Blockchain and Banking: An Analysis of Cross-border Payments in Trade Finance

By Li Yongyong

Blockchain features massive capacity, better security, immutability, and faster settlement.

B lockchain has gained widespread attention around the globe and has been seen as potentially disrupting the traditional banking landscape, particularly trade finance. The innovative concept brings efficiency, decentralization, automation, and security. It has the capacity to ensure certainty in cross-border payments, enable transparency in the movement of trade assets, and facilitate the flow of trade receivables. This article aims to explore the feasibility of blockchain technologies in trade finance from the following aspects: first, comparing traditional cross-border payment forms with existing platforms by analyzing the pros and cons of traditional payment tools; second, conducting an in-depth analysis of blockchain technologies by the use of navigation of the core techniques of Ripple; third, contrasting the application of blockchain in the financial industry in China and the US, and lastly, analyzing recent developments of the application of blockchain in cross-border payments and offering some suggestions for further research.

According to a recent report by consultants McKinsey and Co., cross-border payment flows totaled more than $150 trillion over the 2013 - 2017 period. Most of this was ultimately driven by consumers, even though it was directly generated by businesses. The payments industry recorded over $200 billion in revenue from services provided to payers and payees in 2017 alone. Currently, most cross-border payments are routed via the messaging protocol for the execution of transactions by SWIFT (the Society for Worldwide Interbank Financial Telecommunications).

Despite the great benefits generated by SWIFT, which offers a standard messaging format and a relatively secure network, many banks and their customers alike still feel that it cannot meet increasing demands in terms of efficiency, cost and security.

As financial technologies make rapid advances, FinTech companies are emerging and employing the latest distributed ledger technologies (blockchain) as well as cryptocurrencies. The term “blockchain” originally referred to the distributed ledger technology underlying the digital currency, bitcoin. Blockchain consists of a ledger shared across every computer in a given network. When one party seeks to transfer bitcoin to another party, the payer enters a security code and initiates the transaction. Then, the computers in the network use sophisticated algorithms to verify and clear the transaction. A record of the transaction is then “stored in a block which is linked to the preceding block,” thereby updating the blockchain.

The reason why blockchain can be applied to the banking industry, particularly cross-border settlement, is that it features massive capacity, better security, immutability, and faster settlement. Firstly, blockchain can increase the capacity of the network, through which large quantities of banking transactions can be processed within seconds. Blockchain tends to have better security because there is no single point of failure to shut down the network. However, even the highest levels of our existing financial system have been vulnerable to hacks. In July 2018, for example, a Russian bank was hacked and millions of US dollars were transferred as a result of suspected vulnerabilities of the SWIFT system. The most infamous incident involved the theft of millions of dollars from the Bangladesh central bank - also via the SWIFT network. Blockchain can create immutable ledgers, which can sharply reduce the potential for fraud. Lastly, traditional cross-border payment is comparatively slow, with settlement times often taking hours or even days. This is the main reason why most financial institutions are willing to upgrade their systems. Blockchain can reduce the time required for cross-border settlement to several seconds, greatly enhancing the efficiency of business transactions.

Technical Analysis - SWIFT and Ripple

As the heavyweight in crossborder payment, SWIFT has a strong advantage in the reach of its network. Employing its messaging platform, products and services, SWIFT can connect more than 11,000 banking and securities organizations, corporate customers and market infrastructure entities in more than 200 countries and territories.

The original services provided by SWIFT are composed of a messaging platform, message processed computer system, and precise messaging standards. However, for half a century the fundamental feature for SWIFT has remained unchanged, namely, the intermediary platform for international banks around the globe. Conventionally, the procedure of cross-border payment is demonstrated as follows: SWIFT plays the role of message transferring rather than effecting funds directly to system participants. Each banking institution, which needs to make cross-border payment, must be a SWIFT member. Members pay annual fees in order to support the building of correspondent banking relationships within the SWIFT network.

Nevertheless, with the advent of new technologies like big data and blockchain, SWIFT cannot meet the expectations from both individual enterprises and banking conglomerates in terms of efficiency and cost-effectiveness. And as stated earlier, SWIFT has had its problems with security breaches. In summary, SWIFT has been playing the role of an intermediary much like a clearing house. That is true today despite recent reports of developments in a “Global Payment Innovation,” which is said to improve the efficiency and transparency of cross-border payments.

What differs from conventional cross-border payments is the application of blockchain technology, which has transformed cross-border payment in a disruptive manner. As Don & Alex Tapscott, authors of The Blockchain Revolution (2016) have written, “The blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value.” What constitutes a blockchain is nothing but “nodes” connecting a network as a whole. As indicated below, distributed ledgers can be connected without the need of an intermediary. Business transactions can be processed through distributed ledgers, and this increases efficiency, reduces operating costs and makes transactions traceable.

