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2021/5/14 The application of blockchain in trade finance: opportunities and challenges - Trade Finance Global 1/12 FCI reports 6.6% drop in global factoring statistics in 2020 Trade Finance Global Articles News | Advice | Blogs | FAQs VIEW ALL ARTICLES BY HAITHAM YOUSSEFBY HAITHAM YOUSSEF TUESDAY NOVEMBER 17, 2020 The application of blockchain in tradenance: opportunities and challenges The present article discusses the potential benets of using blockchain technology for trade nance activities and highlights signicant challenges facing the blockchains adoption The present article discusses the potential benets of using blockchain technology for trade nance activities and highlights signicant challenges facing the blockchains adoption. Trending Now 2021/5/14 The application of blockchain in trade finance: opportunities and challenges - Trade Finance Global 2/12 Traditional paper-based trade nance systems Trade nance serves as the lifeblood of international trade in goods and services by enabling transactions between buyers and sellers worldwide. Trade nance provides the credit, payment guarantee, and insurance needed to facilitate the transaction on terms that would satisfy all parties. One of the diculties involved with trade nance is the large volume of paper documents that make up much of the information ow between trading parties. Most of the trade nance activities involve a substantial amount of physical paperwork being shued back and forth between the importer, exporter, importers bank, exporters bank, shipping company, receiving company, local shippers, insurers, and others. This reliance on documents usually has drawbacks, including the cost and time required to prepare, transmit, and check these documents. Paper documents may also be open to errors and even forgery. COVID-19 impact Furthermore, the COVID-19 outbreak has impacted dierent trade nance steps, including deal origination and distribution, negotiable instruments, document transmission, authorized signatures, and shipping. Nowadays, several banks and nancial institutions worldwide are trying to quickly scale their digital initiatives to move toward a world where digitalization is central to every interaction. Banks are looking to utilize technology to streamline trade by creating digital ecosystems that reduce costs and increase trade nance eciency by replacing paper with digital data ows. The International Chamber of Commerce (ICC) survey conducted in April 2020 indicated that banks are focusing on the rapid adoption of blockchain, the digitization of documentation, and automated processing and handling software in response to the COVID-19 pandemic. 2021/5/14 The application of blockchain in trade finance: opportunities and challenges - Trade Finance Global 3/12 Potential benets of blockchain technology for trade nance There has been widespread optimism regarding the application of blockchain in the banking industry. Many industry practitioners argue that blockchain technology can disrupt business and nancial services in the way the Internet disrupted o-line commerce. Blockchain technology holds the potential to change business processes by redening value chain interactions, reducing operational complexity, and reducing transaction costs. Blockchain technology entails a distributed database that autonomously maintains a continuously growing list of transactions recorded in units called blocks, and secured from tampering and revision. Each block contains a timestamp and a link to a previous block. The blockchain combines several computer technologies, including distributed data storage, point-to-point transmission, consensus mechanisms, and encryption algorithms. Most blockchain networks aim to create a database system in which decentralized agents or institutions can jointly record information and maintain it, with no individual party exercising continuous market power or control. The basic idea of blockchain technology is to decentralize data storage so that such data cannot be owned, controlled or manipulated by a central actor. Blockchains proponents argue that the blockchain, serving as a shared ledger (database), may facilitate trade nance using its distributed network, which maintains transparent records of critical transactions among trading stakeholders. The blockchain could potentially enhance transaction transparency and supply chain traceability. Trade nance practitioners claim that moving to paperless trade would be hugely benecial in supporting the supply chain through reduced costs, error-free documentation, and fast transfer of documents to customers. Accordingly, banks would generate more revenue from trade nance activities by attracting businesses not participating in cross-border trade and companies selectively shifting from open accounts to documentary credit transactions to seek greater risk mitigation. It is assumed that blockchain technology can address the shortcomings of the traditional paper-based trade nance system by digitizing, optimizing, and shortening the trade nance process and making it more transparent, cost-ecient, and accessible. By digitizing documents, banks and corporates would reduce the need to collect, scan, and re-key data, leading to greater eciency in the trade nance process. Furthermore, as blockchain allows for simultaneous access to critical documents by all authorized parties anytime or anywhere, it might eliminate manual tracking and reconciliation of paper trails and bilateral e-mails. Using Smart Contracts in International Trade Blockchain technology has permitted the emergence of “smart contracts”. Smart contracts are contracts based on decentralized consensus as well as tamper-proof algorithmic executions. The smart contracts refer to a series of digital agreements, including terms and conditions promised by contract participants. With its programmable protocol, the smart contract allows the execution and automation of contract terms. The essence of smart contracts is that they can enable parties who have no trust in each other to collaborate without the need for a trusted intermediary like a bank. Smart contracts may be programmed according to the terms of contractual agreements, and payments may be triggered by predetermined events. Various research indicated that smart contracts could reduce costs for gathering and processing information, drafting and negotiating contracts, monitoring and enforcing agreements, and managing relationships, allowing for more market-based governance structures under certain circumstances. 