Blockchain – will this be trade and commodity finance’s Uber?

Uber’s success is that it made it as easy to order and pay for a ride as clicking a few buttons. It created a multi-billion dollar market that didn’t exist just a few years ago. Blockchain is a payment technology that enables people to automate functions that previously needed manual input and creates certainty without the need for a trusted intermediary. Whilst this challenges the traditional role of banks as trusted intermediaries, banks can create entirely new markets for themselves in trade finance by providing digitised letters of credit or trade finance instruments for the movement of both digital and physical goods using blockchain.

A blockchain is a distributed ledger which records and verifies transactions. Everyone on the blockchain has an identical copy of the ledger but no-one can edit it. It provides collective, unfalsifiable evidence and verification of the transactions recorded in the ledger.

The implications for electronic trading platforms are significant.

This highly reliable verification mechanism allows functions to be automated through combining blockchain verification with smart contracts which is a piece of software that self-executes contractual obligations on the happening of pre-agreed events. For example, when the performance of one party such as delivery of goods is recorded in the blockchain, the smart contract will automatically cause corresponding performance from the other party to occur, so a payment will be made and recorded in the blockchain.

The implications for electronic trading platforms are significant. For example, an electronic trading platform designed to process accounts receivable (invoice finance or factoring), and letter of credit transactions could use blockchain to substitute paper documents with a digital alternative in the form of a single distributed and shared ledger. This will process transactions faster and more reliably. The distributed ledger provides a single, immutable record of a trade, capable of verification by all parties involved in the transaction. It prevents the fraud that can occur where a seller submits the same accounts receivable invoice to more than one bank for financing.

Master transaction agreements will have to be developed.

Master transaction agreements (for example similar to, but simpler than, those produced by the International Swaps and Derivatives Association or ISDA) will have to be developed to enable banks to trade and manage the sale of commodities and securities on a distributed and shared ledger system.

The challenge is to connect this real world legal contract to the electronic trading platform for self-execution according to its terms.

Banks which bridge the gap between the real world legal contract and the flawless execution of its terms on this electronic trading platform could be the ‘Uber’ success stories of the financial world in the future.