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Letter of Credit (LC) Transaction Using Blockchain – What, Why and How?

As of now, the trade finance industry is rather sloppy, especially with regard to its lengthy processing time. The primary function of the trade finance industry is providing finances to businesses, both at the local and global levels.

In doing so, the industry provides various services like lending, transferring letter of credits, providing insurance, among other things. Out of these many phases of financing, the production and transfer of a letter of credits are by far the lengthiest.

Letter of Credits

Basically, letter of credits is a document which is used to establish trust while carrying out cross-border financial transactions. At times, letter of credits may also be referred to as ‘Documentary Trade’.

Primarily letter of credits or LC acts as a bond. They guarantee payments between parties undertaking business across national borders. In general, the issuing authority of an LC is the bank to which the buyer requests the same.

Through the LC, the buyer promises to pay a certain amount when the payee meets certain pre-defined terms of the contract. The bank, in turn, acts as the guarantor and ensures that any possibility of fraud is ruled out.

The significance of the LC lies in the fact that the cross-border parties mostly don’t know each other in person. So, it is essential that they have an official bond of trust or the LC. As is evident from above, the LC plays a pivotal role in the overall functioning of the trade finance industry.

In fact, it is one of the most common services provided by the industry. However, despite all that, the processing of LC is by far the most tedious and lengthy phase of trade financing.

Present Issues with Letter of Credits

As of now, a majority of the process of LC production is undertaken manually, making the process winding and strenuous. The issuing of a letter of credits is a complicated process as it involves many different parties and stakeholders.

For instance, exporters, importers, banks, shipping authorities, customs, and others interact to issue a single LC. Moreover, the process involves a great number of legalities which have to be established before issuing a letter of credits. The manual processing of all these nuanced steps of the issuing of the LC gives rise to many problems.

  • First, the process becomes much longer than it could have been otherwise.
  • Second, the overall functioning of the trade finance industry has been much inefficient due to its manual functioning.
  • Third, manual production of such huge quantities of documents often leads to errors which ultimately affect the involved parties.
  • Fourth, when documents are produced manually, chances of them being manipulated are high. Thus, the trade finance industry has been vulnerable to fraud and other security compromises.
  • Fifth, the process involves the functioning of multiple intermediaries, which, ultimately leads to a cost escalation.

In this context, many have argued that complete automation of the process is of utmost importance. It is being proposed that the trade finance industry implements the hyper-ledger fabric, enabled by blockchain.

Blockchain as a Solution

In many different ways, blockchain can significantly enhance the issuing process of the letter of credits. In fact, “smart contracts”, enabled by blockchain are advanced, digitized versions of the letter of credits.

Primarily, the application of blockchain in the issue of LC can make the process much more secure and transparent. As the information stored on a blockchain is indelible, it virtually rules out the possibilities of document forgery and fraud.

Every part of information on a blockchain is linked to another and they can be accessed only in relation to one another. This enhances the traceability of the entire process of issuing LC.

Moreover, the application of blockchain automation significantly brings down the overall process cost. It’s rather needless to say that all this enhances the efficiency with which an LC is issued. Most importantly, apart from anything else, blockchain-based LC production would lead to a massive decrease in the processing time.

In the following section, let us take a step-by-step look at how a blockchain-based LC can be produced.

Steps in LC Production using Blockchain

  1. The buyer initiates an application for LC and stores it on a blockchain for review by the bank.
  2. Once the bank receives the request for review, it may either accept or decline the LC, based on the blockchain’s data.
  3. On the approval of the importer’s bank, the exporter’s bank is automatically given access to the blockchain. The institution reviews the information provided and decides accordingly.
  4. After the approval of its bank, the exporter gains access to the blockchain information. He/she reviews the terms and adds his/her own terms on the blockchain.
  5. Through processes similar to steps II, II & IV, the LC comes back to the importer. If the importer has no issues, the LC status is updated as completed. In case of discrepancies, the LC has to again go through these steps.

 

How is Blockchain Technology Beneficial in Trade Finance?

Time and again, bankers and other business officials worldwide have been pondering about the usefulness of blockchain in trade finance. At the outset, let’s take a brief look at the problems which exist within the trade finance industry. This would enable us to better understand the benefits of blockchain in this field.

The primary issue with the present state of the trade finance industry is its vulnerability towards fraudsters. Moreover, the need to process bulky paperwork and the intermediaries make the process sloppy and, at times, rather inefficient.

Recently, there’s been a rapid rise in the popularity of customer services like one-click checkout and e-KYC. In this context, it is high time that the trade finance industry is optimally digitized. In doing so, blockchain can be of significant help for the industry.

The Major Benefits of Blockchain

In this section, let us discuss some of the benefits of the blockchain and their potential impact on trade finance.

First, by doing away with the dependence on the “trusted intermediaries”, blockchain can significantly speed up the processing time. This will enhance the performance of the trade finance industry within the present pace-driven market.

Second, the removal of intermediaries would also make the system more transparent than it was before. Moreover, it will significantly bring down the risk of manipulations which have the potential to harm customers.

Third, the functioning of the industry would become smoother, owing to the elimination of a major share of the paperwork.

Fourth, as the processes are digitized, the overhead costs of businesses come down significantly.

Fifth, owing to the security features enabled by the blockchain, the business-customer and business-business bond of trust is strengthened. This is specifically essential for a capital oriented industry like trade finance.

Blockchain and the Increased Efficiency

Owing to the benefits stated above, a peer-to-peer network using blockchain is a very efficient way of undertaking financial transactions. Apart from other things, blockchain can play a major role in enhancing data transmissions within and beyond the business environments.

