Mainstreaming block chain technology in international commerce

This post was originally published at The Hindu Business Line newspaper here

Distributed Ledger Technology (DLT), a concept of recording and sharing data across multiple data stores, or ledgers as they are popularly called, is an idea whose time has come. The concept of DLT was introduced through block chains in the famous paper by the elusive author known only as Satoshi Nakamoto in 2008.

While the initial application was limited to crypto currencies, it didn’t take much time for the world to realise that the underlying technology of using distributed ledgers has multiple applications spanning various spheres. However, it is only lately that we are seeing actual implementation of the often discussed concepts.

To cite an example of block chain application in mainstream commerce in India, we may look at the Trade Receivable Discounting System (TReDS) guidelines of the RBI, which sought to set up a system to ease the liquidity crunch for MSMEs by way of bill/invoice factoring in the financial market for the supplies made to big corporates. The simplified process under TReDS may be explained with an example. Let’s assume Mismi enterprise, which is an MSME, supplies items to Bigcor, a corporate house. Usually Bigcor takes three months to settle the payments after the delivery of goods. This holds up Mismi's working capital for three months leading to a liquidity crunch for Mismi.

Mismi’s efforts to convince Bigcor to make payments earlier doesn’t work as Bigcor has market power to dictate terms to Mismi and other such suppliers. With the advent of TReDS, Mismi uploads the digitally signed invoice on one of the three platforms currently approved by the RBI. The upload is done after the supplies are made to Bigcor.

Bigcor gets a time window (say of two days) to approve the invoice online, thus verifying the authenticity of the supply and the commitment that it would pay the sum against the invoice raised within three months (or the agreed time frame).

The approved invoice can now be factored on the platform, through auction, by the financial intermediaries like banks/NBFCs. For example, BigBank may buy the invoice at a discount and pay the money to Mismi, thus providing it with immediate liquidity. The actual payment would be realised by the BigBank after three months from Bigcor.

In an ideal competitive market place the discount should equal the interest cost for three months plus nominal service charges. Registration on TReDS has been made mandatory for public sector enterprises by the government. As the public sector is a big ticket buyer for a large number of MSMEs, it is expected that a critical mass would be easily obtained by the system to start rolling. Three platforms (RXIL, M1xchange and A.TReDS) approved by the RBI are already active.

There are two clear advantages of using blockchain technology in such a situation. First, maintaining anonymity of invoice raiser is easier. Second, cross trading across multiple platforms is possible without the fear of double invoicing (double-spend problem). It makes the entire chain secure, anonymous, and verifiable at the same time. The credibility issue also gets sorted out.

As TReDS is one of the early examples of implementation of Blockchain in real commerce, we can look at it as torch-bearer of a future era of trade facilitation.

In fact, if the technology and infrastructure are set up correctly there is no reason as to why the entire paper based international trade transactions shouldn’t be moved onto something based on DLT.

However, when it comes to international trade, two further institutional arrangements need to be put in place. They are:

(a) International arrangement to give sanctity to DLT-based transactions through common agreement or laws and

(b) Physical infrastructure for DLT including the system architecture and configurations.

The first point can be integrated with the trade facilitation efforts in the next stage at the WTO. It could be augmented through efforts at making model laws and best practices at UNCITRAL/UNCTAD. The second part is where individual governments and private sector would have a greater role to play.

We have proved with TReDS that we have the ability to push it. India could become a leader if we take the initiative at blockchaining the entire gamut of international trade transactions. It might indeed be a 21st century issue that India might like to discuss at the WTO.