International Payments, Trade Finance & Blockchain: A qualitative study about the impact of blockchain implementation

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International Payments,

Trade Finance & Blockchain

A qualitative study about the impact of blockchain implementation

Amanda Grandin, Maria Eriksson

Department of Business Administration International Business Program Degree Project, 30 Credits, Spring 2021

Supervisor: Lars Lindbergh

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Abstract

The digitalization of our world is happening at a rapid pace. In the last few years there has been an avalanche of new technologies that could benefit businesses, such as;

artificial intelligence, internet of things and blockchain. To explain blockchain in short one can say that it is a ledger that cannot be changed and the information that is stored on the ledger will be there forever, with the information being stored in a decentralized manner and everyone with the right permissions get access to the same data at the same time. The information networks that build our society today are largely central, big institutions keep information stored centrally in massive data centers. On the contrary, blockchain enables distribution of the information to a myriad of smaller data storages, providing security of the data in the decentralization. Blockchain and its implementation in trade finance and international payments is something that is explored in this thesis, as well as the barriers that impede a large-scale implementation of blockchain in the financial sector in Sweden.

Every year trade finance accounts for approximately 17 trillion USD worldwide, this is a process that is still paper intense and slow. The use case for blockchain has been realized within this sector as there are operating trade finance platforms based on blockchain or distributed ledger technology, but how does blockchain really improve this sector?

During this degree project this has been one of the questions asked and the answer is clear, blockchain will bring efficiency and transparency to trade finance. International payments is also an area that has been researched during this project as it is right now a costly and slow process, the use case for blockchain or distributed ledger technology has been realized in this sector as well, but the implementation seems to be further away. The main reasons why international payments are seen as a use case for blockchain is the same as the aforementioned - efficiency and transparency.

Sweden has yet to see a large-scale implementation of blockchain, some of the barriers found are the challenges of collaboration and agreeing on governance, as well as doubts about the technology from the broad mass as it has yet to be proven efficient and reliable in a large-scale, long term setting. Additionally there are already functioning payment infrastructure in use in Sweden and the cost of implementing blockchain is thus far outweighing the benefits for implementing it.

Keywords; Blockchain, Trade Finance, Supply Chain Finance, International Payments, Efficiency, Transparency

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Acknowledgements

We would like to begin by thanking our supervisor Lars Lindbergh for his suggestions and feedback during our work with this degree project. His comments have helped us

assess and improve the quality of this thesis.

We would also like to send our warmest thanks to all the respondents for giving us their valuable time and enabling the interviews. We are very grateful for all the insights gained from each one of you and hope to one day be as passionate about our jobs as

you all are!

Lastly we have to thank each other for a great teamwork and for making this period enjoyable despite the special circumstances caused by Covid-19!

Umeå, 18^th of May 2021, Amanda Grandin and Maria Eriksson

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List of figures

Figure 1. Public blockchain ... 10

Figure 2. Private blockchain ... 10

Figure 3. Visual representation of the Traditional Privacy model and the New Privacy model ... 13

Figure 4. The correspondent banking model……… 19

Figure 5. Presentation of the themes for positive aspects of blockchain and positive aspects of a decentralized information network. ... 45

Figure 6. Presentation of the themes for negative aspects of blockchain and negative aspects of a decentralized information network. ... 47

Figure 7. Barriers for large-scale implementation and number of respondents that mentioned the theme. ... 49

Figure 8. Improvement areas for international payments and number of respondents that mentioned the theme. ... 52

List of tables

Table 1. Keywords ... 31

Table 2. Themes regarding the possibilities of implementing blockchain. ... 41

Table 3. Mentions of themes regarding possibilities in the interviews. ... 41

Table 4. Themes regarding risks of implementing blockchain ... 43

Table 5. Mentions of themes regarding risks in the interviews ... 44

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Definitions

Anti-Money

Laundering (AML)

Procedures, regulations and laws to prevent illegally obtained funds to be disguised as legitimate income.

Bill of lading A legal document(s) specifying for example the products that are shipped, the quantity and the destination of the goods. It is also specifying the ownership of the goods and is therefore treated as a document of value.

Blockchain Blockchain is a distributed ledger technology that stores information on a chain of blocks, a decentralized database.

Compliance risk The risk of the company’s financial and/or organizational results or its reputation being “hurt” due to violations of laws, codes of conduct, regulations or the organization's standards of practice.

Cryptocurrencies A digital encrypted currency without any central bank to control them, the biggest cryptocurrency to date is Bitcoin.

Core company A big, stable company in the supply chain.

Decentralized information network

We define it as everyone getting the same information at the same time and that information is stored in a decentralized manner.

