Enterprise Blockchain For Trade Financing
The significance of the recent trade financing network komgo
In late September, fifteen of the world’s largest banking and commodity companies announced the formation of komgo (a company registered in Geneva as Komgo SA). komgo will build a global blockchain-based trade financing platform.
Since its formation, komgo has received international media attention as a one of the largest moves from legacy institutions into the blockchain ecosystem. Much of the attention, however, has focused on the “bare bones” of the partnership and of the platform. We instead should be asking the questions: but why is this important? Why does the commodities industry have to gain? What is komgo aiming to improve? How will it impact the industry…and when?
This piece aims to provide a more in-depth explanation of the commodities trade financing industry, its shortcomings, and its opportunities for improvement.
Trade Financing Today: A Lesson in Inefficiency
As it stands today, the commodities trade financing industry is maintained by a surprisingly outdated set of systems and data management. The business is huge, complex, multinational, and interconnected. Governments have different regulations and political nuances. Economies are developed to different degrees and have varying levels of international influence. Each distinct commodity requires unique regulations, shipping specifications, and certification requirements.
Globally, this intense complexity has led to very little standardization or digitization. The industry is stuck in time. The rapid globalization of international trade outpaced technological improvements, and the trade financing industry in particular remains reliant on a paper-based system of record tracking. The reason? Trust.
Commodities financing requires a tremendous amount of trust between transacting parties to hedge against all of the vulnerabilities the industry’s complexity allows. The tolerance for error is low, and the fragility of paper-based data increases this risk. Huge paper trails mean stakeholders wait longer for payment, insurance costs are higher, and opportunities for fraud are greater. Greater risk means stakeholders are less willing to invest in new technology, however, meaning the reliance on paper persists even as the business grows more complex. The cycle is vicious and — for a long time — appeared neverending.
komgo in More Detail
komgo is an open collaboration between ABN AMRO, BNP Paribas, Citi, Crédit Agricole Group, Gunvor, ING, Koch Supply & Trading, Macquarie, Mercuria, MUFG Bank, Natixis, Rabobank, Shell, SGS and Société Génerale. The collection of partners work with ConsenSys to build a shared, blockchain-based platform which enables a streamlined, secure and simplified exchange of data and transaction records.
“The launch of Komgo SA highlights a shared vision for industry innovation and underlines the ongoing commitment among members to build a truly open and more efficient network within commodity trading” said Souleïma Baddi, Chief Executive Officer of komgo.
komgo’s platform will be built as an “open platform” — i.e. available to other industry players who wish to integrate the same blockchain-based system. This openness has been central to the development of the platform since its inception. With an open system, any entity can onboard itself to the shared ledger and begin transacting with other players, benefiting from the optimized technology without having to build a proprietary system. Globally-available “blacklists,” such as the OFAC sanctions lists, and onboarding General Terms and Conditions will ensure only verified good entities to join the open system.
The fifteen companies behind komgo were chosen to back the open platform in order to ensure the project gets off on the right foot. The fifteen original stakeholders are globally and industrially diverse; including banks, commodity traders, a major, and an inspection company from around the globe. With the proper diversity of interests involved in the initial steps, the platform can be assured to address as many pain points as possible across the entire trade financing process.
Because the industry itself has been slow to change, the fifteen stakeholders also needed to have significant “muscle” in the marketplace in order to force widespread adoption. As Toon Leijtens, CTO of komgo, clarified:
“This isn’t about exclusivity — we are building an open platform for everyone. But part of the solution in this space is standardization. To be able to standardize something, you must reach a tipping point where you have included enough muscle in the market so the rest will follow. We’re starting with the right mixture of companies to ensure we stand a chance to standardize and make adoption possible afterwards.” — Toon Leijtens, CTO
Building an open platform is also one of the key reasons komgo is building off the Ethereum blockchain. By building on an open blockchain system, komgo’s platform can select from the best protocols in development across the ecosystem, essentially compiling existing building blocks to arrive at an optimized solution. Building on Ethereum also provides komgo stakeholders with access to Kaleido, a ConsenSys formation. As the Enterprise Blockchain Cloud, Kaleido will help komgo’s platform “productize” itself for a large number of participants at a fast pace. Kaleido eases the onboarding of new stakeholders onto a consortium blockchain, further reducing the technical barrier to entry for legacy companies and startups alike.
