While International trade has grown immensely over the past 20 years and exceeded USD 18 trillion in 2014, in many ways it is still dominated by old-fashioned paper-based methods rather than the latest technology. This can make trade very inefficient, expensive, slow and complex. The emergence of the blockchain technology and smart contracts promises to resolve the current problems and inefficiencies, bearing the potential to save global trade trillions of dollars.
The historical lack of innovation in international trade
There have been several historical developments that could be seen as revolutionizing turning points in the world of global trade. In around 1500 BC the Phoenicians first introduced international trade by founding maritime transport on a commercial scale, establishing long distance trade between Egypt and Mesopotamia. Next, in the 16th century the merchants of Venice introduced the innovation of factoring, a method still used today, enabling a company to sell its debt to a third party financial company at a discount. Finally, in the mid-1990s many companies integrated the internet and mass telecommunication into their business models. Banks, however, struggled to follow this particular path of innovation due to their legacy IT infrastructure. This lack of innovation still impacts international trade today and creates a lot of inefficiencies that have not been fully resolved yet. Although international trade is on a generally positive growth path, it is still dominated by old-fashioned paper-based methods such as letters of credit and factoring and not by the latest technological developments. Both inefficient practices together account for roughly $5 trillion of annual trade today, showing a huge potential for cost savings and more efficient technologies.
The trust problem
In most trade scenarios the low level of trust between both parties when it comes to payment and shipment represents a key problem: While the importer wants to protect himself from any risk by delaying his payment as long as possible to ensure that the goods are delivered as promised, the exporter requires the payment as early as possible to offset his costs and avoid any risks of an aborted shipment. A letter of credit from the importer’s bank resolves this trust problem. It guarantees the payment upon presentation of original documents by the exporter which prove that the goods have been shipped in good order. These letters of credit have been used for hundreds of years and have not really changed ever since.
Complex, cumbersome and bureaucratic
The letter of credit is only one of many other common export documents. Transportation documents, export compliance documents, certificates of origin, other certificates for shipments of specific goods, other export related documents, and temporary shipment documents are needed for an international trade transaction. According to the International Air Transport Association (IATA) each international airfreight shipment can require more than 30 different paper documents, increasing the cost of airfreight and lengthening transport times. It is easy to imagine how inefficient this process becomes when all of these different documents have then to be physically couriered and transferred between the importer, the exporter, the banks, port and customs authorities, the ocean carrier, the insurer, cargo inspectors and various other agents on each side around the world. On top of that, all necessary documents must be accurately filled out without error, inconsistency, or omissions that might result in non-payment, custom delays or even confiscation of the export-goods. This complex and bureaucratic process of signing and referencing all the different documents increases the chances of loss and fraud. While current technologies are able to produce digital documents, the digital exchange itself has always been perceived as problematic given the ease with which data can be replicated and manipulated.
Blockchain and its distributed ledger
Blockchain technology promises the potential to save global trade trillions of dollars and to resolve the aforementioned problems. The new technology is envisioned to solve trust issues between parties that do not trust each other, make trade more transparent and provide an infrastructure to securely store and share data. All necessary documents and information are found on a single decentralized ledger that can be accessed and shared with all parties simultaneously. With a distributed ledger, shipping transactions can be reviewed in real time by any member of a party (think Google docs for trade records), chains of custody can be verified and it is impossible to alter or challenge the authenticity of records. In combination with smart contracts, complex trade transactions execute themselves according to the terms of a business agreement without any human intervention. With this technology companies could save up to 5% of costs of a trade transaction which accounts for just the handling of documentation. More transparency, the prevention of fraud and faster trade are only few among many other envisioned benefits. While this scenario at the moment is still largely theoretical, Wells Fargo and the Commonwealth Bank of Australia (CBA) already completed their first international trade transaction with the new technology, shipping 88 bales of cotton worth approximately $35,000 from the U.S. to China. With the help of blockchain and smart contracts the ownership of the bales was automatically transferred and the payment released as the bales were unloaded and scanned in port.
In the end it remains to be seen how quick and willing other actors on the global market are going to be in adopting the new technology and how far blockchain technology will really go in revolutionizing trade. But whether it will be this technology or the next one, one thing is for sure: Trade will not be able to rely on good old pen and paper forever.