Distributed ledger technology (DLT)

The technology that blockchain is based upon, information storing in a decentralized manner.

Disruptive innovation

An innovation that creates a new market network, which will eventually disrupt the existing market network.

Financial market infrastructure

The “plumbing of the financial system”, the ones that manage clearing, settlement and transactions.

Governance The structure of rules and principles that guides the managing and direction of a company.

Information asymmetry

When one party knows more than the other. This leads to distrust and something called the agency-principal problem.

Know your customer (KYC)

A requirement within financial industries to collect data about their customer, their risk proneness as well as doing a risk assessment of each customer.

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NFT Non-fungible token, crypto-technique that is used to declare ownership of digital assets.

Smart contract Set of agreement on a blockchain that allows automatic transactions as soon as all the agreements on the contract are fulfilled.

SME’s Small and Medium-sized Enterprises, less than 250 employees.

Stablecoin A stablecoin is a cryptocurrency that, unlike cryptocurrencies like Bitcoin, is pegged to an underlying asset such as a fiat currency or an exchange-traded commodity

Supply chain A network of suppliers and distributors that produce and deliver the final good to the customer.

Supply chain finance

Technology based solutions to help lower the financing cost of the supply chain through tracking invoices and approvals from buyers.

An intermediary provides short term credit for the supplier and optimizes the working capital for the supplier and the buyer. A subcategory to trade finance.

Trade finance A type of financing that helps importers and exporters reduce risk and/or improve their working capital. This is a heavily paper-based process.

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1. Introduction

In this chapter the study will be introduced, beginning with a description of the problem background, followed by the research problem and research gap. The presentation of the thesis purpose as well as the research questions will follow, lastly the choice of topic and pre-understanding will be presented along with the delimitations of the study.

1.1 Problem background

Imagine if you could buy a car and you could know the origin of every single piece of that car, you could know where the parts of the engine came from and how they had mined the metals of your car. You could have a look at a ledger and see the origin and the way every piece involved in the production had travelled before ending up in your vehicle.

This is something that can be made possible by blockchain technology. Blockchain can be thought of as a digital ledger that can store information about nearly anything. There is currently a lot of money going into researching blockchain solutions, between 2017 and 2019 the total investment was over 5.1 billion U.S dollars (Statista, 2020).

Deloitte has published an annual survey regarding blockchain every year since 2018 (Deloitte, n.d.). According to their survey in 2020 the weight of importance that managers put on blockchain implementations increases every year, of the managers that were surveyed 55 % indicated that blockchain was one of the top five strategic priorities (Deloitte, 2020, p. 4). 84 % of the managers think that their company will lose competitive advantage if they do not adopt blockchain technology, which is a number that has increased from 68 % in 2018 (Deloitte, 2020, p. 5).

To explain the phenomenon simply one can say that blockchain is a technology that is based on an immutable¹ shared ledger and can track assets in a business network, the chain can track almost every type of asset and this may lead to reduced risks and costs for all parties involved (M. Gupta, 2020, p. 3). The reason that blockchain has gained so much attention in the last few years is due to the fact that it is a fairly simple and secure technology with implementation possible in many areas. Some benefits mentioned by M.

Gupta (2020, p. 9) is that blockchains reduce transaction cost, increase transparency and eliminate duplication. Today there is a lot of literature describing the disruptive influence that blockchain has on many areas, such as governance (Shermin, 2017), traceability (Hastig and Sodhi, 2019, p. 950) and supply chains (Chang et al., 2020, p. 2094).

This study will examine blockchain implementation in trade finance as well as international payments, two processes that are still rather old fashioned and slow. Trade finance is a term for the financing which is involved in trade, it is an agreement between both buyer and seller and usually their respective banks as well. Trade finance is used for mitigating risk according to Meynell (2020) and helps the buyer and seller, the importer and exporter, to solve contractual issues and liquidity arrangements. Bedford (2020) means that trade finance is still a paper-based sector, which leads to a slow and inefficient process.

1 Irreversible, cannot be changed

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In the beginning of 2020 the Covid-19 pandemic swept over the world, causing lockdowns and closed borders. During this time Demir and Javorcik (2020, p. 406) found that companies in Turkey that used trade finance as a risk mitigation technique were more resilient to the economic downturn than those who did not use it. Bedford (2020) argues that the lockdowns due to the pandemic have sped up the digitalization as transactions that had previously been done face to face are now being done electronically.

