How digital assets are democratising global trade and boosting economic growth
by Nils Behling, co-founder and CFO at Tradeteq
Trade powers the global economy. Yet, many SMEs across the world lack access to affordable financing for their trade activities and banks struggle to increase much needed lending. Trade finance has long been the domain of global banks and larger institutional investors but greater democratisation of the market through digital assets is opening it up to new participants – and additional sources of funding.
Most notably, advancements in the digital tokenisation of trade assets are creating entirely new opportunities for institutional and retail investors to capitalise on this emerging and low-risk alternative asset class.
Supply and demand
The lack of trade financing for SMEs is a persistent problem that has led to the widening of the trade finance gap – the shortfall between supply and demand. Research from the Asian Development Bank estimates that the global gap stands at a significant $1.7 trillion.
Capital constraints as well as rigorous cost-cutting and ROI demands sit at the heart of the problem. Regulation demands that banks put aside more capital for trade finance deals. At the same time, banks are forced to “do more with less”. As a result, banks focus on their top tier clients, leaving many businesses, mostly SMEs, under or even unserved. Without a solution, the trade finance gap will continue to expand – and the World Economic Forum expects it to increase to as much as $2.5 trillion by 2025.
Barriers to investment
Banks are increasingly recognising that distributing trade finance assets to capital markets means they can free up their balance sheets and potentially create additional lending capacity and revenues.
For investors, this is a sizable opportunity. Trade finance is a multi-trillion-dollar asset class that has many of the features that private debt investors may look for.
These typically short-term, revolving, and self-liquidating assets potentially offer better spreads and shorter duration than comparable fixed income products. Short duration means that, unlike corporate bonds, trade finance assets generally do not lose value because of rising interest rates.
Yields on new trade finance instruments tend to rise in a sustained inflation environment, giving some protection to investors. And as they are based on the tangible flow of physical goods, trade finance obligations are less susceptible to financial market volatility.
Both default and loss rates for trade finance products have proven to be lower than for other products and asset classes.
Trade finance
However, the typically low-risk, low-yield nature of trade finance assets combined with their high turnover volumes makes these instruments especially susceptible to friction costs. In addition, as a result of historical practices and conventions, trade finance can be somewhat arcane in nature.
As a result, access has in the past been restricted to banks and a small pool of specialised investors. Consequently, the amount of investment into trade finance by private investors has been negligible.
The emergence of tokenisation
The use of distributed ledger technology, tokenization, for delivery and settlement of trade finance investments promises to introduce major changes, opening up the asset class to a wider investor base. These tokenized assets repackage and distribute trade finance into regulated security tokens, using blockchain technology.
While traditionally trade finance investments required significant minimum commitments from alternative investors, the nature of digital assets makes it possible to offer much lower minimum investments at a fraction of current costs.
Through the purchase of security tokens that are backed by trade finance assets, investors can access trade finance in a transparent, cost-efficient manner, and with flexible minimum investments. This brings diversification opportunities to portfolios that were previously only available to much larger players.
Bringing stability to the crypto market
Recent events in the crypto markets and some spectacular failures have rightly raised questions and concerns about the overall sector, especially from private investors that were lured in with promises that eventually could not be kept.
These events can be seen as part of a market cycle that moves from hype, over-leverage, and unhealthy levels of exuberance to a focus on real assets, real substance and real value. No wonder then that leading asset managers, including BlackRock, Abrdn, Fidelity, and Charles Schwab continue to ramp up their stakes in digital assets with new deals and products.
Trade finance-backed security tokens provide much needed stability and substance as they effectively provide an on-ramp for the real economy into the crypto-sphere. Their collateralised regulated nature can offer an antidote of sorts to the turbulence, price slumps, and regulatory turmoil seen in the past weeks and months.
Trade finance-backed crypto assets can be a compelling proposition and an important move in the democratisation of trade finance, which historically has been restricted to banks and larger institutional investors.
By investing in trade finance through regulated security tokens, private investors can now invest in the real economy – in the evolution of trade, in global connections, and the creation of lasting jobs and new opportunities.