Any trade finance network which harps on the benefits of blockchain is bound to stand apart from others which don’t. As an instance for the same, one might look into the success story of Marco Polo. By adopting blockchain, they have substantially overcome the problems of a fragmented and somewhat disoriented trade finance industry.

A Vision for Future Businesses

In the days to come, the successful businesses would undoubtedly be the ones with an integrated work protocol. This would involve complete automation of customer services like e-KYC, as well as, customer support.

Moreover, the infrastructure of the future businesses has to have heightened transparency, enabled by the use of blockchain. This is especially true in the case of the B2B and B2C financial transactions facilitated by the organization.

In order to strengthen the trust, businesses would have to work with “smart contracts”. As we know it now, these contracts are a primary beneficial outcome of the blockchain technology.

Moreover, these contracts can hasten up the financial processes by automatically initiating transactions based on pre-defined criteria. This way, all the involved parties know that their finances are secure and certain.

Most importantly, once the terms of business are agreed upon, neither of the parties can alter the same. This is ruling out the possibility of misinterpretation and manipulations.

Blockchain and Enhanced Authenticity

Authenticity in the trade finance industry is way more crucial than it is in other industries. Any information stored on a blockchain is indelible and is linked to one another to form a chain. Consequently, the blockchain makes it very easy to trace back a series of transactions in relation to one another.

Moreover, the unique cryptographic encryption of the data ensures the validity of its ownership. Any new information added to a blockchain goes through a pre-defined and automated validity screening which allows for easier verifications. This also ensures that the information is not changed in the process, which is crucial in terms of financial interactions.

As the entirety of financial transactions can be accessed from a single point, a business’s authenticity is firmly established. Plus, issues like delay in transactions and the need for data-sharing is eliminated by the successful application of blockchain.

In all, blockchain is a technology which could significantly change the way businesses work at present. Especially for the trade finance industry, the prospects offered by blockchain could pave the way to a brighter future.

 

AI Advent in Banking

Verismart, an identity blockchain platform, is automating the inter-institutional ‘Know Your Customer’ and compliance process for banks, telecoms and others. The process of Digital Identification/KYC is a quite complicated one. Among many other things, it involves Biometrics, extensive profiling, social and financial know-how, government regulations. Prior to generating a Digital Identity, Verismart takes all these factors into close consideration.

How is it different from any other digital identity platform?

For over three years, Verismart has dealt with a variety of stakeholders, including government entities, financial institutions, regulators and corporates. Moreover, we have worked with other digital platforms from more than 3 countries worldwide. Owing to this experience, we have learned the major problems faced by the democratization of Digital Identity in India. Especially with Aadhar, India’s API-based authentication platform, the major problem is with regard to the security of the information. It has been rather difficult to ensure that only trusted organisations have access to the personal data stored in the Aadhar’s database in accordance with the standards of the GDPR. Moreover, most private enterprises have not prioritized the consent of the customer before taking their information. In short, there hasn’t been any proper check on the way the individual’s data is being used by the various enterprises.

We, at Verismart, have realized the core of the problem and have found the solution for achieving an end-to-end solution. This includes the KYC on-boarding process, as well as, the backend compliance which is mandated among regulated institutions. We have figured out a model, which gives the individuals better control over their digital data. Plus, it fits into the matrix of the regulatory framework. Our primary focus lies with the highly credible and trustworthy institutions like banks, telecoms and other major utility platforms. This plays a major role in earning the trust of the Government sector.

Moreover, it simultaneously simplifies and adds value to the process for customers using the e-KYC procedure with such institutions. Consequently, we ensure that the customer doesn’t have to go through the entire tedious process of identification again and again. A majority of banks and telecoms have a similar backend compliance procedure and we extend its benefits to our customers.

We, with our blockchain platform, ensure this ability through a three-way handshake mechanism. Herein, the regulated institutions become sponsors of your verified, authenticated and compliant digital identity within the digital landscape. Each of these institutions is subjected to strict vigilance and regulations and has intensively focused on all the security parameters. The best part is, they are not custodian but the enabler of the individual’s digital identity. No identity information on the blockchain can be accessed with the real-time consent of the user.

In fact, although the process is very efficient, it is also quite simple and involves a digitally encrypted post-on-boarding protocol. The institution can enable a claim on the ID which can be read by other third parties. The entire process is based on the interests and choices of the user. Moreover, at each major step, the institutions have to get the consent of the users which enables them full control.

In order to bring these into reality, we are building a syndicate across different geographies. We have partnered with almost 22+ global banks and telecoms leading to steady monthly growth in the numbers. Nowadays, economic digitization is the priority and we are mitigating the problems of on-boarding a digitally non-compliant user.

Recently, we have launched a banking and telecom consortium within India, US and UAE. Through this, we have successfully created a wave with total partner banks, payment wallets and money exchanges. Over 29 organisations have combined to solve issues with cross border compliances, trade Finances, Letter of Credit and so on.

A few recent acknowledgements:

Recently, Verismart has proudly featured among the Top 5 RegTech companies among the 850 participants in the Digital Innovation challenge. Moreover, Verismart is one of the three finalists in the Finx Award for Global Financial start-ups. The organizers of this prestigious award are organisations like Fintech Galaxy and entrepreneur.com. Along with these, Verismart is among the various KYC, KYT processes with which VISA partnered this year at GiTEX. In all, VISA undertook partnerships with 7 different start-ups as a part of this project.