
- Document volume: 400 to 500 transactions each day, each having 20 sub-documents, is involved here.
- Compliance checks on a massive scale: On average, 32 compliance checks are present in multiple documents.
- Eroding manual accuracy: Consistent increase in the number of errors can result in low-risk compliance.
These dated paper-based trade finance systems must be replaced as soon as possible. As such, for Trade Finance, Blockchain technology plays a significant role in introducing new digitized solutions.
So how can Blockchain solve problems in Trade Finance?
Modern trade finance could benefit greatly from the implementation of blockchain technology. Trade finance providers, such as banks and consumers of trade finance products, i.e., businesses that purchase and sell goods and services, both benefit from the usage of blockchain technology.
Using blockchain technology in trade finance can cut processing time, eliminate the need of paper, and save money while ensuring transparency, security, and trust in the transactions. There is no chance of manipulation when intermediaries are removed from the process.
Here are some key benefits of blockchain in trade finance:
- Efficiency: The trade finance process is made more efficient by completing the transactions directly between the appropriate parties, without an intermediary, and using digital data. The parties can use blockchain technology to create smart contracts that automatically initiate commercial transactions. In this way, trade finance operations can be drastically streamlined, reducing costs and enhancing transaction speed.
- Traceability: With the use of blockchain technology, importers and exporters can see exactly where their goods and assets are located. In addition, the former owner can pass on relevant asset information to the new owner for possible action. This opens the door to new sources of funding and raises the bar for what constitutes a perfect investment in the exchange of products. Trade finance can benefit greatly from blockchain in this way.
- Transparency: Blockchain, as a distributed ledger technology, is able to record multiple details of transactions against business agreements and share the data to strengthen the trust in the system further. As a result, the possibility of data tampering is reduced, and a wider range of funding choices is provided.
- Auditability: It is possible to audit every trade finance transaction using the Blockchain indefinitely and in a sequential manner. In addition to providing a permanent audit trail for the life of the traded asset, this also reduces compliance expenses and improves the ability to authenticate assets.
- Security: Independently verified cryptography is used to authenticate each transaction within the trade network. Financial organizations can transmit private information thanks to encryption and cryptographically protected keys.
How Blockchain Benefits Buyers and Sellers in Trade Finance
The following benefits and prospects in trade finance are available to buyers and sellers thanks to blockchain technology:
- Access to a diverse range of trade finance solutions via a single platform: Buyers and sellers may easily shop around and compare a wider range of items on the site as participating banks roll out new offerings. Companies spend a lot of time and money in the trade finance industry when they inquire about new goods, compare and contrast them, and then choose the best answer. As a result, you end up with a tedious and time-consuming purchasing experience. By sticking with a trade financing source they’ve worked with in the past, many customers avoid this level of difficulty. Clients are often aware that a change in service provider could save them money. As a result, they are often constrained by the time and expense of making a transition to a new supplier. Choosing new products and service providers and switching to a better offer is now easier thanks to blockchain.
- More affordable traditional trade finance products for SMEs: Blockchain presents a great platform to access trade finance in ways that are not possible for these businesses under the conventional system. Traditional trade finance solutions are typically too expensive for smaller businesses because of the risks and complexity inherent in current trade finance procedures. Both providers and customers benefit from the benefits of trade finance being simplified by the use of blockchain technology. SMEs can take advantage of lower-cost items as a result of this.
- The order’s progress can be monitored at any point in time: Access to unified data on the blockchain may be beneficial to companies and purchasers in particular. They may keep tabs on the progress of their orders at each point along the way. Customers and merchants may be able to communicate more effectively now.
- Networking: Clients can also look into new potential markets using their trade finance platform built on the blockchain. Buyers and sellers could utilize the platform’s data and analytics to investigate growth into new areas because it often has data and analytics on various markets, clients, and suppliers.
- Unified documentation: Client organizations, like banks, could utilize the blockchain to streamline their own trade finance documents in the same way. Documentation on the blockchain is advantageous to clients who frequently have to utilize their own systems to store, view, and update trade finance documents.
Risks associated with importing and exporting goods can be reduced through the use of a variety of financial products in trade finance. Credit lines and insurance are the most common types of trade finance instruments.
A great deal of paperwork and documentation is required in today’s trade finance activities. Blockchain technology might minimize this complexity, and trade finance activities could be streamlined.
Trade finance providers, such as banks and other trade finance organizations, as well as consumers, such as importers and exporters, benefit from the use of blockchain technology. Small and medium-sized businesses (SMEs) could benefit from blockchain technology in the banking sector since it will allow the banks to reach a wider range of customers.
Trade finance platforms built on the blockchain can help clients streamline their paperwork and operations. Trade finance products can be purchased more easily, and switching providers can be done at cheaper prices if they are able to do so. Client organizations might also have access to external data and new markets as a result of blockchain.
The adoption of blockchain trade finance, on the other hand, is hampered by a number of issues. These include the price of development, the lack of consistent standards, privacy, access regulation, and the legal recognition and enforcement of smart contracts in the United States.Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.