How Blockchain is Revolutionizing the Trade Finance?

Blockchain Technology offers various advantages to financial companies, including reduced transaction processing time and improved fraud detection, resulting in cost savings. The combination of blockchain and data analysis enhances the security of trade finance data, allowing for smooth scrutiny of large volumes of information.

Trust is crucial in digital transactions, particularly in global trade involving financial institutions and shipping companies. Despite the increasing scalability of blockchain technology, its adoption for trade finance transformation remains limited.

Blockchain in Trade Finance

The use of blockchain technology is revolutionizing global trade finance by enhancing safety, efficiency, and transparency in the entire process. This technology enables faster cycles, and automation, and eliminates human errors, creating trust through open transparency. Its impact is also felt in the capital market as blockchain allows for the exchange of financial securities with fewer intermediaries and lower costs, resulting in greater customization.

Blockchain technology aims to reduce the reliance on intermediaries, minimize transaction time and cost, enhance trading transparency, and streamline transaction processing. It also facilitates the tokenization and securitization of assets, reducing costs by 35% to 65% compared to traditional methods. Tokenization enables the transformation of tangible assets into digital assets on a blockchain, including real estate, commodities, private equity shares, and physical goods.

The adoption of this technology in trade finance streamlines the process and significantly reduces costs, including reducing transaction time from hours to seconds.

Current Landscape of Trade Finance

Trade finance is a critical aspect of international trade, with financial institutions providing credit to ensure the security of financial transactions. This process benefits both buyers and suppliers by fulfilling the delivery, payment, and auction cycle, closing the funding gap, and shortening the trade cycle. The availability and stability of financing mechanisms are vital to the $16 trillion international trade industry, making trade finance a driving force for global trade.

However, several factors such as variability in trade and legislation requirements and operational and logistical difficulties when many parties participate expose certain business participants to business risks and failure. Increasing numbers of litigation and fraud related to trade financing have been reported by the International Chamber of Commerce, including Citigroup’s $1.1 billion lawsuit due to financing falsified receivables and several banks’ losses of $400 million due to trade financing fraud.

To address these challenges, blockchain technology is emerging as a solution. This provides secure and transparent networks for trade finance transactions, making them faster and more efficient.

Smart contracts automate trade finance deals, reducing processing times and increasing efficiency, and providing end-to-end visibility of transactions. Additionally, the decentralized nature of blockchain eliminates the need for a trusted intermediary, mitigating the risk of fraud and reducing transaction costs.

Market Segmentation

The global trade finance market was valued at $44,098 million in 2023 and is projected to grow at a CAGR of 7.4% from 2024 to 2030, reaching $90,212 million by 2030. [Source: https://www.alliedmarketresearch.com/trade-finance-market]

Trade finance acts as an intermediary between importers and exporters to mitigate transaction risks and enhance working capital efficiency in businesses by financing international trade flows. It includes activities related to financing both domestic and international trade. The market is segmented based on several factors, including product type, service providers, and end-users. Understanding these segments can help businesses tailor their strategies to specific customer needs and preferences, thereby enhancing their competitive edge.

Blockchain Solutions for Trade Finance

Blockchain technology offers various solutions that can transform trade finance and bring numerous benefits. Here are some key points that can help clarify any doubts you may have about this technology:

• Real-time document review

By linking financial documents to the enterprise blockchain, they become easily accessible and can be reviewed and approved in real-time, significantly reducing the time it takes to initiate a shipment.

• Disintermediation

Banks that use this technology to facilitate trade finance do not need to rely on a trusted intermediary to assume risks, which eliminates the need for correspondent banks.

• Decentralized contract execution

When the terms of a contract are fulfilled, the status is instantly updated on the blockchain, reducing the time and personnel needed to monitor the delivery of goods.

• Automated settlement and reduced transaction fees

Executing contract terms through smart contracts eliminates the need for correspondent banks and reduces transaction fees. This leads to more automated settlement processes and lower costs for businesses.

