As the gift that keeps on giving, the blockchain benefits from the variety of ways in which it can be translated to finance. Although cryptocurrencies are its largest asset, the capabilities of the blockchain are by no means limited to the trading of digital ledgers.
In this guest post for The Fintech Times, Rahul Nath discusses the wider abilities of the blockchain, and specifically how it could be utilised to unburden trade finance of its current vexes.
Nath is Head of Product at Drip Capital, Inc. Nath brings 15 years of experience in the Product and Strategy domains. He has lived and worked in North America and South-East Asia. Prior to Drip, he was leading product strategy at Google US. He has also worked as a management consultant with McKinsey and at Citibank’s Consumer Banking business. He has a B.E in Computer Sciences from NTU Singapore and an MBA from the Wharton School at the University of Pennsylvania.
THESE days, it’s almost impossible to avoid talking about non-fungible tokens (NFTs) and cryptocurrencies. With governments getting into the act with plans to launch central bank-backed digital currencies, there’s renewed public interest in the intersection of technology and finance. The US Federal Reserve has asked for public feedback on an official digital dollar.
On the other side of the world, India’s finance minister announced that India’s central bank would launch its digital currency as early as this year. These are significant moves that could change the face of fintech as we know it, powered by a common underlying technology – blockchain.
Blockchain is a secure, distributed ledger that keeps a decentralised record of every transaction. This record is distributed to every participant in the network, and the design ensures that the record is permanent and tamper-proof. Participants can verify records independently without relying on central clearing authority, making such a system far less prone to hacking than conventional systems today.
Thus far, cryptocurrencies have been the largest application of blockchain technology. Still, the potential use cases for blockchain are far broader, from industries like automotive and healthcare to essential services such as voting.
Trade finance, with its various instruments to facilitate cross-border trade, is one area that can benefit tremendously from blockchain’s distributed ledger. Blockchain can significantly improve collaboration and simplify processes, thus reducing the processing time and improving transparency. It can also eliminate the need for intermediaries, improving the economics of other ecosystem players.
In its current form, trade finance has several pain points. Trade participants are vulnerable to process inefficiencies and uncertainties in trade regulations across geographies. Inadequate insight into the movement of goods, complicated paperwork, and increased compliance requirements often add to the pain. A Cognizant study estimates that almost 60 per cent of trade finance applications globally from small and medium-sized businesses (SMBs) are rejected by banks, contributing to the $1.7trillion global trade finance gap. Blockchain technology and applications built on this technology can meaningfully address many of these issues, specifically in four key areas.
Smart contracts: As global processes get increasingly digitised, contracts can no longer be the traditional, paper-based, slow, and cumbersome protocols they once were. Smart contracts on the blockchain are self-executing agreements between two or more parties based on a predefined set of rules and conditions coded into the contract, designed to streamline processes that involve multiple intermediaries. These are already powering the world of decentralised finance (DeFi in short) and are a promising solution for trade finance. Apart from eliminating the need for third parties, smart contracts ensure that data cannot be lost or modified. Gartner has predicted that by 2023, organisations using blockchain smart contracts will increase overall data quality by 50 per cent.
Faster, cheaper payments: In conventional trade finance, payments are often delayed because of mismatched data between letters of credit and trade documents. Amendments to the letters of credit or corrections to the trade documents are arduous and often lead to delays. Compliance verification can be automated by creating a system on a blockchain platform. Since blockchain keeps a record of every modification or amendment to the data, any changes to the underlying data (traditional paperwork) can be automatically updated. Furthermore, blockchain is already paving the way for a better currency flow worldwide. Borderless transactions that cost less sound too good to be true, but because they eliminate middlemen (banks, in this case), blockchain-based transactions can be faster and cheaper than current payment methods.
Transparent factoring: Invoices accessed on blockchain provide a real-time and transparent view into subsequent short-term financing, according to consulting firm Deloitte. Because all transactions can be viewed by all parties concerned, there is no room for fraud.
Security and trust: Blockchain itself is protected by a robust underlying layer of cryptographic security. This means that all data stored on the blockchain is tamper-proof and therefore credible. Blockchain-powered solutions can thus solve the lack of trust in existing systems and significantly reduce the need for time-consuming and expensive verification processes and paperwork.
To be sure, blockchain is not a magic wand that will solve all the problems with trade financing and other issues related to cross-border trade overnight. Some experts believe a lot of the transparency and security features are still merely theoretically possible and will become a reality only as blockchain grows and matures.
As with all new technologies, realising the true potential of blockchain will hinge on adoption across the cross-border trade ecosystem. A few major players are already making early investments, but the path to, and pace of, widespread adoption remains unclear. Nonetheless, the potential of blockchain to transform cross-border trade is evident, and it’s a matter of when not if.