Meynell (2020) argues that the entire supply chain benefits from involving banks in the trade finance process. This leads us to the subcategory of trade finance that has been looked into, namely supply chain finance. Supply Chain Finance is described by Hofmann (2005, p. 3) as the intersection between finance, supply chain management, logistics and collaboration. It is used to create value through the supply chain by planning and controlling the financial flows of the supply chain. ICC (2020, p. 62) means that supply chain finance could be seen as an umbrella term for different types of trade finance solutions.

Supply chain finance is growing and according to ICC (n.d.) this is due to the fact that a lot of importers and exporters are now using Open Account-terms, which means that the goods are shipped before the payment is due. This change has come partly due to an increased trade with emerging markets that believes that an insistence on traditional trade finance terms such as documentary credit reflects a lack of confidence of the country and their institutions, but also due to the larger and more complex supply chains that we see today (ICC, n.d.)

Supply Chain Finance is one of the areas where blockchain is researched to provide better solutions, where the traditional method of getting financing is very dependent on processes where asymmetric information is a problem. Du et al. (2020, p. 1046) performed a study in China where they created a supply chain service platform based on blockchain technology and their results showed that it can provide efficiency, trust and decreased transaction costs. One of the main arguments for implementing blockchain technology is that it improves transparency (Petrov, 2020a), which is important for a functioning financial industry.

According to WTO (2018, p. 99) around 60 % of the SMEs that request trade finance are denied by the bank. This is hopefully something that supply chain finance can help mitigate, as it is more focused on looking at the bigger picture rather than just a sole company and its merits. In Sweden 99.9 % of the companies are SMEs (Holmström, 2020) and according to the European Commission (2019, p. 1) 65.2 % of the Swedish population is employed in an SME and they stand for 61.2 % of the value added in the Swedish economy.

Today you can send a message to someone across the globe and it reaches them within a couple of seconds, but if you send an international payment outside the Eurozone it can take up to five days for the money to reach them (Riksbank, 2019). KPMG (2018, pp. 16- 17) have found some major issues with the international payment sector today, some of them being the processing time, the cost of it and the lack of transparency of international payments. The process today builds a lot upon correspondent banking, meaning that the money that one sends from Sweden goes to various banks and sometimes central banks before the funds reach their destination (BIS, 2018, p. 14).

Currently we have one player that has monopoly when it comes to international payments, and that is SWIFT (Dasgupta & Grover, 2019, p. 3841). SWIFT is a messaging service

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for banks across the globe to send information about international payments (Qui et al., 2019, p. 429). During 2018 SWIFT completed a proof of concept using distributed ledger technology (DLT) for their services, this DLT project partly aimed to see if real-time account visibility could improve capital optimization (SWIFT, 2018, p. 8). The report conducted regarding this project found that the back office costs of international payments need to drop with 90-95 % for it to remain competitive when other players are entering the market (SWIFT, 2018, p. 5).

The financial system that we have today is according to Tapscott and Tapscott (2017) outdated. KPMG (2018, p. 18) have listed old payment systems as one of the challenges for international payments. Today trillions of dollars are sent through our global financial system, serving billions of people all over the world (Tapscott & Tapscott, 2017). This gives cause to the systematic security checks that have to be done, after all, 45 % of the financial intermediaries suffer from economic crime every year according to Tapscott and Tapscott (2017).

Everyone that has a bank account in Sweden has at some point had to answer questions such as “What is your primary source of income?” or “How do you plan to use the bank’s services?”. This is the bank’s Know-Your-Customer (KYC) process, which is required by the Swedish law. According to the Swedish Bankers Association (2019) every bank needs to, amongst other things, find out the identity of the customer and how they plan to use the bank’s services. Today every customer has to go through a KYC at every bank they have business with, for companies this could be a lot of banks if they operate in different countries. Demarco (2019, p. 65) claims that a KYC-process for a large company can take up to 50 days with numerous papers to fill and forms to send in. Marsh (2019, p.

338) further states that this is very time consuming for the banks. Hanbar et al. (2020, p.

145) argues that blockchain could optimize the KYC-process for example by letting banks share the costs of KYCs, improve the accountability of the data and increase the throughput of the systems.

According to Sönmez-Özekiciǧlu and Yetis (2020, pp. 84-85) asymmetric information can be found in the banking sector, and if the information asymmetry is too extensive this could affect decision making and impede an efficient financial market. Yang and Li (2018, p. 3261) mean that technologies such as AI, big data and blockchain have the ability to reduce information asymmetry and transaction costs. However, the authors also argue that due to the quick rise of fintech the traditional financial risks and traditional technological risks weave together - which results in new types of risk - these new risks and innovations will in turn increase the information asymmetry between regulators and those who are being regulated (Yang and Li, 2018, p. 3259).