Ripple Company, as the largest and most successful operating supplier of cross-border payments, has developed inter ledger protocol (ILP), which resembles the internet http protocol.

ILP brings new efficiency by enabling real-time settlement, ensuring transaction certainty and removing settlement risk. Ripple's software also includes data-rich messaging between all transacting parties - delivering a real-time payment experience to end users.

The blockchain technologies within Ripple and the recent developments in technologies within SWIFT can be compared in order to identify their strengths and weaknesses. Generally speaking, Ripple tops SWIFT in terms of efficiency, cost reduction, and security.

Analysis of Blockchain Technology

According to Wikipedia, “A block chain is a decentralized, distributed and public digital ledger that is used to record transactions across many computers, so that the record cannot be altered retroactively without the alteration of all subsequent blocks and the collusion of the network.” Moreover, “Ripple is a real-time gross settlement system, currency exchange and remittance network created by the Ripple Company. Also called the Ripple Transaction Protocol (RTXP) or Ripple protocol, it is built upon a distributed open source internet protocol, consensus ledger. ”

There has been criticism that Ripple is not truly decentralized because it maintains a trusted Unique Node List (UNL) and Ripple has centralized control over the nodes. But it is our understanding that Ripple still uses the basics of blockchain technology.

Although Ripple has its own cryptocurrency called XRP, it is totally independent of the Ripple network for the transfer of dollars, euros, or even frequent flyer miles. And there is huge enthusiasm for Ripple as opposed to Bitcoin. Banks are actually making use of Ripple technology - rather than the cryptocurrency - to make transactions.

Ripple maintains a trusted UNL (Unique Node List) that is meant to protect against potentially malicious or insecure validating servers. And this is what leads to criticism that Ripple is not really blockchain technology. Because they argue that Ripple has a list of trusted nodes, it can complete transactions within seconds, while bitcoin often requires 10 or more minutes. But Ripple uses another algorithm that allows the achievement of consensus on collectively trusted sub-networks within a larger network. This is just a novel algorithm that avoids failures and doesn't mean Ripple is not blockchain.

Currently, there are 43 members of the Ripple network while some 100 banks work with Ripple on a consulting basis as compared to SWIFT's 11,000 financial institutions. It is believed that Ripple will be a mainstream player benefiting from a “network effect” at some point, meaning that as more financial institutions join the Ripple network, the incentive for others to join will increase. How much more time will be required? That remains to be seen. However, so long as Ripple continues making substantial progress in this area, more banks around the world will embrace this technological advancement.

Analysis of Blockchain Applications

Ripple has led to numerous applications since its introduction and development has focused on two parts: use of the currency and crossborder payments.

By 2014, Ripple Labs was involved in several development projects related to the protocol, releasing for example an iOS client app for the iPhone that allows iPhone users to send and receive any currency via their phones. This Ripple client app no longer exists, however. In July 2014, Ripple Labs proposed Codius, a project to develop a new smart contract system that is “programming language agnostic.''

Since 2013, the protocol has been adopted by an increasing number of financial institutions to “offer an alternative remittance option” to consumers. Ripple allows for crossborder payments for retail customers, corporations, and other banks. Ripple has been described as simplifying the exchange process by creating pointto-point and transparent transfers in which banks do not have to pay corresponding bank fees.

The first bank to use Ripple was Fidor Bank in Munich, which announced a partnership in early 2014. Fidor is an online-only bank based in Germany. In September of that year, the New Jersey-based Cross River Bank and Kansas-based CBW Bank announced they would be using the Ripple protocol. By December Ripple Labs began working with global payments service Earthport, combining Ripple's software with Earthport's payment services system. Earthport,which operates in 65 countries, has a client list that includes Bank of America and HSBC. The partnership marked the first network usage of the Ripple protocol.

In February 2015, Fidor Bank announced it would be using the Ripple protocol to implement a new real-time international money transfer network, and in late April 2015, it was announced that Western Union was planning to “experiment” with Ripple. In late May 2015, Commonwealth Bank of Australia announced it would be experimenting with Ripple in relation to intrabank transfers.

Ripple Company notched expansions in 2015 and 2016, opening of an office in Sydney, Australia, in April 2015 and opening offices in London and Luxembourg in June 2016. Many companies have subsequently announced plans to experiment or integrate with Ripple.

