Rise of Embedded Trade Finance Rests on Tokenization and Interoperability

Beyond tariffs and the shifting supply chains, the re-shaping of international trade depends on one constant: trade finance.

Trade finance enables payment for merchandise and services between exporters and importers. It’s an umbrella term that encompasses everything from letters of credit to purchase orders and receivables factoring, and it can be done domestically and internationally.

The World Trade Organization estimated that as much as 90% of trade relies on trade finance. According to Global Market Insights, the segment is dominated by banks, at 70% of the estimated $9.7 trillion trade finance market.

Several FinTechs and platforms have been coming to market to offer their own trade finance solutions.

However, trade finance has been slowed by the complexities of country-by-country regulations (in the case of international trade), tracking payments and manual processes. A report from the World Bank said trade credit is critical for smaller businesses.

“It facilitates the exporters’ business development and sales diversification (credit opinions from credit insurers can be a major market intelligence tool),” the report said, adding: “It strengthens the balance sheet.”

However, many small firms, especially in the United States, view financing as a challenge. Per a World Trade Organization report, the U.S. International Trade Commission found that 32% of small firms in the manufacturing sector and 46% of small firms in the services sector consider the in-place processes of trade finance to be “burdensome.” Half of trade finance requests by small businesses are rejected.

The rise of embedded finance — and specifically tokenization, which is underpinned by blockchain technology — helps make trade finance more efficient by improving and speeding the transfer of, say, letters of credit and short-term financing. Rendering the physical trade documentation that enables the financing (such as bills of lading or the terms of the financing itself) into digital representations over the blockchain allows for instant verification of the transaction and terms. Generally speaking, the programmable nature of the tokens themselves enables smart contracts that allow funds to be released to firms once terms are agreed upon and fulfilled.

In an example of tokens used in pursuit of more efficient cross-border commercial transactions, the Citi Token Services for Cash program went live in October after being piloted between Singapore and New York.

“By using distributed ledger technology and smart contracts, Citi has created a patented programmable payment and liquidity platform, which will reduce costs and streamline processes,” the bank said at the time.

In another example, Standard Chartered’s SC Ventures backed the collaboration of FinTech SWIAT and Olea, a digital infrastructure platform, to enable supplier financing across the blockchain — in this instance, tokenizing receivables. DekaBank was the funder for the inaugural tokenized receivable.

Challenges remain in the move toward tokenization of trade finance. In a paper from the Bank for International Settlements, there’s the observation that “private initiatives are developing tokenized multi-asset infrastructures, including features such as 24/7 availability, transaction tracking and programmability. Furthermore, some FinTechs and startups are leveraging asset tokenization to offer financial services — from credit to investment options — more efficiently.”

However, the paper also noted: “A fragmented market with poor interoperability may limit the potential benefits of tokenization. Fragmentation could prevent tokenization from reducing frictions, developing innovative use cases and mitigating risks. Different ledgers — both centralized and decentralized — by various providers could vie for market power.”

Interoperability challenges could be mollified through standardized messaging formats and unified ledger protocols so that users could open and use accounts across any ledger, the paper said.

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