Blockchain enables exporters, importers and their respective banks to share information on a private distributed ledger. The trade deal can then be executed automatically through a series of digital smart contracts – contracts written in computer code that can be executed automatically once certain conditions are satisfied. The parties involved in the transaction can visualise data in real time on their devices and see the next actions to be performed.
Application of blockchain to Letter of Credit
Smart contracts running on distributed ledger technology, which provides a single, immutable record of a trade verified by all parties, are seen as a key innovation in the trade finance space, with an increasing number of banks looking into real-world applications.
Using blockchain technology can help streamline the manual processing of import/export documentation, improve security by reducing errors, make companies’ working capital more predictable and increase convenience for all parties through mobile interaction.
The positive properties of blockchain technology look set to address some of the key challenges facing the trade finance sector. For example:
- Capabilities around transparency and consensus will help mitigate the ever-present risk of documentary fraud and hopefully reduce the cost of transaction reconciliation between and within banks
- The traceability associated with blockchain could potentially provide assurance and authenticity of products in the supply chain
- The immutability and digital uniqueness inherent in this technology also offers the potential to provide a secure transfer of value and deliver a solution to the trade finance problem of endorsement
- The challenge of maintaining Chinese walls or data privacy among counterparties to trade transactions could be overcome by utilising tokenisation as a form of cryptography, whereby parties are only allowed to access permissioned information
- Because of the distributed nature of blockchain, there is an indicative promise of resilience and robustness; this could potentially be broadly adopted at a reasonable development cost
- Smart contracts offer the possibility of self-executing contracts triggered by the efficient exchange of digital data, potentially revolutionising the long-serving Letter of Credit.
- Internet of things (IOT) which is still in the early stages of application to trade finance could be used to move physical assets while they are simultaneously tracked and purchased.
The seven steps to a blockchain-based Letter of Credit (LC) transaction:
1: The importer creates an LC application for the importer bank to review and stores it on the blockchain.
2: The importer bank receives notification to review the LC and can approve or reject it based on the data provided. Once checked and approved, access is then provided to the exporter bank automatically for approval.
3: The exporter bank approves or rejects the LC. If approved, the exporter is able to view the LC requirements and is prompted to view through the application.
4: The exporter completes the shipment, adds invoice and export application data and attaches a photo image of any other required documents. Once validated, these documents are stored on the blockchain.
5: The documents are viewed by the exporter bank, which approves or rejects the application.
6: The importer bank reviews the data and images against the LC requirements, marking any discrepancies for review by the importer. When approved, the LC goes straight to completed status or is sent to the importer for settlement.
7: If required due to a discrepancy, the importer can review the export documents and approve or reject them.