Can Blockchain Really Transform Trade Finance?
By Alok Pathak on ALTCOIN MAGAZINE
Ever since the launch of bitcoin cryptocurrency about 10 years back, the technology behind it i.e. blockchain has created equal buzz around the world. Blockchain, used as a buzzword, is being applied to almost everything under the sun today. The hype and buzz are such, that it is touted to be the next big revolution after the internet, so much so that people who missed the internet bandwagon are jumping on to blockchain without giving a second thought, just so they do not miss this opportunity like they missed the internet boom.
Firstly, the distinction between bitcoin and blockchain is that while bitcoin is a digital currency, blockchain is a mechanism or framework that prevents the biggest risk in digital currency i.e. double spending. While you cannot present the same $100 bill to two different persons at the same time, such a scenario is possible with a digital currency. Blockchain works as a distributed ledger to solve this problem.
So is a blockchain really immutable or completely safe? The answer is NO. Blockchains are also subject to several hacks and thefts, the biggest of which is known as “51% attack”. Being a new technology, people are so busy looking at one side of the blockchain that they are completely blinded towards the current and future potential threats or risks in a blockchain based solution.
But while blockchain is successful with bitcoin, is it really necessary for everything else? Since this blog is dedicated to trade finance, we will discuss blockchain’s application in this field.
Like a bitcoin-based blockchain, a variant known as Ethereum Blockchain or “smart contract” is believed to revolutionize international trade finance field. It has its own digital currency “ether”. It allows participants to define business logic that enables completion of a smart contract based on the defined events.
Now let us revisit how international trade takes place and try to fit in blockchain based solutions –
i. Open Account — Here, the seller has complete trust in the buyer that he will pay up. The cheapest form of international trade. No bank, no letter of credit required. Obviously, no blockchain is also required.
ii. Advance Payment — Here, the buyer has complete trust in a seller that he will ship the goods. Again, the cheapest form of international trade. No bank, no letter of credit required. Obviously, no blockchain is also required.
iii. Documentary Collection — Here, the buyer and seller do not trust each other, hence entrusts the documents to be handled by banks. However, the banks provide no guarantee of their own. This provides some sort of assurance to the seller, but it is still not complete. Banks just handle the documents as per the instruction of the parties in the trade transaction. Now, because there is no undertaking of a bank, this is something that a smart contract may replace.
iv. Letter of Credit — Here again there is complete distrust among trading partners, but in this transaction, the seller has an independent undertaking of a bank, provided he complies with the terms of the letter of credit. This is absolutely necessary when there is no trust among trading partners.
Now, this trust of a bank in a letter of credit is misunderstood with the trust in a smart contract or blockchain, which is related to the transaction integrity.
It is the guarantee of the bank that provides comfort to the seller, which obviously will be missing in the smart contract. Hence, no matter how secure the transaction is, no smart contract can replace a third party payment assurance.
A few more points related to blockchain and cryptocurrencies that I find interesting are –
1. In a smart contract, the buyer will probably have to block or deposit the bill amount at the time he enters into a contract. Now, we all know the time value of money. Buyers try to delay the payment as much as possible. So for someone who imports millions of dollars’ worth of goods daily, it’s a big loss!
2. Another point that I find interesting is the claim that a blockchain based trade finance transaction is completed much faster than a normal LC. The point is, bulk of the goods in international trade are shipped by sea and it takes at least a couple of days for voyage and customs clearance, even for very nearby ports like Dubai and Mumbai. So what is the point of completing a transaction in a day when the goods won’t reach the buyer the same day! Also, an LC can be issued and transmitted in a matter of hours, if not minutes and can reach the beneficiary the same day. So the claim that LC takes a lot of time for issuance is unfounded.
3. Digital currency is supposed to replace the traditional currency, yet we see it is benchmarked or valued against the traditional currency. How can a replacement derive its value from the thing it is trying to replace? What will be the value of digital currencies once they replace the traditional currency? Today a bitcoin is worth XXX dollars, which is fuelling the interest in bitcoin. Tomorrow if digital currencies take over, what will the values of digital currencies be pegged against?
4. Every country has its own currency, whose value is based on a host of economic factors and the state of that particular economy. But a digital currency will have the same value across the world. Imagine a country like Zimbabwe having a currency whose value is the same as the dollar of USA. It simply does not make economic sense.
5. The more we circumvent banks and financial intermediaries, the more difficult it will be for corporates to raise loans from them. Financial intermediaries have a role to play in any economy. They are not just some useless middleman. A bank can lend only if it has deposits and income. They don’t create money out of thin air to lend. Hence, the more we bypass them, the more difficult it will be for corporates to raise money from financial intermediaries like banks.
6. Finally, whether it’s a traditional LC or blockchain based smart contract, an applicant who is determined to defraud a bank can do so even with a smart contract. In fact, it will be much easier with a digital currency. It all depends on how strong the bank’s KYC system is and how well it investigates suspicious transactions.
So while the use of newer technologies is a good thing, but its application must be to improve a well-established system rather than to speed it up at the cost of generating more haziness in an already opaque system.
Digitization of transactions is far better than digitizing the currency itself, as it will only open up a can of economic problems going ahead.
- Disclaimer — Views expressed are personal and without prejudice to any organization, person or entity. The article is not to be construed as advice in any form. Neither the author nor the website shall be liable to any person for any loss or damage arising out of any act or omission in connection with the published article.
