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6-WEEK ONLINE CERTIFICATE PROGRAM
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Blockchain technology is making substantial inroads in trade finance and international trade to help minimize the complexity and risk of human error. The trade finance superstructure is the financial industry’s solution to the myriad nuances of value transfer from country to country and between the respective currencies. Contracts, credit, currencies, and financial institutions are all involved in the sale and passage of goods from one country to another, and different norms and regulations guide all of their interactions. Blockchain is simplifying this notoriously complex system with decentralized ledger technology and on-the-ground hardware.
International trade is a notoriously complex enterprise. Every international shipment has at least two sets of regulations and could deal with two or more currencies, languages, and financial institutions. Yet, despite all this complexity, all data must be harmonized to facilitate the free flow of goods and services between countries specializing in their production.
Smart contracts aren’t intelligently written contracts; they’re contacts that exist on the blockchain and automatically execute based on outside criteria. Their storage on the blockchain is essential because it memorializes the contract in an immutable (unchangeable) way. All parties to the contract, including lending institutions and regulatory agencies, can view the contract in a location-independent manner. Smart contracts virtually eliminate the need for trust since all parties can access the contract, which contains a record of fulfilled transactions. These contracts also control the flow of funds; funds cannot be released until the terms are met, and the contract, by virtue of its code, decides when the terms are met rather than any of the parties.
As the responsible parties for fund transfer and credit creation, banks play the central role in trade finance. Blockchain technology streamlines much of the complexities of international funds transfer and credit creation. The importing bank will review the purchase agreement and extend the necessary credit. The exporting bank will also review the purchase agreement and the terms set by the importing bank. As soon as the exporting bank accepts the purchase agreement, a smart contract is created and memorialized on the blockchain. This smart contract automatically executes itself when the terms of the agreement are met.
Once the import and export banks have reviewed and approved the purchase agreement, the exporter will sign a letter of credit that is memorialized on the blockchain. In September 2016, the first blockchain letter of credit was created between Ornua and the Seychelles Trading Company on a fintech platform created by an Israeli startup. $100,000 of dairy products were financed and shipped internationally. Usually, securing this funding agreement would take 7 to 10 business days. However, because of the efficiency created by blockchain technology, this was reduced to four hours. As a result, the amount of paperwork and the margin of human error was also significantly reduced.
The Sirona-Seychelles Trading Company isn’t the only case study. Since then, 3PL companies like Maersk and other shipping companies like Hapag-Lloyd and DHL have instituted blockchain technology. This introduction of blockchain has increased the efficiency of shipping and regulatory compliance, among other things. This adoption of blockchain ultimately lowers the cost of shipping services for customers and helps blockchain adopters become more competitive in the global market.
Blockchain technology allows for unparalleled transparency among all pertinent stakeholders. Decentralized ledger technology provides a single source of truth for any transaction, such as the transfer of funds, submission of bills of lading, and more. Any part that needs to verify the legitimacy of a given transaction is free to check the ledger for its authenticity.
The ease of access that blockchain technology can provide fuels increased transparency. All the information relevant to a shipment or transaction is stored on the blockchain, which is immediately accessible to the stakeholders. The one caveat is that for the totality of blockchain’s benefits to manifest, all parties must be using the same platform. A missing link in this blockchain usage will negate its upstream and downstream utility. However, the more companies begin using blockchain technology, the easier international transactions will become.
The blockchain is immutable by its very nature. Because of decentralized ledger technology, the blockchain cannot be modified unless all nodes issue their consent to the modification. This consensus mechanism virtually eliminates the possibility of fraudulent transactions and provides a single source of truth for all relevant parties. Since nearly every country’s banks function on a different system, the possibility of fraud is also high. However, blockchain’s immutability mechanism virtually eliminates this risk. Bills of lading have also been erroneously duplicated, leading to double-spending. These errors become entirely avoidable if all trade finance actions are memorialized on the blockchain.
Because smart contracts are essentially self-executing, the roles of banks and other financial institutions within international trade finance are reduced. This reduction in prominence and utility leads to significantly reduced transaction fees. In some cases, like domestic trade, financial institutions may be entirely sidelined by a blockchain that can handle intermediation and escrow-like payment approval. With traditional international trade finance, financial institutions no longer need intermediary correspondent banks to mediate risk.
Regulatory compliance is a painful but necessary part of any international transaction and trade finance. Phytosanitary licenses, FDA prior notices, and more abound, and this documentation can be easily misplaced. Blockchain allows governmental regulatory agencies to be stakeholders on the blockchain and check document submissions for the corresponding export and import. Any regulatory agency would be able to participate in viewing the single source of truth, which vastly streamlines import and export customs.
International trade finance is one of the many industries being transformed and improved by blockchain technology. The economic principles of blockchain are far from relegated to the realm of bitcoin and cryptocurrencies. The Wharton School created the economics of blockchain executive education certificate program to help executives and those involved in finance better understand this new technology. This executive education certificate program features more than 50 lecture videos, seven industry case studies, and three crypto valuation models to help professionals feel comfortable with blockchain technology. For more information or to enroll in the Economics of Blockchain and Digital Assets course, visit our information page for next steps.
This article is for marketing purposes only and does not intend to represent the opinions of the program.
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