Though komgo and its platform are two new initiatives, the product itself — initiating a commodity trade on the blockchain — is not new. Part of the appeal of komgo’s platform is that it has been tested and proved in the past. In early 2017, ING and Société Génerale facilitated a trade with Mercuria of crude oil on its way from Africa to China. The transaction was enacted and recorded on the blockchain and demonstrated a number of efficiencies, including reducing the time commitment of involved banks from three hours to 25 minutes. In early 2018, a shipment of soya beans from the US to China became the first agricultural trade fully enacted on the blockchain, facilitated by ING, Société Génerale, ABN Amro, and others. With a history of successful, proven use cases, komgo is well-positioned to launch a fully-functioning product.
komgo will launch with two initial products: a KYC process and a Letters of Credit product.
komgo’s KYC Process
As komgo partners began investigating opportunities for blockchain integration into the trade financing industry, the most recurring pain point was Know Your Customer (KYC) requirements and regulation. The focus on KYC in the industry is logical. The quantity of involved parties, slow paper trail, and international nature makes it highly susceptible to fraud. Considering the low tolerance for error, ensuring the trustworthiness and authenticity of trading partners is crucial to hedge against risk. Today’s KYC efforts require the work of multiple departments within a company and a tremendous amount of external data collection from regulated bodies and trading partners. All this documentation is collected, stored, and transferred manually, often in company drives, emails, messages, and attachments. This legacy form of data management is highly susceptible to human error. People forget. Details fall through the gaps. Vulnerabilities are exploited.
komgo’s blockchain-based KYC process leaves the data with the owners and allow these owners to only allow selected actors to retrieve a copy. Data is shared using end-to-end encryption and the user of the data can verify the validity of the documents by inspecting cryptographic fingerprints of that data on the blockchain to confirm that it was fresh and untampered. The revolution on komgo’s platform comes with radical data transparency and immutability previously impossible without blockchain technology. Only with complete confidence in its data can a company continue participating in a commodity trade with another entity.
Letters of Credit Recording
If two traders are able to settle a transaction with their own funds, it is known as an open accounts trade. No banks are needed and the traders can pay themselves. When dealing with larger transactions — millions of dollars’ worth of commodities, for instance — these smaller traders are still interested in making their working capitals available.
A letter of credit is a paper document that describes the financing option people have on a commodity trade. It is essentially a record of a bank loan to a trader so that trader can participate in a transaction that otherwise would exceed their working capital.
Banks want reassurances that they will not lose the money they’ve lent money to a trader. Once the bank has financed some cargo, it becomes the “owner” of that shipment temporarily. If something goes wrong, the bank will take that commodity as collateral on their loan. A letter of credit will include all this information.
Before a bank feels comfortable confirming a letter of credit that outlines its temporary ownership of cargo, however, it additionally wants assurances that the commodity is correct, and that it is of the right quantity and quality. This requires more documentation, more verification, and more trust in third party stakeholders to pass along accurate information.
komgo’s shared data platform will digitize letters of credit to provide better visibility and fraud protection into the trade financing process. Moreover, a blockchain-based ledger would allow komgo stakeholders to digitally attach verifications of cargo shipments to specific letters of credits, reducing the susceptibility of fraud when banks temporarily own a commodity shipment.
More importantly, however, komgo is starting with letters of credit because they are where banks most intimately connect to the commodity industry. By focusing on letters of credit early on, komgo’s platform can be better built to address the needs of all parties in commodity trading. Getting banks involved early means their voices will be heard sooner and solutions will be built into the core komgo infrastructure to support continued adoption across industries.
Looking Ahead: The Roadmap for komgo
The significance of the komgo announcement lies in its real-world application of blockchain technology. For all the hype, the excitement, and the future use cases of the technology, very few groups have actually shipped a useable product. Now, with proofs of concept behind them, these fifteen stakeholders are charging ahead with enterprise adoption.
Looking ahead, komgo remains committed to an open, shared platform. They speak to a future of a shared economy where everyone benefits. To that end, interoperability of the platform is key. Breaking down incumbent barriers to entry and optimizing data management costs are top of mind in this new vision for trade financing, and komgo is poised to deliver. komgo has the ambitious goal of launching by the end of 2018. The effort will require the involvement of all fifteen stakeholders and ConsenSys as we together build a tangible example of the possibilities of blockchain technology.
Everett Muzzy, ConsenSys
Content retrieved from: https://media.consensys.net/enterprise-blockchain-for-trade-financing-c005ec8fa079.