Soaring bitcoin prices have caught the eye of the trade finance industry. Finbarr Bermingham reports on efforts to marry the old and the new.


November 2017: the price of bitcoin rockets through the US$10,000 mark. Previously the preserve of dark corners of the internet, cryptocurrency chatter has started to traverse mainstream airwaves and hog prime newspaper column inches.

As the price of bitcoin has risen, the noise in trade finance has grown from a whisper to a dull roar. The phone buzzes, a message from a commodity trader in Southeast Asia, saying the thoughts of bitcoin are keeping him up at night: how could he get involved? These interactions are becoming more common, as bankers, lawyers, startups, fintechs and exporters look for a piece of the action. Everywhere, people are looking for ways to exploit the interest in cryptocurrencies.

In December, Ukrainian company Varamar became among the first shipping operators to accept bitcoin as payment. The move was not, the owners claimed, a publicity stunt, but would allow it to transact with companies in sanctioned countries. Using cryptocurrency bypasses the quandary of clearing euro or dollars, running the risk of being penalised by the EU or the US’ Office of Foreign Assets Control (OFAC) in the process.

“Paperwork for transactions is a complicated issue with banks, and bitcoin payments will help solve that by being faster. It could also help solve payment problems in countries like Pakistan, Russia, Sudan, Yemen and Qatar, which have safe companies but are victims of sanctions being imposed against their governments,” company founder Alexander Varvarenko told Bloomberg.

GTR knows of at least one bitcoin deal, in Hong Kong, which has been structured in the same model as a commodity trade financing. The Hong Kong Monetary Authority (HKMA) classes bitcoin as a “virtual commodity”. Therefore, it is possible to borrow money to buy bitcoin, using the cryptocurrency as the underlying asset.

“What’s more risky, a warehouse full of steel or copper in the middle of China, or a bitcoin that exists on the internet that I can’t get my hands on?” asked one party that was involved in the structuring.


Trade ICOs

Perhaps the most prominent linkup between the two worlds is in initial coin offerings (ICOs), with companies using cryptocurrency to raise money for trade lending, or to build a platform for funding.

ICOs – also referred to as token sales – are unregulated means of crowdfunding, using cryptocurrency. In theory, through an ICO, you can raise money from anybody, anywhere in the world.

This is done by issuing digital tokens, which are sold to investors for a reward. Sometimes, this mirrors an initial public offering (IPO), whereby the investor gets a stake in the company. But, more often, it is for a more nebulous reward, such as a discount on tokens traded on a future platform, or a stake in the transactions launched on the platform.

For trade finance lenders it offers access to an unorthodox – and, theoretically, unlimited – pool of investors in a market that is booming. In July 2017, a report by research firm Autonomous found that startups had raised in total a record US$1.27bn in the first half of the year through ICOs. Given the attention the sector garnered through the back half of the year, this number is likely to have risen substantially.

In July last year, invoice financing company Populous was among the first trade finance-focused companies to raise funds in this manner. It raised the equivalent of US$10mn in just five days, issuing Ethereum-based tokens called Pokens. Most of the investors were high-net worth individuals (mirroring a trend in fiat trade finance, where funds and family houses are piling into the sector).

Founder Steve Williams told GTR at the time that the process was much simpler and faster than traditional cross-border fundraising. “If you think about the complexity around different currencies and settlements and consolidation of payments, it’s a much more efficient strategy to use tokens, and it opens up the market to the rest of the world,” he said.

In November, SME financing company ModulTrade launched an ICO to raise US$15mn-equivalent, using a similar model. The company established a ModulTrade token (MTRc) which is also based on Ethereum, at a rate of 700 MTRc to 1 Ethereum (at the time of writing, US$474). The soft cap (minimum wished to be raised) has been set at 5mn MTRc, with a hard cap (the point at which they will halt the ICO) set at 30mn MTRc. Investors in the token offering are able to buy MTRc at a discounted rate, with the ICO set to expire at the end of January.

The MTRc will be used to provide financing to SMEs using the platform, which allows buyers and sellers to transact using smart contracts. Therefore, by investing in these tokens, you get a discounted cryptocurrency to lend to small businesses.