Ripple and China

Although Ripple is expanding business quickly in an era of cryptocurrencies, China is still a new market for the company. So far there is only one Ripple member from China and that is Lianlian Pay. As the Chinese online shopping market expands at a rapid pace, third-party payment companies have emerged. Founded in 2003, Lianlian Yintong Electronic Payment Co., Ltd (Lianlian Pay) is the fourth largest non-banking third-party payment service provider in China with an existing network of over 100 financial institutions and billions in payments each year between merchants and consumers.

Lianlian Pay services range from cross-border clearing and settlement to currency exchange, local regulatory filing and declaration, renminbi disbursement and online renminbi acquisition. In Feburary 2018, Lianlian Pay joined RippleNet and adopted Ripple's xCurrent, a solution based on blockchain to receive realtime, cross-border remittances, invoice payments and e-commerce payments. The cross-border payment now supports settlement of 19 currencies and enjoys direct connection and comprehensive service from all major domestic banks. It powers the cross-border transactions linking China, the US and Europe. And there is one Chinese bank that cooperates with Ripple; Shanghai Huarui Bank, one of the top five privately owned banks in China, signed a strategic agreement with Ripple in May 2016. Cooperation includes payment, settlement, transfer, loans and securitization. They are working on an innovative cross-border transfer product together right now, which will greatly reduce transaction time and fees.

It is still too early to tell whether Ripple will be successful in the crossborder payments field. In mainland China, some large-scale banks, such as China Merchants Bank, have launched projects related to the application of blockchain for money transfers among counterparties. It is reported that CMB is planning to expand these applications to other areas in trade finance, such as L/Cs and bank guarantees among others.

Blockchain Applications at ICBC

As the nation's largest bank - and one of the biggest global financial institutions - ICBC has been at the forefront of technological innovation in China. ICBC's e-banking is believed to be one of the best among Chinese banks. ICBC, both at the headquarters level and in various business departments, has been particularly alert to global developments in the technology field. Headquarters has established seven Labs of Innovation to promote development in blockchain and biological recognition among other areas. The first autonomous and controllable blockchain platform has emerged from this development effort. As of now, there are several programs that have been launched through the platform successfully, with a focus on the functions of agency operations, certificating and monitoring.

Blockchain applications have been tested in several pilot programs, and one of them is the Financial Products Trade Platform, launched in November 2016. The platform was established based on precious metals accounts, which enable different institutions to join in and form a secondary market. Registered customers can use this for buying, selling, transferring or giving. It enriches the trade models and ensures high quality of transaction data. At the same time, it decreases regulatory costs as transactions can be recorded using blockchain.

Another example is the Global Account-Opening Witness Program. This system is maintained with the coordination of regulators and ICBC's domestic and overseas institutions. Any overseas branch can make use of this system which offers the benefit of being convenient for post-transaction monitoring by regulators and the bank itself.

In addition to those programs, there are also some on-going programs such as the Sino-Africa Blockchain Bank Guarantee Platform, a platform that efficiently connects Asia and Africa by employing blockchain technologies. Another example is the blockchain application in receivables services for the online supply chain. ICBC is also one of three leading banks that has put in place a public chain initiated by the China Banking Association in an effort to apply blockchain in domestic settlement. Traditionally, clients need to submit documents repeatedly for different transactions at banks. To improve efficiency, ICBC has developed a shareable blockchain to verify and store data. This has obtained an exclusive patent from the China Bureau of Intellectual Property Rights.

Conclusion

Blockchain technology has fundamentally transformed the traditional method of cross-border settlement. It has greatly improved transaction efficiency, reduced operating costs and resulted in greater transparency. Ripple is a growing factor in cross-border payment and is already a welcome source of innovation.

Along with the internationalization of the renminbi, coupled with the nation's development strategies, ICBC is expected to work to apply blockchain technology in crossborder settlements in the future. It is reasonable for ICBC to use the Ripple network, without using the Ripple cryptocurrency XRP internally for international payments just as Santander did in April 2018. And if more banks turn to Ripple, they can adopt RippleNet, as MUFG Bank Ltd., Bank of Ayudhya (Krungsri), a Thailand-based subsidiary of MUFG Bank, and Standard Chartered Bank agreed to do in May 2018.

Meanwhile, according to Standard Chartered, “Since 2015, Ripple and an advisory team made up of a diverse set of leading transaction bankers including Standard Chartered and MUFG Bank have been building the Rulebook, a common framework that ensures operational consistency and legal clarity for every transaction. This group actively advises on maintaining and enhancing rules and standards.” If Ripple is going to be the mainstream of cross-border payments, it is the standard that matters. If ICBC can join the trend at the outset, it is widely believed that ICBC will benefit as RippleNet gains traction. As for ICBC, it is a significant step in applying technical advantages in the FinTech era.