This article is an updated version of a thought piece I wrote for the Entrepreneurship without Borders course[1] at The Massachusetts Institute of Technology (MIT) circa October 2016. Eximchain, the disruptive blockchain tech company I mention in the article, became a fatality of the COVID-19 pandemic (however its founders continue to do foundational work in DeFi), but the rest of the article has aged pretty well.
During my MBA studies at MIT several pressing questions were raised about the feasibility of a fully decentralized supply chain, and how blockchain technology might change the game for stakeholders. In this article I focus on a particular part of the supply chain: trade finance for the transportation of finished goods between manufacturers (exporters) and retailers (importers), and how this process can be opened up using the blockchain.
Containerisation of finished goods and commodities has its roots in the 1920s, however it was not until 1961 that a global container standard was agreed[2] and not until the 1980s that containerisation started to proliferate through the shipping industry. It heralded a new era for global trade, where manufactured goods (like television sets and Harley Davidsons) could be securely shipped in a specific-sized container across continents, significantly reducing the expense of international trade. In the past decade, however, the ability to ship finished goods has increasingly favoured larger companies with established multinational presences and trade relationships.
One of the key challenges has been securing financing during the actual transportation of finished goods, commonly referred to as a Letter of Credit[3]. Given the time it takes to be transported from the manufacturer in a foreign country to their ultimate destination, the goods need to be insured for significant events such as losses (damage or physical loss of the items during transportation) and to ensure payment between the counterparties, especially if they do not have an established trading relationship. A small- to medium-sized manufacturer (SME) of products (owning one factory, for example) in China or India may be able to raise financing from local banks for working capital, but is unable to secure trade credit for the international movement of its goods.
Some of the pain points for trade finance banks are: the time consumed by assessing credit risk for each counterparty; difficulties establishing counterparties’ identities; and the fact that it is a largely manual process, all of which result in higher fees or no terms being offered to SMEs. Companies like Nike and Walmart, on the other hand, have developed highly sophisticated supply chains with lenient financing terms provided by international banks. SME manufacturers ‘locked out’ of direct global trade are more likely to supply goods to these global giants instead of directly to consumers, unless they are prepared to carry the risk of losses/badwill while their goods are in transit.
Finding a way to provide trade finance to SMEs would open up global trade to many more participants, bring better efficiency of trade (allocation of resources), and ensure the best prices for suppliers and consumers. If the blockchain could also be harnessed to track goods from creation to receipt – as proposed by Jessica Leber[4] and Rebecca Migirov[5] – then issues such as slave or child labour, environmental destruction and violence or political turmoil could also be effectively addressed.
In my experience visiting newly constructed containerships and ports across Europe, the U.S., Asia and the Middle East during my former banking career, containerships already implement sophisticated tracking software to monitor each container and its cargo to ensure faster loading/unloading times and to comply with international law, for e.g. the handling of refrigerated or volatile goods. New ports are also largely automated with tracking at each stage of unloading, stacking and warehousing before transhipment or transfer to land-based transportation. The main barriers exist at customs checking (especially in the U.S.), and related document checks by transhipment agents and the final importers (the ultimate receiver of goods). All these hurdles delay the point at which trade finance can be relinquished and the exporters are no longer at risk (paying a fee to their banks). Banks that provide trade finance are generally not prepared to devote the required amount of time to insure this movement of trade where small shipments are concerned.
Blockchain has the potential to significantly impact each of these current barriers. If we are able to verify not only the origins of a given product, but also ensure everything from the identities of manufacturers to the materials used in production, using smart contracts for example, then importers and exporters will be able to agree transactions in a timely manner and customs departments can effectively identify shipments that require investigation or can be approved instantly upon arrival. This efficiency can then be used at each subsequent stage of the supply chain.
Perhaps more relevantly, on the financing side, banks – or even a new collection of investors looking for an alternative to bank-based investments – will have access to a secure and accurate record of exporters’ and importers’ activities, which can be used to implement smart contracts[6] to start and terminate their exposure automatically. This also allows banks to assign creditworthiness to their customers to easily measure credit risk, thus significantly reducing transaction costs, while also giving tangible records against which to conduct anti-money laundering (AML) and Know-Your-Customer (KYC) checks. This ease on doing business has the potential to open up the trade finance market to the majority of global trade partners, 90% of whom currently conduct their trade on an open account basis.
MIT spinoff Eximchain[7] is currently investigating the feasibility of such an approach for trade finance, and is hoping to implement a creditworthiness score using observed data from its trade settlement service, allowing investors to originate loans for future trade financing. Of course, there is a long road to tread, and this paper is only looking at a small – but critical – part of the supply chain, ignoring the potential reluctance of lorry driver unions, governments, and sheer consumer apathy for how goods are made available to them. There is also the real possibility that, even if a decentralized supply chain – or even a part of it – is demonstrated to be feasible, Nike or Walmart would be the biggest beneficiary of such a system and choose to acquire it. Finally, we must not ignore the risk that existing trade finance banks develop their own individual systems which frustrate the interoperability of a global trade finance solution.
Still, on the face of current evidence, there is a compelling opportunity for a blockchain technology to support the transition to a new trade finance model with a level playing field for all participants, with full transparency for manufacturers, retailers and consumers.
[1] Also known as Implications of Blockchain Technology for Economic and Financial Development
[2] https://www.worldshipping.org/about-liner-shipping
[3] A letter of credit is a promise by a bank on behalf of the buyer (customer/importer) to pay the seller (beneficiary/exporter) a specified sum in the agreed currency, provided that the seller submits the required documents by a predetermined deadline; definition from International Chamber of Commerce
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