Op-ed: Will blockchain disrupt the development finance sector?
Our people op-ed series:
As a part of Cardano Development’s efforts in supporting our employees to explore business-related topics, Joris van Oppenraaij, in charge of country selection and impact at CD’s Water Finance Facility, has written an article to explore blockchains potential to disrupt the development finance sector.
Blockchain technology is used today to help reinvent how transactions are managed. They can take time and costs out of almost any process, enabling near real-time operations, and they deliver a high degree of accuracy and control. Moreover, blockchain can solve the ‘trust problem’ in situations where trust between transacting entities is not possible, like when transacting entities do not know each other and are not able to check on each other. Lastly, the tokenization of assets and the cryptocurrency space is gaining ground as an alternative to the regulated money system; see this recent OECD article for more background.
So, with all the buzz and promises, will blockchain disrupt the development finance sector in a scalable way? In this brief article, I will share some considerations about that.
There are already a host of operational blockchains solving market problems, but these blockchains are not a one size fits all solutions, and financial services are privatizing their own blockchains on a case-by-case fashion. This report gives a good overview of ‘internal’ blockchain applications, which could add value in any business’ finance operation. A more external application that starts to gain ground is in trade finance, where ‘documentary credit’ is the main product. Platforms such as the Contour Network offer solutions for this and the Asian Development Bank was involved in the first cross bank blockchain letter of credit transaction.
With large financial companies now operating and testing distributed ledger technology solutions to address specific problems or improvements in their business processes, scalability, is still not really taking place. In my humble opinion this is a matter of time though.
In the field of development finance, I currently consider the following applications as most appropriate and most promising:
Cross border payments and blockchain powered by use of escrow services.
In Africa there are high cross-border transaction costs that can complicate and limit the amount of trade transactions. This prevents business expansion and limits trade. Traditionally, the global payment processes take several days and are often exposed to risks of exchange rate fluctuations, intermediary bank fees and beneficiary errors. This impacts international trade directly, adding additional burden and costs to transactions. Blockchain technology could solve those problems through escrow services, thus making transactions cheaper.
Tokenization of assets
In general, the tokenization of assets is a promising field in capital raising of startups and small and medium enterprises. Within the impact investing space, this could become more relevant over time for example in the case of issuing impact bonds, because the tokenizing/monetizing of impact might become easier. It could bring transparency into social projects and create more streamlined processes when proving impact for ROIs for investors, governments, etc. The South African Wadappt platform and the Ixo Foundation are examples of that.
The factoring business space could benefit from the use of blockchain technology. The process of selling accounts receivable (i.e., invoices) to a third-party financier and the subsequent settlement with the invoice payer could be automated to a further extent and therefore become cheaper if managed on a blockchain. Cardano Development’s start up IMfact is currently exploring whether it’s feasible to introduce blockchain technology.
I believe blockchain will change the way finance is practiced worldwide, but I do not believe that the development finance sector will lead that development on the short or medium term. At the same time, I would advise all players in the development finance market to keep a close eye on the developments and to look for blockchain savvy partners outside their conventional networks in order not to miss the boat.
When applications become more widespread and cryptocurrencies become more mainstream, there could emerge a leap-frog technology effect in the development finance space, comparable with what the mobile phone did to the telecom sectors in developing countries.