Blockchain: closing the $1.5 trillion gap in trade finance
It might not be the most glamorous subject, but trade finance is something that quietly facilitates about $16 trillion of trade globally every year. In short, trade finance solves the problem of trust between buyers and sellers of raw materials, goods, and commodities. We’ve compiled a report where we looked at how distributed ledger technology like blockchain is being used to address inefficiencies in the trade finance system. Amongst other findings, we learned that costs could be reduced by 35%, opening up an additional trillion dollars of global trade. You can download the full report for free on our site.
Rubber ducky, you’re the one
In every transaction, there is risk for both buyer (importer) and seller (exporter). Imagine you are trying to buy a shipment of rubber ducks from my factory in Germany. If you pay up front (cash-in-advance), you are bearing the risk until the rubber ducks are delivered. In the other extreme (consignment), if you only wanted to pay once you had sold the ducks to your downstream customer, I would bear all of the risk from the moment they leave my factory to head to port.
Give me some credit
Somewhere in between these poles are letters of credit (L/C) and open accounts. In our example, a letter of credit would be a commitment from your bank that I will get paid once the goods are received. You would establish credit terms with your bank, with an agreement in place of when to pay the seller. These L/C documents will then get passed between each actor in the chain (10–20 in total) and eventually get validated by my bank. When the rubber ducks are delivered, the payment will finally be made.
If it ain’t broke…
In reality, trade finance is a little more complicated in real life. And the system does work, having not changed much in centuries — besides the introduction of the fax machine in the 1970s.
But this whole paper-based process takes between 1 and 2 weeks. And according to research from Boston Consulting Group, over 90% of the 5,000+ document interactions in this process are ‘ignore/transmit to next party’. In other words, processing all of the paperwork for a trade finance transaction is cumbersome and time-consuming.
Because of the immutability of data on distributed ledgers, damages from fraud and human error are greatly reduced. Blockchain is a good match for the coordination and documentation problems of trade finance. A number of consortia have formed to tackle exactly these problems. R3, a consortium of over 200 partners (primarily financial institutions), has created the Corda distributed ledger. In addition to tackling other issues in finance, Corda is being used as the underlying infrastructure for two trade finance consortia, Voltron and Marco Polo Network.
Led by CryptoBLK, Voltron is a consortium of 12 member banks and is designed to streamline the entire trade finance cycle primarily through document automation and digitization, starting with Letters of Credit. Initial integrations include electronic Bill of Lading system Bolero and essDOCS.
Marco Polo Network is led by technology company TradeIX and consists of 14 public member banks. With a heavy focus on interoperability with legacy systems, it aims to streamline the flow of working capital by addressing inefficiencies in data storage, identity management, contract enforcement, and asset verification. In late March, Marco Polo achieved the distinction of completing the first ‘real’ (i.e. not a test case) blockchain-based trade finance transaction between firms in China and Germany. After the goods had arrived in Germany, a smart contract triggered an automatic payment to the Chinese firm.
Several consortia have decided to build on Hyperledger Fabric. we.trade is a collaboration between 14 European banks and helps SMEs access financing solutions for new trading relationships, a group currently accountable for 74% of rejected applications for trade finance. eTradeConnect, which started life as the Hong Kong Trade Finance Platform (HKTFP), is designed to increase efficiency and reduce fraud for trading partners in and around Hong Kong. It is estimated that Asia accounts for 40% of the $1.5 trillion gap in trade finance.
Komgo, built on JP Morgan’s Quorum blockchain and led by Consensys, is the fifth major trade finance consortium. Its focus is on improving efficiency for commodity traders and is composed of 10 banking partners.
You may notice from the market map that some banks appear in multiple consortia. This is due to the fact that being present in multiple networks increases the likelihood of the banks of both importer and exporter having access to compatible/interoperable technology.
Not just banks
Besides these bank-backed consortia, a bunch of blockchain startups are also innovating trade finance. Slovenian startup CargoX has created a blockchain solution for the Bill of Lading (B/L) document, and has already partnered with a number of logistics firms, carriers, and trading partners. Their ICO raised about $7 million last year, and they launched the platform in March, 2019. Tango Trade and Hijro both raised seed rounds from major investors like Draper Associates, Village Global, and Digital Currency Group. TradeLens, a joint venture of IBM and shipping giant Maersk, is already processing 10 million events every week from 100 organizations like ports, terminal operators, third party logistics providers, and carriers. For a full list of the initiatives and companies included in our report, check out our trade finance market page.
Now that these initiatives have had time to work with DLT and sign up partners, you can expect to see a lot more news in the coming months. With Marco Polo recently completing its first live transaction, and platforms like TradeLens already actively being used, the age of blockchain-enabled trade finance is truly here.
To read the full report and see other market maps and platform comparisons, head to our insights page.
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