Will Smart Contracts on Blockchain be the future of Trade Finance?
Trade Finance Industry Landscape & role of Banks.
According to WTO report, Trade Finance accounts for more than USD 10 Trillion annually. Leading Global Trade Finance providers, largely banks, sell competitive Trade Finance services and products e.g. Letter of Credit, hedging products etc. Other stakeholders such as port & custom Authorities, Shippers, Insurance companies also participate in trade finance transactions. In a most basic transaction, banks issue and confirm Letter of Credit, verify documents such as Bill of Lading and release payments. Banks also offer currency hedging products and offer loans.
Life is not smooth for banks.
Banks earn during this trade facilitation but face numerous challenges. E.g. just few years ago, major banks including Standard Chartered were duped of their money due to a fraud. Since Trade Finance is based upon paper based contracts and lacks transparency among all stakeholders; fraudsters were able to exploit this and secured financing from multiple banks using same invoices and collateral.
In addition, manual processes to verify documents also increase transaction costs and settlement cycle. Banking industry spends billions and takes weeks to settle.
Blockchain is the new kid on the block.
Blockchain technology addresses the existing Trade Finance problems. Using a permissioned Blockchain, all parties can transact and settle based on consensus. Blockchain makes trade life cycle visible to all parties and brings transparency. These transactions can also be made immutable and may help in reducing cost of trades.
What about Smart Contracts?
Current manual contracts can be replaced by Smart contracts and hosted on blockchain. Smart contracts can contain contractual obligations and settle on its own without any human intervention. These smart contracts can be integrated with the payment gateways and make the trade an automated process.
R3, a global banking consortium for Blockchain has built prototypes to support trade finance on Blockchain. Standard Chartered and DBS Group have been testing their product named TradeSafe using hashing algorithm.
A smooth journey for Blockchain Smart Contracts?
Smart contracts on Blockchain may replace existing inefficient Trade Finance processes in few years but it may not necessarily be a smooth ride due to several challenges.
· Absence of Standard Framework — In order to reap the real benefits of Blockchain technology, global financial institutions will have to agree on a common framework. Bringing all the banks to common ground may be a difficult task.
· Smart Contract is not a contract — Smart Contract appears to be highly promising but today’s Smart Contract is just the code and not a legal contract. Legal implications of unfulfilled or contested contracts are not fully thought through. Today’s smart contracts may not be smart enough to comply with KYC and other regulations.
· Interoperability Issues — Integration of Blockchain with existing IT systems could be another challenge for the banks. Banks will have to invest in building systems and APIs to communicate with Blockchain.
· Lack of unique Skills — Smart contracts will require a unique skill, combination of IT and legal knowledge. This skill does not exist today.
How do you see Blockchain smart contract becoming a possibility in Trade Finance?