Signaling theory is a close relative to information asymmetry, this theory is described as a way to reduce information asymmetry by sending out signals between two actors (Connelly et al., 2011). Song et al. (2020) studied signaling theory in a supply chain finance setting and found that the relations of the supply chain network sends out a signal to the financial service provider.

One part of blockchain that is particularly interesting for fintech is the use of smart contracts. M. Gupta (2020, p. 17) describes smart contracts as a set of agreements on a blockchain that governs business transactions. Smart contracts could for example be utilized in trade finance as automatic payment triggers when certain documents are sent (Youssef, 2020). Ganeriwalla et al. (2018) argue that utilizing blockchain technology and

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smart contracts in supply chains can improve the transparency and improve processes, which in turn saves time and money.

When it comes to trade finance and blockchain, the current trend is that banks create blockchain consortia in order to digitalize processes and bring efficiency into an otherwise inefficient industry (A. Gupta, 2020). By creating blockchain consortia, banks are rising above the fact that they are competitors since they realize that they can achieve more if they work together while at the same time they are more environmentally friendly, which leads us to the triple bottom line framework. The triple bottom line framework promotes the formation of partnerships within the environmental, social and economic bottom lines in order to increase sustainability (Elkington, 1998).

1.2 Research problem

Blockchain has been a major topic in technological development regarding fintech for the last few years, CEOs all over the world are listing blockchain as a top strategic priority and a driver for competitive advantage. The CEO for IBM, Ginni Rometty said that

“blockchain will do for transactions what the internet did for information” (Cochrane, 2018). Trade finance and international payments consist of slow processes today, trade finance being paper based with physical papers being stamped, signed and handed over between the owners. International payments are slow outside the Eurozone, fairly intransparent and complicated. Due to the reasons mentioned above this study will examine what impact blockchain could have on trade finance as well as international payments.

China is a nearly cashless society (PWC, 2021) that has published a lot of research regarding blockchain and the different use cases of the technology and have started to implement the technology in various sectors. Sweden is also a nearly cashless society and was deemed the second most innovative country in 2020 (WIPO, 2020), however we have yet to see a large-scale implementation of blockchain in the financial sector in Sweden, nor is there much published research about the topic.

1.2.1 Research gap

Trade finance is, as mentioned, a very paper intensive process and there have been articles written about how digitalization could improve the industry (Bedford et al., n.d.).

Blockchain is currently beginning to be used in trade finance in Sweden by trade platforms such as; we.trade, Contour and Marco Polo. However, so far there has not been a lot of published articles about the matter. Petrov (2020b) conducted a study regarding implementation of blockchain in trade finance and global payments. His results regarding trade finance includes signs of efficiency gains, lowered cost and a reduction of third parties. Our study differentiates from his by addressing the matter from a Swedish point of view by mainly talking to Swedish professionals involved in the trade finance and international payments sector.

This study also includes international payments as it is an important part of global trade and thus trade finance. The aim is to see which areas of international payments work well, which areas could be improved and what impact blockchain could have on the industry.

KPMG (2018) addressed the challenges of international payments in their survey and we aim to see if the common view of the financial industry in Sweden is that blockchain could improve these areas or if it is an area where blockchain should not be implemented.

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Petrov (2020b) also incorporated global payments in his study, and he found some areas where blockchain could improve global payments. Our study differentiates by addressing this matter in a qualitative way and considering facts as well as personal thoughts and viewpoints of our respondents.

1.3 Thesis purpose

The purpose of this work is to investigate why there has not been a large-scale implementation of blockchain technology in Sweden, with the focus being on international payments and trade finance. Previous studies have identified areas such as transparency (Cole et al., 2019, p.496), security and efficiency (Iredale, 2021) as some of the main benefits of blockchain. Efficiency is something that could be improved in trade finance (Bedford, 2020), while international payments could benefit both from increased efficiency and transparency (KPMG, 2018). This work will investigate how the financial industry perceives blockchain and especially the way the technology can affect information sharing and reduce information asymmetry.

As mentioned earlier this study will focus on the implementation of blockchain in Sweden and hopefully bring some illumination on the lack of large-scale implementation in the financial industry in the country. By looking at previous studies of implementation of blockchain one can conclude that most of them are based in China, the UK or the US.

This study also hopes to contribute to the research of blockchain implementation in Sweden as there is currently not much research about the country in question and we hope to find what the financial industry sees as the biggest barriers of implementation. We want to shed light on the impact that blockchain could have on international payments and the trade finance industry, as well as the attitude that these sectors have towards the technology. Additionally, we will discuss in short what other possible areas in the financial sector blockchain could be utilized.

