Here's how blockchain reduces the overall costs associated with trade

Almost 90 years after the Smoot-Hawley legislation imposed trade tariffs that made economic conditions go downhill and sent people into despair, history looks like it might repeat itself. Trump’s tariff increases on steel and aluminum imports have sparked fears of a retaliatory war from Europe and other nations. The move has also prompted the World Bank to issue a warning that the impact on global trade could drop by about 9 percent, the same as during the 2008 financial crisis.

Although such a dire scenario may not come to pass, global trade is showing signs of slowing down. WTO predicted a 4.7 percent increase in the total gross merchandise exchanged around the globe in 2017; the prediction for this year is 4.4 percent.

The combined impact of unfavorable trends – protectionism, higher risk, slowing growth, and pessimism – will be felt on the cost of trade transactions. But with the help of digital technology, it is possible to limit the extent of the cost passed on to the end consumer. This article profiles one of the technologies that can really swing things in the world of trade finance, namely Blockchain.

Broadly speaking, Blockchain and other distributed ledger technologies can reduce trade transaction costs on three fronts.

Reduce transaction-related costs

International trade transactions are riddled with cost, complexity, and documentation. To cite just one example, a shipment of refrigerated goods going from Africa to Europe can involve more than 200 interactions between 30 officials and agencies. Just the financing process, from approving to issuing a Letter of Credit (LC), can take between 7 and 10 days. But a distributed ledger can dramatically bring down the time and handoffs, and consequently, the transaction costs. Last year, a machinery export deal between Japan and Australia carried all its trade processes on a Blockchain-based platform reducing the delivery time to two hours from several days earlier, cutting down the labor and cost of creating and dispatching documents, and making the entire process transparent to all parties.

The technology also eliminates intermediaries since the transactions are approved by a network of several thousand members by consensus. The immutability of Blockchain transactions provides an additional layer of safety since the transactions once posted and approved, cannot be repudiated, changed or withdrawn.

Check fraud

Fraud and malpractice in trade transactions can take a massive toll on the economy. A study by John Zdanowicz, a fraud expert and professor at the FIU College of Business, found that between 2003 and 2014, false invoicing rose 30 percent in the United States, from US$ 168.31 billion to US$ 230.58 billion, and total trade invoice fraud cost the country about US$ 2.3 trillion in taxes.

Duplicate invoice / bill of lading financing is rampant because banks have no way to check the authenticity of documents. With Blockchain, however, that problem is eliminated forever, because with network consensus and total transparency, there is no way a document can be duplicated or forged.

It is also impossible for a supplier to renege on an order at a late stage of a transaction. Once the paperwork is put on Blockchain, the network holds the supplier liable for keeping his end of the bargain.

If the innate safety and security of Blockchain could lead to just 10 percent of global trade transactions, it would significantly reduce banks’ spending on Anti Money Laundering, fraud detection, and risk management solutions. This would not only offset some of the cost increases arising from protectionist measures but also provide visibility and traceability, both of which are sorely lacking in trade transactions at present.

Improve banks’ balance sheets

Today most banks are struggling to meet even their cost of equity, let alone make a return on it. At the same time, banks are forced to spend sums of money on contingent liability insurance to protect themselves against potential lawsuits, loan repayment default, and losses to a third party for which they are liable. Blockchain can help reduce this cost. Since with Blockchain, there is little or no risk of a deal going bad, the need for contingent liability insurance reduces. And if an insurance company is brought aboard the network, it can track each and every transaction, and even revise the premium downward. The same logic applies to other service providers such as logistics partners, warehousing companies, and customs agents.

The potential of Blockchain and other distributed ledger technologies to lower the cost of trade is immense. A leading management consulting firm estimates that if implemented right, distributed ledger technology can reduce trade finance operating expenses by as much as 50 to 80 percent, and LC processing time by 80 percent. Technology providers are responding with a variety of solutions. A few months ago, Infosys formed an award-winning Blockchain-based network called India Trade Connect with a consortium of Indian banks to address trade finance processing requirements. Progressive banks across the world have also started seeing early results of their Blockchain implementations.

This is just the beginning.

The article is written by a Business Insider India contributor - Rajashekhara V Maiya, Vice President and Head of Business Consulting and Strategy at Infosys Finacle.
Rajashekara Maiya is responsible for Finacle’s business consulting practice where he heads client advisory, product strategy and pre-sales functions. He is also responsible for strategy regarding acquisitions and global alliance partnerships. He represents the company while interacting with external stakeholders such as analysts and the media. He has played several roles across diverse areas, including product management, solution architecture, implementation, and pre-sales over the last 18 years at Infosys.