Blockchain Implementation in Trade Finance

The goal of achieving full digitalization in trade finance to simplify its complexities may take some time to accomplish, as the industry has been slow to implement blockchain technology despite recognizing its benefits. There are several reasons for this slow adoption, including:

• Lack of standard blockchain protocol

The absence of standardization across various blockchain platforms and the use of diverse consensus mechanisms, coding languages, and privacy policies create disparities that hinder interoperability and make it difficult to connect with each other.

Solution:

To prevent fragmentation that may limit the use of blockchain in trade finance and to promote full adoption, developers, technology providers, and other stakeholders must collaborate interdependently.

• Legal Systems need to recognize digital trade documents

The legal ambiguity surrounding electronic documents within various legal systems presents a significant obstacle to the widespread adoption of blockchain in the trade finance industry.

Solution:

Harmonizing regulatory frameworks and establishing legal recognition of e-documents are essential to promoting the utilization of blockchain technology in trade finance.

• High implementation costs

The high cost of establishing and sustaining a blockchain network is viewed as a major impediment to its universal adoption, as running blockchains entails considerable expenses in terms of computing power and electricity.

Solution:

Consider using a permissioned blockchain, which allows control over who can join and participate in the network, reducing the cost of maintaining and securing the network.

• Information Broadcast and Privacy Concerns

The decentralized nature of this technology poses security challenges, as every party that can process and contributes to the structure has access to the transaction thread and individual components, raising concerns about privacy.

Solution:

Implement identity management solutions to ensure that only authorized parties can access and view specific data on the blockchain network. Utilize encryption technologies to protect sensitive data and provide privacy for users.

Successful Use Cases

Blockchain technology has found various successful use cases in the trade finance industry, including international trade through Letter of Credit (LC) transactions. LCs are a widely-used payment guarantee issued by one bank to another to facilitate international trade, which can be impacted by various factors such as different laws, distance, and lack of personal trust.

Here’s an example of a successful trade finance transaction that demonstrates how blockchain can be utilized in trade finance involving a supermarket, borrower, funder, and supplier:

Supermarket:

A large supermarket chain needs to purchase a large quantity of fresh produce from a supplier located overseas.

Borrower:

To finance the purchase, the supermarket creates a purchase order and requests a loan from a trade finance provider. The loan will cover the cost of the goods, shipping, and other related expenses.

Funder:

The trade finance provider reviews the purchase order and agrees to fund the loan, as long as the supplier meets certain criteria and the supermarket agrees to repay the loan with interest within a specified timeframe.

Supplier:

The supplier agrees to the terms of the purchase order and prepares the goods for shipment. They also agree to provide certain documents, such as invoices and bills of lading, to prove that the goods have been shipped and are on their way to the supermarket.

Shipment:

The goods are shipped to the supermarket and the necessary documents are sent to the trade finance provider to prove that the goods have been delivered.

Repayment:

The supermarket repays the loan with interest, using the profits from the sale of the produce. The trade finance provider receives their repayment through blockchain technology, which provides a secure, transparent, and efficient way to manage the transaction.

What does the Future Signify?

Blockchain technology is transforming trade finance by eliminating untraceable obstacles and promoting trust in transactions. The government of Dubai has embraced this technology for all financial transactions, making it the first government to do so. The industry is now experiencing collaboration and co-creation among companies to benefit from blockchain in trade finance, leading to an increase in demand for developers. This technology is expected to continue rising in trade finance, as many businesses are adopting efficient and automated processes to showcase its benefits. This shift is from traditional manual paper-based processes towards digitalization.

As a result, the trade finance sector has a high demand for blockchain technology. Therefore, if this trend continues, the worldwide Blockchain in Trade Finance and Credit Insurance Market is expected to experience significant growth between 2024 and 2025.

Contact Gyan Consulting for more information.