Cryptocurrencies are increasingly top of the mind for business world and governments, and so is blockchain—the technology underpinning it. This week I attended a financial analysts’ workshop on the growing influence of alternative investments—with focus on cryptocurrencies and FX online trading. The event covered a number of alternative asset classes including real estate investment trusts, cryptocurrencies, asset-based securities, exchange traded funds (ETFs), hedge funds and private equity.
The Central Bank of Kenya (CBK) Governor Patrick Njoroge gave a keynote speech and even devoted sometime after his speech to expound on the regulatory aversion towards the former—stressing that the anonymity behind it is not desirable and has incubated illicit financing.
The aversion, in my view, is largely expected from such a central authority tasked with, among other things, financial stability—and is understandable. I must admit that while I have struggled to understand blockchain, I have been able to reconcile a few things. Blockchain itself is the primary technology and its usage transcends cryptocurrencies. That’s a very vital clarification.
Further, cryptocurrencies are backed by nothing. Not gold. Not silver. Well, except the Venezuelan cryptocurrency—which is backed by the country’s vast oil reserves. However, away from cryptocurrencies, blockchain technology itself presents myriad of usage opportunities--especially in financial services. And one such area is trade finance.
This week, Nairobi hosted the Global Trade Review’s 2018 edition of the East Africa trade and commodity finance conference—where blockchain dominated talks. Simply put, trade finance entails the facilitation of exchange of goods and services, locally and internationally, against trade documents.
It includes actual financing (or lending), issuance of documentary credits such as letters of credit and guarantees, factoring, export credit and insurance. Financed trade transactions make up an enormous portion of global trade – approximately 80 to 90 per cent of world trade relies on some form of it. However, large volumes of paper documents still make up much of the information flow.
How does trade finance work? Winam company in Kenya wants to import heavy fishing equipment from Hokaido in Japan. Winam wants to pay for the goods but is a little hesitant, just in case the goods don’t show up. Hokaido is also hesitant to load the equipment, just in case Winam doesn’t pay. This hesitation breeds mistrust.
To break the impasse, Winam asks his bank to issue a letter of credit to Hokaido’s bank, undertaking to make the payments once documents, such as bill of lading, are provided by Hokaido.
The two banks help establish trust by holding money for both parties. This arrangement has been in place since Caesar first dated Cleopatra; with almost little or no change to both the process and amount of paperwork that changes hands.
There is an increasing case for this legacy process to be streamlined using blockchain. Here’s where it gets crusty. A blockchain is a data structure that allows for the distribution of digital ledgers across a network by using cryptography.
With digital ledgers, each participant to a transaction can securely amend a ledger without the need of a central authority-such as a central bank.
Because a blockchain is updated quickly by each participant on the network to reflect the most recent transaction, it removes the need for multiple copies of the same document.
In the case of Winam, Hokaido and their banks, each party maintains its own file of documents. Apart from the data security and integrity bit, it also significantly cuts transaction settlement time.