Evgeny Kaplin, former Sberbank trade banker and ModulTrade CEO, tells GTR that there has been a lot of interest from former colleagues and banking peers, in line with the level of publicity cryptocurrency is gaining in the mainstream and financial press.

Kommerce, a Singapore-based startup, launched an ICO in November with a view to raising US$30mn to US$50mn. The proceeds will help fund a three-year programme of financing highly-liquid, fast-moving commodities such as cooking oil, coffee, sugar and rice into Africa.

Harveen Narulla is the CEO of Kommerce and also the founder of Pan-African Logistics, a company that brings the same sorts of goods into Africa. He thinks an ICO will provide Kommerce with the start-up capital to support small trading companies on a continent starved of bank debt.

“A container of cooking oil will cost you less than US$20,000. We want to put money towards a trade that churns frequently. It takes 45 days for an end-to-end transaction to complete. We want to build a stable of such regular transactions. If a merchant is bringing in five containers but thinks he can do 10, we can deploy the cash to acquire 10 for him. We don’t want to do ad hoc deals, but regular, repeatable deals,” he tells GTR.

Launching an ICO allows Kommerce to bypass the “venture capital dance”, says Narulla, who has been involved in that space for a decade.

He explains: “It’s a desire to bypass talking at people who don’t understand the subject or are already doing well enough financing developed markets, so it’s not worth their while looking at new markets. We can also bypass Africa sceptics, because there are many and with good reason. Our subset of people is very narrow, so instead of spending one or two years flying around the world, I’d much rather go to people who are willing to finance based on the potential of this upside.”

Another Singapore outfit looking to capitalise on the ICO boom is Trade Finance Market, which last year launched a blockchain-based solution with the aim of stopping the double financing of invoices. The tool allows banks and factors to check if another funder has already paid an invoice by cross-referencing it against a blockchain-based central registry. The company also provides funding to underbanked SMEs.

“The ability to be able to quickly fund transactions that have passed our diligence filters is the main reason we are doing an initial token sale. Transactions will be further de-risked through the use of security and smart contracts using blockchain technologies. This will also keep costs down and savings are then passed onto our SME clients,” executive director Raj Uttamchandani tells GTR.

The company is planning to launch a pre-ICO, a period used to screen potential funders to ensure they comply with anti-money laundering (AML) standards. The funds will be raised by issuing the company’s own token, EximCoin.

Uttamchandani says: “Crypto investors are on the lookout for tokens that can provide a return through real world utility – having a social benefit also helps. Through our platform, EximCoin holders will be able to view in real time as trade deals are initiated, financed and completed – providing reassurance to all parties involved that their money is at work with SMEs and that they will see returns within a 120-day period,” he says.

He compares the noise around ICOs – not to mention blockchain – to the internet hype 20-odd years ago. There will be a lot of failures, but the cycle has also laid the grounds for companies such as Amazon, Google, Facebook and Alibaba – the cornerstones of the internet as it exists today.

Uttamchandani continues: “In time, crypto-based products and technology in general will evolve in ways we cannot fully realise now – for example the same way running ICQ or AOL/Yahoo messenger on a desktop computer via a dial up connection eventually spawned a video call on WhatsApp running on 4G mobile. The one thing we can say is that this is just the start of the journey for crypto technology and we are very excited to play our part in the process of its evolution.”


Legal problems

Just as the bitcoin price thrust the crypto market into the spotlight, it also raised the spectre of the risks involved. These markets are unregulated. The anonymity of investors and the connections with the dark web make cryptocurrency the perfect vehicle for money laundering and other nefarious activities, and regulators are struggling to get a handle on it.

In September, China banned ICOs outright, saying they left investors unprotected and dismissing the entire practice as “illegal fundraising”. The HKMA chief executive Norman Chan followed this up by claiming that “bitcoin or other digital currencies do not require holders to trade under their real name, which allows them to be used for money laundering activities”. Similar warnings have come from the Monetary Authority of Singapore and the Securities and Exchange Commission in the US.

