Consider this hypothetical situation:
A business owner in Canada wants to import some goods from China. He finds an exporter in China, places his order, and is now waiting for his shipment to arrive.
Now, notably, the exporter may be hesitant to ship goods before receiving the payment. On the other side, the importer may not want to release the funds before accepting the shipment.
To help ease the situation, traditional banks or financial institutions step in.
The bank releases a “letter of credit” to the exporter.
What is a Letter of Credit?
A letter of credit is a bank-issued document that ensures the payment is made on delivery or receipt of the goods.
Ideally, the importer would deposit money in his account. And the bank would issue a letter of credit against the deposit to the exporter.
Upon confirming the receipt of goods/shipment, the importer would then notify the bank and the exporter.
The exporter would need to submit the receipt of shipment with his bank, along with the letter of credit. And simultaneously, the importer’s bank would initiate the payment to the exporter.
It’s complicated. Right?
This is where blockchain technology comes into the picture.
What is Blockchain technology?
In this context, consider blockchain as a digital spreadsheet of transactions or an electronic ledger. But, unlike regular logs, the transactions here are distributed.
Typically, the ledger is distributed over a network of peers, known as a chain.
The transactions are, however, recorded the same way as in a regular ledger. Every transaction record contains the amount, date and time, sender’s and receiver’s information, and each user’s signature.
The noteworthy point here is that the transactions do not go through a central server/authority. In other words, these transactions are decentralized.
So, there is no involvement of a bank or a financial institution.
But, the question is…how does this technology help traditional trade finance?
How Is Blockchain Technology Changing Traditional Trade Finance?
Traditionally speaking, sending or receiving money from anywhere in the world is done through the SWIFT platform.
SWIFT stands for Society for Worldwide Interbank Financial Telecommunications.
Although there are other platforms, SWIFT is preferably used worldwide by banks for communicating.
However, despite being one of the most popular platforms, the system has several inefficiencies.
For instance, any cross-border transaction goes through several banks before reaching the final receiver. As a result, the system is quite time-consuming.
Besides, the involvement of a third party in the transaction creates transparency issues. And not to mention, it is also costlier than sending money between two banks without an intermediary.
In contrast, blockchain technology is a peer-to-peer network, which does not involve any intermediary. As also mentioned already, it is a decentralized ledger.
That being said, the technology has several other benefits to offer to the trade finance sector. Though some users may need to take Blockchain Training, the system can still prove to be far more convenient for both parties. After all, the success of any technology depends upon how easily users can learn to use it.
Nonetheless, here’s how it is helping the trade finance for business owners:
The first and the foremost benefit blockchain has to offer is enhanced efficiency.
Unlike traditional SWIFT-backed financial trading, there is no intermediary involved. Besides, there is no paperwork involved.
All these features make blockchain trade financing less time-consuming and more efficient.
Secondly, stakeholders can have real-time access to their transactions.
Both the importer and the exporter can have access to the shipment-related documents in real-time. As a result, the shipment process can be initiated quickly and offer a more economical option.
Speaking of the cost of the transaction, both parties can also save money in terms of interest to be paid to the bank for delayed shipment.
Tamper Proof Transactions
It is noteworthy that every transaction that is registered on the blockchain is irreversible.
Though the blockchain network allows everyone on the network to access any transaction, it does not allow making any changes to them.
Once a transaction has been registered on the network, it cannot be altered. Thus, eliminating any possibilities of duplicacy or transaction tampering.
Easy Transaction Auditing
Blockchain also allows users to track every transaction involved in financial trading.
For example, the users can see who initiated the transaction, who approved it, the transfers made before and after a particular transaction and more.
In short, the transactions on a blockchain network are easy to audit. And therefore, it can help business owners keep a check on their business finances.
Automation Of Transactions
One of the most important features of blockchain is automation.
Unlike a traditional trade, where the parties need to share consent or approval at every step in the transaction, they can automate it.
In other words, the importer can set contingencies for completing the transactions. For example, the importer may put up a date contingency or a document-related contingency. And the transfer will only initiate after the contingency is fulfilled.
Last but not least, every user on the network has a unique code or signature that allows them into the network. The code is often called a “digital key.”
The purpose of this key is to ensure that no third party can access the information in a transaction.
Besides, every transaction is protected with a cryptographic code. So, for completion, these cryptographic code needs to be deciphered. And this is how the network helps keep the transactions secure.
Blockchain-backed trade financing can be a game-changer for cross-border trades.
It can speed up the process while also keeping it safe and secure. And not to forget the economic benefits it has to offer to international traders.
The only challenge here is educating the traders about the technology and teach them how to use it.
Most people know the technology as synonymous with cryptocurrency or digital currency only. Note that blockchain is just one of the many technologies that help with the trading of cryptocurrency.
Perhaps, this is why we are witnessing a lot of other technology-backed products using blockchain.
So, to begin with, the users need to be enlightened about the technology and how it is different from cryptocurrency.