InsightsThe Evolution of Trade Finance: Blockchain Signals New Era

26.02.2020| Resources

Here, we explore the history of trade finance, the challenges it faces today and how blockchain in trade finance is its future.

Jump To –

  1. The History
  2. The Evolution
  3. The Future
  4. The Mission

Trade Finance solutions have been leveraged for centuries, yet over the past couple of years they became the center of attention again. This renewed interest is driven by a new technology, blockchain. To understand the impact blockchain will have on trade finance, explore the content on this page to learn more about trade finance history, the challenges it faces today and how blockchain in trade finance will redefine its future.

Over the past decades, advances in information technology and digital transformation took over the business world. The financial services industry has changed. Yet, the way trade finance is conducted would still look very familiar to merchants from the Middle Ages.

While many corporates and financial institutions alike are focused on leveraging fintech solutions, trade finance specifically has not benefited as much as other financial sectors. Today, this is about to change. Trade finance utilising blockchain and distributed ledger technology is the next step in the sector’s evolution. The market interest, available technology and timing are now right to make it happen.

A Brief History of Trade Finance

The roots of early forms of trade finance date back thousands of years ago in Mesopotamia. The oldest examples of promissory notes and letters of credits were discovered on Babylonian clay tablets dated around 3000 BC. These were used to foster business activities around the trade routes in the region.

Trade finance was used throughout the Roman Empire in the context of importing and exporting to distant regions. It was also instrumental in helping Roman merchants expand their operations. As such, contributing to the growth of the overall economy and to the expansion of the Roman Empire.

With the fall of the Roman Empire in the 3rd century AD, the practice was somewhat abandoned until the 15th century. It is around this time that its second phase of development started in Europe, especially in medieval England in support of wool, cotton and finished cloth trade.

Trade finance gained in popularity in the 17th and 18th centuries, as the practice was expanded to America. Here it financed long-distance trade between the American colonists and their English, and subsequently Continental European trading partners.

Prior to 1930, trade finance was mainly used in the garment and textile industries and in the form of factoring. However, after the second world war, it became clear that it could benefit any trading business with new trade finance solutions being launched.

The developments of logistics solutions that followed and the introduction of new technologies made trade finance increasingly strategic for companies in various industries.  Today, it can be leveraged by SMEs (Small and Medium-sized Enterprises) and large corporations alike, globally, and in any sector. Along with this growth arose challenges that the sector still faces today. The digitisation of trade finance using blockchain technology aims to solve these challenges.

trade finance using blockchain

A Sector Under Pressure to Accomplish Its Digital Transformation

To best understand the journey trade finance has taken over the past 50 years including the major technological developments, refer to The Evolution of Technology in Trade, written by Dave Sutter, Chief Strategy Officer at Marco Polo Network. This white paper lays out the three paradigms underpinning how technology is being leveraged and developed in trade and working capital finance.

The Evolution of Trade Finance Technology

From the middle of the 20th century up to the beginning of the 21st century, businesses relied almost entirely on enterprise software and financial systems installed and managed on-premise. These on-premise systems were either developed by third parties and licensed to companies or built in-house as custom, proprietary software to suit the needs of that specific company.

While these on-premise software systems have made internal processes faster, more digital, and more efficient, they remain digital islands. These data silos are unable to connect seamlessly with other trading partners without complex, bespoke integrations. As a result, they still inject cost, risk, and friction into any trade transactions involving parties outside of that system.

The early 2000s saw a second paradigm emerge: trade platforms and networks managed by third-party providers, in an effort to address the connectivity challenge still prevailing. The goal was to bring trading parties onto a centralized destination platform or network to facilitate multi-party trade transactions. These are operated by a third-party vendor and available as cloud-based or SaaS (Software as a Service) solutions. Unfortunately, this approach did not remove the need for costly integrations but added issues relating to data custody, control and privacy.

blockchain in trade finance

Top Challenges in Trade Finance Today

Today, financial institutions and their corporate clients are faced with four major challenges when it comes to financing trade.

1. The Trade Finance Gap

In a recent report by the Asian Development Bank (ADB), the global gap in trade finance (the amount of trade finance requested by importers and exporters but rejected) is estimated at about $1.5 trillion. This could reach $2.5 trillion by 2025 according to the World Trade Organisation (WTO). The global gap is a major barrier to global trade and economic growth affecting particularly developing countries, mid-market firms and SMEs. 

