Blockchain and distributed ledger technology: what are they and are they different?
Distributed ledger technology is best explained as any type of technology that enables the sharing of data and records across participants on a network, allowing each party to make changes that are tracked and shared with the other participants, without the need for a single or central database. In sum, it is a distributed database maintained over a network of computers connected on a peer-to-peer basis, such that network participants can share and retain identical, cryptographically secured records in a decentralised manner.
Blockchain is one type of distributed ledger technology that uses a sequence of blocks, creating a permanent information chain to record a transaction. Such transactions could involve the transfer of title from one participant to another. Hence, every blockchain is a distributed ledger, but every distributed ledger may not employ blockchain technology. However, in practice the industry today generically refers to all distributed ledger technologies (DLTs) as blockchain, even when the underlying technology may by slightly different. With this in mind, we will refer to distributed ledgers generically as blockchain in this note.
Blockchains may be public or permissioned (private). In the Financial Industry, where anonymity of participants is not acceptable, private blockchains may be used where a network operator would permission members onto a node on the network. However, even in such cases, the database remains distributed and there is no central authority owning or controlling the data.
As data is stored across nodes on the network, blockchains are considered more resilient to attacks and vulnerabilities than a single, central database could face. A significant amount of computing power is consumed on public blockchains to establish the authenticity and validity of transactions through a process referred to as consensus. This process is relatively lighter in permissioned and private networks, where the members are already authenticated on their nodes and hence they consume less computing power, making them much more scalable and transactionally performant.
How does blockchain transform and facilitate a letter of credit (LC) transaction?
Letters of credit support approximately 13 per cent of merchandise trade globally and remain in demand to mitigate risks between buyers and suppliers who may not trust each other or wish to raise working capital finance. However, the processes involved are highly inefficient: they have remained paper-based over centuries leading to delays in payments, which in turn inhibits customers from selling more to their counterparties and increasing operating costs. Digitising LCs has been a challenge due to the different types of parties involved: buyers/sellers, banks, shipping companies, ports, freight forwarders, insurers, regulators, customs, etc. and attempts made so far have been restricted to few legs of the LC creating digital islands or silos with limited visibility and transparency.
Blockchains can support the flow of LCs in a purely digital form, including the transfer of title of goods, wherein various parties could access the blockchain network through a node, but the data would still remain distributed with each party, who can access relevant visibility of the flows and transfer title accordingly. By digitising the LC flows, the process from submitting export documents to their bank upon shipment by the seller, to receiving an acceptance from the issuing bank to pay, can be completed within 24 hours, compared to 5-15 days in a traditional framework.
This will allow sellers to conclude transactions faster and increase their trade turnover with such buyers. It will also make LCs paperless and more efficient and cheaper to operate while improving risk management through better visibility. This could make LCs more viable and they could help bridge the large trade finance gap that is often raised as an inhibitor to world trade.
By digitising the LC flows, the process from submitting export documents to their bank upon shipment by the seller, to receiving an acceptance from the issuing bank to pay, can be completed within 24 hours, compared to 5-15 days in a traditional framework
HSBC’s groundbreaking blockchain transaction – what it is all about?
On 14th May, HSBC completed the first live end-to-end trade finance transaction on a scalable application for the issuance of a fully digitised letter of credit, using blockchain technology. The application was developed on R3’s Corda platform. R3 is a consortium of more than 200 firms across industries and has developed Corda, which is a built-for-purpose blockchain platform. The flow on this application mirrors the existing letter of credit process (agreeing letter of credit terms, application, issuance, advising, amendment request and its approval, document presentation, discrepancy resolution, and bill settlement instructions) and the single blockchain Corda network was used for all participants, instead of relying on multiple systems.
Agricultural conglomerate Cargill was on both sides of the transaction as applicant and beneficiary of the letter of credit (sending a shipment of soy beans from Argentina to Malaysia, with HSBC Singapore acting as the issuing bank and ING Geneva acting as the nominated bank under the digitised letter of credit).
HSBC has also pioneered blockchain technology use-cases in Open Account trade using IBM’s Hyperledger underlying technology.
On 3rd July, HSBC, in conjunction with 3 other banks, completed multiple trade transactions on the we.trade open account platform. We.trade is a joint venture company established by HSBC, Deutsche Bank, KBC, Natixis, Nordea, Rabobank, Santander, Societe Generale and UniCredit. We.trade enabled corporates to complete end-to-end digital trade transactions, through to auto-settlement undertaken by the buyers’ banks on the due date, all on a single platform. This included creating purchase orders, confirming shipment of goods, raising invoices and confirming agreed settlement conditions have been met. The we.trade platform seamlessly connects buyers, sellers and their respective banks, by providing a single source of information, which is visible in real time and on a need-to-know basis for each participant in each transaction. The objective is to make cross-border and domestic open account trade transactions fully digitised, easier to manage and faster to execute.
These 2 milestones mark progress of the industry from proof of concepts in sandboxed environments, to developments on applications that can be scaled for production processing and we have significant interest across corporations and banks. By being part of these initiatives and other regulatory programmes like the HK Trade Finance Platform (HKTFP), HSBC is exploring mechanisms to connect these different networks and meet client needs across traditional and open account trade terms.
Companies are always looking to streamline operations – Is blockchain the only way?
While there will be more transactions on these blockchain platforms, with more corporates, banks and other parties of the trade ecosystem joining, we anticipate it may still take another 3-5 years of collaborative work for this to gain critical mass. In the interim, corporations must start preparing for the digitisation of trade by embracing existing digital offerings like electronic Bills of Lading, Mobile & Desktop Trade Applications, SWIFT for Corporate for Trade, etc. These would require companies to consider the necessary ERP and accounting system changes and integrations that will be needed to support blockchain based trade flows in the future. We have been working with our clients to embrace such existing digital offerings that besides providing immediate efficiencies across certain processes, e.g. eliminating physical bills of lading or digitising the process of preparing export documents or submitting LC applications, will help them develop the right infrastructure for the future.
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