The technology has developed magnificently since the inception of blockchain in 2008; the first decentralized electronic cash system. The fastest-selling form of cryptocurrency; has made people interested in knowing how to buy these digital currencies.
Blockchain is unraveling at a fast speed, and may soon become a sustainable financial tool on a global scale. One of so many diversities of life the blockchain technology is finding its way to is trade finance and global trade.
The environment of trade finance remains unclear and a fractured industry in which paper processing is still very much dominant and multiple participants along the transaction life cycle. This archaic method has been a cause of limitation to all the companies involved e.g. Banks, importers, and exporters, export credit agencies, and various service providers.
Due to the rising cost and the risk involved so far, the industry has been searching for a way out in which it can be easier, more efficient and trade can be digitized making it perfect enough for the benefits of blockchain technology.
Using blockchain technology for trade finance means a faster and more transparent cross-border trade and a reduced trust in manual techniques. For example, Vertex Market has taken it upon them to create a Peer-to-Peer platform for Cryptocurrencies, allowing their customers to exchange conveniently and any currency easily into Crypto and back.
What Is Trade Finance?
Trade finance refers to the financial methods used by companies to encourage international trade and commerce. Trade finance makes it possible and easier for importers and exporters to transact business that relates to trade receivables finance and global trade.
The World Trade Organization (WTO) calculates that roughly 80 to 90 percent of world trade depends on trade finance, mainly of a short-term nature. In addition, private banks account for almost 80 percent of the trade finance market. Banks play a significant part in international trade by giving trade finance products that decrease risk.
How Does Trade Finance Work?
For example, A Company in the United Kingdom attempts to import a shipment of goods from supplier C Company in China. The importer wants to pay for those goods but is reluctant to do so before making sure that the goods will appear as ordered. The exporter is also skeptical to ship the goods, without being assured that the fee will arrive for the goods they supply.
Into this dilemma, the importer’s bank issues a letter of credit to the exporter through the exporter’s bank guaranteeing to pay the exporter’s bank once documents have been provided by the exporter ascertaining that the goods have been loaded onto the cargo ship or any means at which the goods would be transported. In this case, both the importer and exporter are insured, and the banks take on the position of holding the money for each party. The bank is the middleman and insurer in this case.
This pattern has been in place for hundreds of years, with rather little difference in the method and in the significant amount of paperwork being shifted back and forth between the importer, exporter, importer’s bank, exporter’s bank, shipping company, receiving company, local shippers, insurers and others. With each step of the procedure, all the paperwork must be verified between numerous parties, guaranteeing its precision. Blockchain can be a boon for this kind of transactions, one can transact in any digital currency. For example, if I have to transact to Nigeria I can directly use the same technology, which is totally secured with a private key. Know how to buy Ethereum in Nigeria and get your transactions secured.
Limitations of trade finance
Blockchain technology can promote procedures in trade finance transactions. Although presently, there are some limitations in the cross-border trade process, they are:
- Manual processes are used by the importer’s bank, to check sales authorization and import documents, analyze inconsistency, and provide finance to the exporter’s bank which takes a lot of time and can be subjected to human error.
- Invoice factoring is requested by the exporters who present their invoices to various banks, hence obtaining financial influence results but in an increased risk profile just to meet up with the deadline of the delivery of goods.
- A delayed timeline can be a result of the involvement of a lot of financial mediators, each of these mediators having their policies and internal procedures to carry out payments and confirm lines of credit.
- Multiple communication channels, means, and formats are usually used for trade finance, with underlying documents being submitted either electronically or in paper format. This put businesses and banks likewise to miscommunication and fraud.
- Delayed payments result from numerous monetary mediators investigating to verify that the documents submitted are in conjunction with the terms of the documentary credit or the guarantee. This process is rather time-consuming especially since it depends on the number of mediators in this banking chain.
- Duplicate documents can be submitted to banks, which may result in the processing of more than one transaction, and can cause drawbacks in recognizing whether any financial institution has already guaranteed a trade.
- Tampering with financial records can occur when means of communication or documents used in the transaction are not authenticated or protected against unauthorized access. Records may be altered, imitated, or fabricated.
The above listed are some of the obstacles that financial mediators face daily. Blockchain technology has the potential to decrease these risks or might eliminate them. Blockchain could revolutionize trade finance in the following ways:
Benefits of blockchain technology in trade finance
- Blockchain technology improves capability, as transactions are executed directly between parties without mediators. Import/export documents can be seen or opened by all parties and can be reexamined and authorized in real-time, thus eradicating mistakes and delays.
- Real-time access to trade documents guarantees that the shipment of goods commences in a shorter time, lowering the time and costs of documentary and also customs compliance.
- The threat of duplicate documents is eradicated since documents can be tracked.
Transactions can be skillfully traced, enabling audit processes. This reduces fraudulent actions as transactions are documented transparently and sequentially. A comprehensive inquiry of past transactions would help in performing a risk assessment for coming trades. For example, if you want to transact bitcoin to naira, you will be able to trace how every transaction is made.
- In terms of security, transactions are singly assessed through sophisticated cryptography to guarantee their genuineness.
- Collaboration is enhanced as transacting entities can share trade finance-related data.
- Sovereignty is gained as the introduction of smart contracts eliminates any dependence on a related bank and payment of transaction fees.
Limitations in implementing blockchain technology
- Legal and regulatory frameworks may not yet be conducive to deal with the particular features of blockchain technology; for example, some countries only understand negotiable instruments if they are on paper and signed. The obscurity of the extraordinary identifier may affect certain contracts and may be difficult to implement. Furthermore, as blockchains are not grounded in a particular location, questions originate pertaining to territoriality and relevant jurisdiction.
- Broad application of blockchain technologies and automation of many manual processes will make specific jobs in the trade financing region redundant, reducing job rates, and probably building harmful associated economic effects.
- The lack of standardization hinders the execution of blockchain technology owing to the increased number of Distributed Ledger Technology (DLT) platforms. Besides, as the agreement is expected across networks, the system action comes to be slower.
- The system is still liable to human error as data entry is still reached by suitable parties.
- There are data security and privacy worries, as transaction progressions can be used to point out parties.