Blockchain and trade finance: whitepaper
Trade finance is an often cited use case for blockchain but it is important to be cynical to cut through the hype. But on the other hand, trade finance offers a compelling set of use-cases for the deployment of simple ledger verification – and, in time, smart contracts.
PrimaDollar is a specialist provider of trade finance and also real-time ESG data based on worker voice. Click here for more information about the linkage between trade finance and ESG.
Why trade finance and blockchain?
Trade finance is the process of getting exporters paid at shipment whilst buyers (importers) pay later. Trade finance requires trust between counterparties and so is often linked to the idea of using a blockchain ledger to record activity and transactions.
As most of us know, blockchain is a mathematical technique used across a network of nodes to generate an encrypted record of a transaction. With strong encryption, participants, both in the network and externally, can rely upon the resulting ledger entry as irrefutable evidence of the logging of the transaction into the ledger.
What can we use blockchain for?
It is important to break down the above paragraph into its components – so that we can then consider the relevance of this technique in the real world of commerce and trade.
First, the blockchain is being used to evidence the logging of a transaction. That is not the same as the transaction having occurred.
Second, whilst the logging of the transaction may be mathematically irrefutable, it does matter in our view, “whose blockchain it is”. Whilst trust may be derived from the methodologies employed, any ledger system is only as good as the people who built it.
Third, extending ledger entries into the legal world of enforceable contracts is also problematic. Legal systems are lagging along way behind the leading edge of technology and fintech. Care needs to be taken when it comes to relying upon the ledger entries alone.
For more comment on blockchain, check out this article on LinkedIn: click here.
What about trade finance?
With these very practical reservations expressed, where can blockchain play a role in trade finance?
PrimaDollar is a global provider of trade finance, with clients in over 30 countries and a leading player in the Indian export finance market. We have the flows and the networks in place to start linking together banks, capital markets, insurance, logistics, importers, exporters and trades. It is a very exciting time, and as our business digitizes, we are ideally positioned to include ledger-verification and smart contracts to support the legal agreements that underpin our business.
The main reason why this works is because our form of trade finance is very simple. The exporter ships, we pay him. The buyer can pay later, and we take the buyer credit risk. This is not like traditional trade finance which is quite complex, involving multiple banks and many communication steps. The simplicity of our model can be used as the basis of a trusted environment, which means that the implementation is quick and the value is immediately available to all the participants.
And this is what PrimaDollar is doing?
And so we are doing exactly this – so that every interaction “above the waterline” is matched by a similar interaction “under the waterline”. As we all know, the waterline is the boundary between the visible world in the air and the invisible world under the water – and our systems and processes adopt a similar approach. Above is the conventional world, below is the blockchain.
When importer arranges a program for his suppliers, we organise his exporting suppliers into a network over our platform. Each time an exporter ships his goods, he enters into a financing agreement with us – shipment-by-shipment. This is an old-fashioned contract, absolutely visible, although our exporters can sign digitally. Behind the scenes, the action of signing the contract inserts the signed transaction data into the ledger which results in the private blockchain evidencing the signature and the automatic generation of a smart contact matching the physical contract that the exporter has signed. This process is mirrored throughout the customer journey. When the buyer makes a payment, this is shown on our dashboards and visible systems – but also then recorded by us into the ledger and verified across the network. Each visible step in the conventional world is matched by signed transactions entered into the ledger and broadcast across the private network.
What is the value proposition?
Today, the value of these steps is that we can then provide, in parallel and simultaneously, both a ledger-and a conventional view of our world to our financiers, logistics partners, insurers and customers. The addition of the ledger gives a second, verified way to understand what is going on – cutting through the complexity of de-normalised, processed and presented data to the core transactions underlying our business – which can be shown “unvarnished”. Moreover, the operation of the ledger verification automatically broadcasts the transactions to the interested participants in a secured manner and ensures that everyone is in step and as close to real-time as we can make it.
This benefit is realised now – and it has a direct impact on the confidence that our counterparties have in the way that we work with them – and results in better communications, better flows of information and, in time, lower funding costs for our clients.
And the future?
At some future point, we can expect that our implementation of smart contracts will start to bring benefits too. Whilst legal systems are generally still not yet ready to recognise smart contracts as being legally enforceable, we see benefits flowing from operating them in parallel. As mentioned at the start, we believe that it does matter whose blockchain it is – and that there is a difference between one blockchain implementation and another, even though mathematically they should be identical. When it comes to using smart contracts as the evidence of a binding legal contract, we believe that track record will matter. Getting these implemented now means that we will build up a history of correct and accurate processing with traditional contracts being matched into smart contracts, thereby building up the confidence of our counterparties and the history of the accurate performance of our systems. These things will matter in the future, at a time when perhaps the world starts to recognise the validity of smart contracts supported by ledger verification ….
So private blockchains have a role to play in trade finance – and in any networked environment where technology is used to connect third parties together, where shared data is involved, and where trust is important. The simpler the network and the product involved, the more quickly trust in the ledger can be built – and the more quickly value can be realised.
Trade finance and ESG
Increasingly, trade finance facilities and supply chain finance will be linked to compliance with ESG standards in supply chains.
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