In 2018, the WTO reported that 60% of trade finance requests by SMEs were rejected. As a result, trade finance is regularly listed as one of the top three obstacles to exporting. Indeed in many cases, if the request is not accepted by the financial institutions, the transaction will not take place.

2. Trade Finance Processes: still paper-based and manual

Trade finance processes are not yet entirely digitised. Data is still entered manually without automated cross-checking with parties submitting financial data on a spreadsheet or via printed and scanned documents. These processes are cumbersome, slow and prone to errors.

To illustrate the scale of this issue, Maersk ran a test in 2014, featured in The Economist, The World in 2019. The test revealed that a shipment from Kenya to the Netherlands included over 100 actors, 30 people, and 200 interactions. From the 34 days of shipment, 10 days were due to waiting for documents.

Looking closer at these interactions shows how big the potential for efficiency gains is. Each interaction involves the submission of information in data fields. A review of the end-to-end trade finance process carried out by The Boston Consulting Group (BCG), reveals that a single transaction can involve approximately 5,000 data field interactions.

The Boston Consulting Group (BCG)

These data fields are entered in various documents, which themselves are duplicated, creating a chain that generates discrepancies. This drives huge inefficiencies with only 1-2% of the data entered create value-add, while 85-90% is ignored and transmitted to the next party.

BCG estimates that the full digitization of trade finance processes would enable the streamline of over 90% of data field interactions, creating a process that is not only faster but also less vulnerable to error and fraud. Trade finance utilizing blockchain technology is key to accomplish this full digitization.

3. Trade Finance Systems: siloed and disconnected

Trade finance generally involves numerous parties such as a buyer, a seller, their respective banks as well as insurance providers, logistics companies, etc. Yet today, there is not one platform where all these parties can connect between each other. Instead, they need to connect to a multitude of platforms in order to initiate business, share documents and communicate.

These disconnected and ageing systems place hard limits on both banks and their corporate clients. For financial institutions, it limits their ability to develop new offerings and scale new revenue streams at a low marginal cost. For corporates, it makes access to trade finance solutions complex or even sometimes out-of-reach. The low adoption rates of certain trade finance products, particularly among SMEs and mid-market companies, reduce growth perspective and hinders economic development.

4. Leveraging Trade Finance: still risky and costly

The lack of connectivity forces all participants in trade finance transactions to undertake a multitude of complex and costly systems integrations. These different systems also must be updated and maintained.

It also impedes the effective digitalization and automation of trade finance, forcing all parties involved to rely on manual processes. This leads to transactions taking months when they could be completed in a matter of days. Errors are common and expected, causing delays and adding costs for time-consuming reconciliation processes.

Participants in a given transaction do not have access to a shared source of truth to know if delivery or a payment took place. The absence of transparency results in a lack of trust and consequently a high-risk assessment and costs.

trade finance distributed and powered by blockchain technology

The Future of Trade Finance: Distributed and Powered by Blockchain Technology

The evolution of trade finance is now at an inflexion point. After experiencing a slow start, the conditions to accelerate its digital transformation are here. There is the technology to transform trade finance: blockchain or DLT (Distributed Ledger Technology), a ground-breaking vision: distributed trade platforms and networks, and the resources: a complete ecosystem led by its biggest players embracing coopetition. Let’s deep dive into these major drivers of trade finance innovation.

An Introduction to Distributed Platforms and Networks

Trade finance powers global trade which is driven by companies embracing opportunities to do business with new partners. But today, these numerous firms and B2B transactions compose a global network supported by no common infrastructure.

Costly integrations to connect, data custody, control and privacy remain major challenges for participants leveraging trade finance to conduct international trade. So what is needed to solve these challenges?

In place of the current siloed systems and manual intensive processes, parties should start transacting via a truly digital and connected ecosystem for global trade, as outlined by Dave Sutter in “The Evolution of Technology in Trade”.

This can be defined as an ecosystem “that connects the majority of participants involved in global trade and allows them to exchange trade data and assets as seamlessly as one would exchange text messages and emails”.