2021/5/14 The application of blockchain in trade finance: opportunities and challenges - Trade Finance Global 4/12 Smart contracts generally may increase trust in data due to the secured storage system and guarantee operations to be executed automatically without human mistakes or intermediaries involved in making the payments. Thus, smart contracts and blockchain technology seem to be appropriate for international trade activities in which the importer and export have little -if any- trust in each other. Smart contracts could secure trust among parties in open account trading, enhance transparency in trade transactions, guarantee data reliability, reduce the risk of errors or fraud, and facilitate the exchange of payments. Initiatives to apply blockchain technology in trade nance Blockchain technology is still at an early stage of development, and further research is needed to enhance its eciency and security. Several business institutions have established their own blockchain laboratories, working in close collaboration with blockchain platforms, and published a series of studies on this topic. In 2016, Barclays announced its cooperation with ntech start-up named Wave to initiate the supposed rst global trade transaction with its blockchain-based letter of credit project using the Wave blockchain platform. The transaction guaranteed the trade of almost USD100,000 worth of cheese and butter between Irish agricultural food co-operative Ornua and the Seychelles Trading Company. In 2018, HSBC announced that it completed a trade nance transaction to issue an entirely digitalized letter of credit, using blockchain technology. In this transaction, HSBC Singapore acted as the issuing bank of the letter of credit, and ING Geneva served as the nominated bank. During the same year, Banco Bilbao Vizcaya Argentaria (BBVA), a Spanish bank, used blockchain technology as a substitute for traditional trade documents. This project was related to the importation of frozen tuna from Mexico. The letter of credit for this project was issued by BBVA. In this transaction, the blockchain solution provider utilized digitized documentation and electronic signatures to replace traditional paper-based trade documents. In 2020, Standard Chartered and DBS Bank Ltd announced that they have kicked o a project to use a blockchain network to register trade nance transactions with the support of twelve other banks, including ABN Amro, ANZ, CIMB, Deutsche Bank, ICICI, Lloyds, Maybank, Natixis, OCBC, Rabobank, SMBC and UOB. DBS Bank Ltd and Standard Chartered mentioned that they would work with the Association Banks of Singapore to implement the trade nance registry within Singapore before expanding it globally to cover major trade corridors at a later stage. IBM has been spearheading the application of blockchain and smart contracts to trade nance. In 2017, IBM and Maersk, cooperating with Hyperledger Fabric, announced the completion of an end-to-end digitalized supply chain model using blockchain technology, which involves trading parties and various ports and customs authorities. Furthermore, dierent types of blockchain consortiums have emerged to promote blockchain technology and its applications. The development of trade nance platforms was carried out by several large banking consortia in collaboration with technology providers such as IBM Hyperledger or R3 Corda. 2021/5/14 The application of blockchain in trade finance: opportunities and challenges - Trade Finance Global 5/12 Large banking institutions have opted for cooperation because digital platforms could be ecient and benecial to clients if they reach sucient size and market coverage. The most well-known blockchain consortiums related to trade nance are we.trade, Marco Polo, Contour, Komgo, India Trade Connect, and eTradeConnect. Download our whitepaper: Blockchain & Trade: Where do we stand? Download free Challenges facing the implementation of blockchain in trade nance While the goal is to reach complete digitalization, achieving this target is likely to take some time, assuming it can be fully accomplished. As it could be recognized, the adoption of blockchain technology in trade nance has been slow. This slow adoption of the blockchain may be attributed to several factors. The hereunder factors seem to be among the principal causes of the weak adoption of blockchain technology in the trade nance eld. 1. The lack of standard protocol for blockchain networks One of the primary problems related to the development of digital platforms in trade nance is that each platform developer is trying to do something dierent. Even within the blockchain community, there are dierent coding languages, consensus mechanisms, and privacy measures, creating silos that are unable to connect with each other. This problem leads to a lack of interoperability and standardization between various blockchain platforms. Blockchain is not a technology that individual rms may deploy on their own, it is crucial for multiple stakeholders to work together. Platform developers and participants should avoid fragmentation that could limit the benets of these platforms for the trade ecosystem and prevent its widespread adoption. The future of trade digitalization relies on interoperability and the development of end-to-end solutions. A crucial step towards end-to-end trade digitalization is creating an ecosystem that allows seamless exchanges of data between existing platforms. Accordingly, there is a need for the development of a global standard protocol for blockchain platforms in order for these platforms to be able to communicate directly with each other. If each party in the trade nance network maintains its own proprietary source of information as it does today digital documentation of each transaction would need to be checked and re-entered manually at every step of the process. Having many dierent centralized systems globally would create localized data centers that do not interoperate with each other. The existing consortiums and platforms appear to be digital islands, with paper documents often serving as a bridge to each island. For blockchain technology to achieve its expected benets in trade nance, all of the ecosystem participants, including trading companies, logistics, and shipping rms, banks, and customs, need to agree on a uniform set of technology standards and business rules. There are several initiatives working towards creating a set of digital standards for trade. Some of these are focused on particular sectors or geographies, while others are more general. 2021/5/14 The application of blockchain in trade finance: opportunities and challenges - Trade Finance Global 6/12 The ICC Digital Standards Initiative, which was launched in September 2020 with the support of Enterprise Singapore and the Asian Development Bank and the participation of the World Trade Organization (WTO), is an important step towards the development of globally accepted digital standards for trade. Article: REVEALED: The 19 Standardization Projects aiming to glue trade together Read now 2. The Need for Legal Systems to Recognize Digital Documents in Trade The discussion of the digitalization of trade would not be complete without mentioning the importance of building a harmonized regulatory environment that can support the digitalization of international trade. It could be said that a considerable challenge facing the adoption of the blockchain across the trade industry is related to the uncertainty over the legal status of e-documents among legal systems. Most of the legal systems worldwide are likely to recognize the status of paper documents in international trade. However, it appears that many jurisdictions do not recognize e-signatures and e-documents for trade activities. The ICC banking commission report about the legal status of electronic bills of lading in ten jurisdictions, including UK, USA, Germany, Netherlands, UAE, China, Singapore, Brazil, India, and Russia, revealed that the legal status of electronic bills of lading is still unclear in many jurisdictions. The report indicated that most of the above mentioned surveyed countries have some form of legislation, allowing contracts to be created and signed electronically. However, only the USA (New York law) recognizes electronic bills of lading as having the same legal status and