This weekly four-part series serves as a guide to blockchain for trade finance. Fluent Network’s founders Lamar Wilson and Casey Lawlor provide GTR readers an overview of how blockchain technology provides transparency, streamlines asset transfer and lowers the operating costs of global trade finance programmes for all relevant parties. Follow the links for Part 1, Part 3, and Part 4.


Part 2: Creating the framework for an automated supply chain                

While there are currently many solutions on the market that make an effort to standardise supply chain processes, they often end at the informational or business logic level. The vast majority are simply technology wrappers on antiquated, siloed financial and IT systems. There still exists a fundamental divide between vital business information, like invoices and trade contracts, and the financial transactions that need to be executed by banks and other institutions to complete the transaction. At the end of these processes remains a herculean effort to reconcile the business logic and related documents with the financial transaction.

This leads to systems that require a tremendous amount of manual intervention, still rely heavily on paper, and demand co-ordination between different parties during a trade finance transaction (which involves information, asset transfer and payments). Payments and asset transfers through correspondent banking networks, Swift and third-party financial services provide little (if any) connection to the actual business processes.

Additionally, the efficiencies provided by software solutions extend only to the manual processes that connect these disparate systems. This automation adds significant cost, time and human interactions to supply chain operations. It is a bottleneck that has previously been unsurpassable with existing siloed software systems.

Automation through smart contracts

Interconnectivity between multiple parties and both business and financial processes is the key to creating cost and time-saving efficiencies in trade finance. A blockchain-based network, allowing a peer-to-peer transfer of digital assets in parallel with information and business logic, can reduce this friction and provide interconnected financial rails for truly transformative business applications.

For example, various inputs can be collected on a blockchain platform to automatically execute the release of funds or transfer of digital assets (such as receivables) based on smart contracts. This process allows for a qualitatively different approach to trade that has the potential to marry information, transactions, trade contracts and business logic to provide automated digital asset transfer alongside real-time settlement.

This idea, taken to its logical extreme, could mean truly automated supply chain and financial operations between businesses (and even machines) with no-touch straight-through processing.

But, before we get too far ahead of ourselves, let’s begin with a few use cases in how this technology can provide real value in the near future.

Currently, international wires can go through two or more correspondent banks and take up to six days to settle. Domestically, 50% of US businesses still use paper cheques. Even in our digital age, the fees and delays related to wire and cheque processing are chalked up to the cost of doing business.

Additionally, the opacity and friction associated with these methods cause significant issues for corporates, financial institutions and auditing professionals trying to reconcile and settle these transactions on many different systems. When a wire transfer is sent, there is almost no information regarding the recipient, what goods or invoices they are for, or when the funds will ultimately be available.

These factors limit the predictability required for forecasting and forces finance and accounting departments to be reactive instead of proactive. Collecting and processing these payments and matching them with invoices (paper or digital) can be a nightmare during the reconciliation process for both buyers and suppliers.

Imagine the process of collecting, verifying, and transferring remittance information, invoices and receiving reports between three or more parties involved in a factoring or receivables finance transaction. Now expand this to millions of businesses and billions of financial transactions involved in global trade every year. This process is a huge bottleneck for both banks and businesses involved in trade finance and injects significant risk for the financier.

Real-time transfers

Compare this to a blockchain-based trade network, where information and business logic can be connected directly to the payment rails themselves. Ownership of digital assets such as receivables or approved payables can be represented on the blockchain and transferred peer-to-peer across a distributed network along with b2b payments in near-real time.

By avoiding the black box of a correspondent banking network, where remittance data is limited to the few lines included on a Swift message, you can programmatically tie business logic, digital assets and payments together on one platform and automate their transfer based on predetermined digital inputs.

A simple example is using time or inventory as an input. International payments can then contain all of the necessary information for straight-through processing. Finance professionals that represent buyers, suppliers, financiers and audit firms will have an unparalleled view of the real-time cashflow of their organisation, allowing them to make informed, proactive financial decisions and subsequently limit risk.

Connecting these siloed parties on a single platform also massively reduces the co-ordination and operating costs of trade finance related to the collection of onboarding/compliance documents and remittance data. Instead of manual co-ordination of these documents along with the necessary payment instructions between the three disconnected participants, payments are routed based on real-time asset ownership information on the distributed ledger. Buyers pay their bills as they normally would, and the funds are routed to the bank, factor or other financier who has purchased the invoice. As you begin to add digital contracts into the blockchain (smart contracts) that trigger under specific conditions, businesses can execute supply chain operation and take advantage of automated financing as needed.

Real-world example

Let’s put a few of these use-cases together in a real-world example.

Your inventory management system detects that you’re running low on steel. Once steel inventory drops below a certain level, a purchase order is automatically sent to your preferred steel supplier. The supplier captures the purchase order, scans its inventory management system, confirms the necessary stock of steel, and starts the process of fulfilling the order. They ship the correct amount of steel and automatically issue an invoice for the goods to the buyer.

The buyer receives the invoice, performs a three-way match and automatically approves payment with a cryptographic signature. This signature confirms the approval and a promise to pay, as represented by a smart contract, on the due date. The supplier now has an approved invoice that he can do two things with: first, hold it and receive payment at term; second, sell that receivable and receive early payment from a funder.

Another option would be to program the system to sell receivables automatically based on preset variables like discount rate, current cash balance, or more. In the case of early payment, the supplier’s machine will detect that it requires more cash to buy more raw materials to meet other incoming purchase orders. The machine automatically sells the receivable, which is represented on the blockchain as a unique digital asset, receiving payment in real time. These funds can now be used to purchase raw materials or settle the supplier’s outstanding invoices.

This system, called ‘just-in-time, automated financing’ is only possible with the marriage of information, business logic, smart contracts, payments and digital asset transfer. On a distributed ledger-based platform, working capital can flow seamlessly and efficiently across your global supply chain as needed, and more importantly as directed by the organisation’s finance professional. Now apply this concept to the entire supply chain and trade networks – the level of efficiency and transparency that could be achieved across entire trade ecosystems is mind-boggling and would provide tremendous value to all parties involved.

The if/then statements above illustrate how supply chain information can be used as an input for smart contracts on a blockchain-based platform to execute and settle trade transactions. These smart contracts are the key to connecting financial transactions and supply chain operations to eliminate friction and automate processes that previously required human intervention. In the future when all parties connect on blockchain-based platforms, we could see massive increases in efficiency and utilisation of working capital in global commerce.