A new technological paradigm makes this possible: distributed platforms and networks. By design it enables:

  • Independent software systems to transact seamlessly, securely, and in real-time over an open, distributed network that has no single owner, operator, or point of failure. 
  • Each user to retain control and custody of their own data. Allowing them to comply with all their jurisdictional, regulatory, and organizational requirements.
  • Users to connect-once-to-connect-to-many (COCM) and automate complex multi-party trade finance transactions.
  • To maintain one single source of truth across independent systems and trading parties who do not know or trust one another. Keeping data in sync and verified through complex math and cryptography, not human intuition.

blockchain global business networks

Blockchain, a Game-Changer for Global Business Networks

Over the past few years, there’s been a growing interest in blockchain triggered by the launch of the cryptocurrency, Bitcoin. Numerous articles and videos were shared on the subject, fuelling the hype and spreading misconceptions. Yet, the overarching technology i.e. DLT can be used to bring significant value to various sectors, including B2B (business to business) transactions and financial services. The advantages of using distributed ledger technology and blockchain for trade finance is certainly a game-changer.

Understanding the Concept of Blockchain and DLT

A distributed ledger is a database that exists among multiple users or across several locations i.e. each user/location has a copy of the database. It is thus “distributed” as opposed to a single, “centralised” database to which many users connect to.

Blockchain technology enables the recording of transactions on a distributed ledger across a network of users.  The data from these transactions is stored into blocks. Each block includes a time-stamped record of the transactions. These blocks are linked to each other in chronological order, thereby creating a chain or blockchain.

Thus, blockchain is one type of distributed ledger. All blockchains are distributed ledgers, but not all distributed ledgers are blockchains. The hype around Bitcoin made the term blockchain very popular and used to refer to any type of distributed ledger or DLT application.

Today, several companies are developing DLT protocols to suit various business needs such as Corda by R3, Hyperledger Fabric and Ethereum and leveraging different programming languages including Java, Kotlin, C++, or Python.

What Are the Benefits of Blockchain and DLT?

The core advantage of this technology is that it creates a single, shared source of truth to connect parties that do not initially trust one another. It also enables real-time exchange of data and assets between parties.

Trade finance is a perfect use case for blockchain application. Blockchain in trade finance facilitates unprecedented levels of connectivity while preserving the data ownership and privacy levels expected for financial transactions. In addition, it provides financial institutions with superior audit and compliance capabilities. This is enabled through the provision of a forensic audit trail as well as improved transparency and tracking of trade assets.

Corda blockchain technology, developed by enterprise software company R3, is particularly suited to financial services and trade finance in terms of permissions and interoperability to connect business networks. Moreover, it provides inherent identity management, automated contract enforcement, asset verification and tracking.

benefits of distributed ledger technology

Trade Finance Innovation: A Mission for the Entire Ecosystem

Trade finance transactions involve numerous parties; financial Institutions, their corporate clients but also logistics companies, insurers, electronic invoicing, procurement and compliance services, ERP providers, and various technology providers.

Trade finance is truly an optimal use case of blockchain and its transformation will impact and benefit the entire ecosystem. As a result, many are getting involved which is not only good news but a requirement for its success.

They do so by becoming members of various initiatives and trade finance blockchain consortia, launched to harness the value of this technology to improve trade and working capital finance solutions. Together, they define, challenge, develop, test and deploy new products and processes, in order to design the new normal for efficient trade finance transactions.

One of the main projects focusing on trade finance blockchain solutions is the Marco Polo Network, a global network developing a range of open account trade and working capital finance solutions. The Marco Polo Network is the largest and fastest growing trade and working capital finance network in the world.

Other large projects include focusing on Bank Payment Undertaking (BPU) for SMEs, VAKT and Komgo addressing needs in Commodities, TradeLens and Cargo for Shipping and Freight and Voltron as well as eTradeConnect focusing on Letters of Credit and e-bills of Lading.

These initiatives are important for the industry and lead to compelling projects and collaborations. They gather financial institutions, their corporate clients and technology providers to work towards a common goal.

These are very exciting times for the trade finance sector, and blockchain is an attractive technology with a lot of potential. Professionals need to develop their knowledge of the different concepts to drive innovation in their organisation and understand the benefits of joining trade finance networks.