Furthermore, tales of ICOs not yielding the reward they were ought to are ten a penny, while fly-by-night ICOs selling real estate, fast cars and even more ethereal concepts such as karma and luck have helped raise concerns further still.

Understandably, legal experts are looking at the market keenly. Jolyon Ellwood Russell, a trade finance partner at Simmons & Simmons in Hong Kong, is unequivocal about the risks involved.

He tells GTR: “There are inherent risks on the general unregulated nature of ICOs. There is of course the sources of funds and financial crime issues. Bitcoin has not had the cleanest of reputations and, given the mammoth appreciation recently, some regulators are monitoring whether ICOs might be an easy means to profit from illegal bitcoin accumulation and diversify into legitimate businesses.”

The other risk is regulatory, Ellwood Russell says. The law looks at substance over form. If the substance falls within an offering to the public and in return shares or an interest in the company is issued, then this is regulated as any stocks and shares market. “Whatever it might be called in techno-speak, if it looks like a duck and sounds like a duck, it usually is.”

Singapore-based financial lawyer at Bird & Bird, Kim Kit Ow, says that the fact that there’s so much attention on the area of cryptocurrency means that regulation is even more important.

“I strongly believe that we need to regulate, not just because I come from a regulator’s background. If people think it is just fun for a few years and then we let it die, by all means let it die. But if we’re thinking of building up something that will stay and we’re seriously thinking of it as an alternative to fiat currency, we need to start working on serious and specific regulations,” she tells GTR.

There are, of course, ways in which one can mitigate some of the risks, such as the risk of losing money invested in an ICO, or of becoming involved in a deal with anonymous individuals with illicit histories.

Offering a bespoke token with a specific reward that is not directly financial nor equity-based is one way for those raising money to protect themselves. By offering a discounted token on which to trade on the platform, businesses such as Populous and ModulTrade are arguably shielding themselves from the full force of the risk.

ICOs are conducted on exchanges, which have varying degrees of scruples. In Hong Kong, Gatecoin has emerged as one of the more reputable, recovering strongly from a hack last year in which hackers stole US$2mn in cryptocurrency.

Thomas Glucksmann, head of marketing, explains that Gatecoin will conduct thorough AML and KYC checks on all token buyers. “There are a lot of dodgy projects,” he tells GTR, but says that there is no reason why legitimate crypto investors can’t be a good fit for trade finance lenders. However, he says, it takes careful planning and diligence to pull it off successfully.

Equally, Steve Ehrlich, lead emerging technology analyst for New York corporate advisory Spitzberg Partners, has heard a lot about trade-based ICOs, particularly in the logistics space, but has some advice for those hoping to do it within sound legal parameters.

“The short answer is to hire a good lawyer that has expertise in the relevant jurisdiction. They can help a company understand its regulatory requirements by assessing whether or not what it is issuing is considered to be a security. This determination is crucial because securities come with additional requirements and complications, such as limiting to whom you can market your ICO,” he says.


Do we need it?

There’s no doubt that additional funds to support small businesses would be welcome – there are many reports citing the gap in financing for these smaller players.

Trade finance is not suffering from a liquidity problem however, but a dearth in risk appetite. Banks, chastened by regulations, are increasingly focused on the least risky transactions and it is important that new sources of funds are harnessed.

Will this come from cryptocurrency? The volumes discussed thus far are miniscule when stood next to the market gap. However, any legitimate source of funding should be encouraged (with “legitimate” being the operative word).

The market is developing extremely quickly, but this is a very small sector of it. Aside from legality, cryptocurrency also suffers from issues around integrity. It’s worth pointing out that at the time of writing, 15% of all Ethereum network traffic is dedicated to CryptoKitties, a game that allows users to buy internet cats. This is by some distance the largest use of smart contracts on the Ethereum network.

For every trade-based initiative, there are a hundred get-rich-quick schemes that make seasoned traders and lenders bristle. That’s not necessarily a bad thing: the industry and the people within it must modernise. But regulators should act quickly to ensure the potential is not lost, while those interested should choose their investors with extreme care and vice versa.