1.3.1 Research question

Given the relevance blockchain is predicted to have in the financial sector in the future and a need for research concerning the subject, the following questions were identified to address the research gap and will be discussed throughout the thesis:

How can blockchain technology affect the trade finance and international payments industry?

What are the barriers for large-scale implementation of blockchain technology in the financial sector in Sweden?

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1.4 Choice of topic and preunderstanding

We are two students in our last year of the International Business Program at Umeå University and during our last years of studying we have specialized in financial management. The interest of blockchain technology was first awakened in an Operations Management course that both of us took during the sixth term of our studies as we both wrote about the technology and its use cases within Operations Management for a short essay during that course. We discussed the subject and started to realize the complexity yet simplicity of the technology and its ability to spread far wider than only Operations Management. When deciding to write our degree project together both of us knew that blockchain would be included as we still had not lost our curiosity of the technology.

When starting this work our knowledge about blockchain was very limited, we both have an interest in technology and that has helped us a lot through the more technical parts of this study. A lot of research around blockchain has been read for this paper, however we have decided to exclude the most advanced technical details from this paper as our general knowledge about technology is not vast enough for us to know that we interpret the advanced technical details correctly. For this study the most technical aspects of blockchain technology are deemed redundant since it is not our purpose to evaluate the technology itself, rather its uses and the perception about it. Our limited knowledge about the technology has helped us to start this project with an open mind and an objective point of view.

We first started to look at implementation of blockchain within supply chain finance, as there were many interesting studies previously done on the subject. That our choice fell on supply chain finance at first was partly due to our specialization in finance but also due to the fact that one of the authors have worked with supply chain management and have an interest in the subject. As we soon realized that trade finance and supply chain finance are quite similar in Sweden we chose to reevaluate our direction towards trade finance with supply chain finance as a subcategory. That we did not eliminate supply chain finance from this work is due to the fact that most recent studies have been on supply chain finance rather than trade finance, as supply chain finance is a growing subcategory of trade finance.

After some discussion amongst ourselves and our supervisor we soon realized that this direction was a bit too narrow for us to get a sufficient base and enough respondents, which is why we then chose to expand to international payments as that is a topic that is very relevant for trade finance as well. From our previous studies and experiences we had knowledge about trade, however not trade finance or supply chain finance. We did not have extensive knowledge about the mechanics behind international payments either.

This has given us an objective perspective about the topics and the ability to read and analyze both positive and negative aspects of the topics.

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1.5 Delimitations

● International payments will focus on end-users and commercial banks, not central banks directly. We will however mention initiatives taken by Central Banks in regards to their digital currencies, in order to discuss its impact on the payment infrastructure of the future.

● As blockchain has been implemented more broadly in countries outside Sweden, such as China or the United States, we have thus chosen to investigate what prevents a large-scale implementation of the technology in Sweden.

● We have chosen respondents based on the area they are operating in, our main focus have been to find respondents with a knowledge about blockchain as well as international payments and/or trade finance, but we have also wanted to include respondents with a general knowledge about the blockchain situation in Sweden specifically to be able to answer our second research question.

● Due to limited technological knowledge we have chosen to assess blockchain from a business perspective and not go in-depth at the most technological aspects of the technology. This is due to the fact that we are after all business students and do not have the relevant knowledge to properly describe and assess the programming and technical aspects behind blockchain.

● This study is treating supply chain finance as a subcategory to trade finance, as the definitions for supply chain finance is varying between different sources and in Sweden they have been used interchangeably.

● Distributed ledger technology and blockchain differ a bit in the technical details, however, as we do not focus on the most technical aspects of the technology we will use the words interchangeably.

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2. Theoretical point of reference

This chapter will introduce the main topics of the paper, namely blockchain, trade finance, supply chain finance and international payments. It will also briefly introduce E-kronan, the Swedish central bank’s initiative for a digital currency.

2.1 Blockchain

Blockchain is a technology that has been a major topic of discussion during the last few years. Below the fundamentals of blockchain will be presented, from the technology and the areas that are important in the financial industry such as the design of the network and smart contracts, to drivers and obstacles.

2.1.1 Technology

Blockchain technology can be divided into two stages - Blockchain 1.0 and Blockchain 2.0 (Li et al., 2020, p. 843). Blockchain 1.0 was the initial stage and was mainly used for cryptocurrencies, whereas the development Blockchain 2.0 is the kind that introduced things such as smart contracts. Blockchain in short is an immutable shared ledger that stores information about transactions and tracks assets in a business network (M. Gupta, 2020, p. 3), it can track and trade almost every asset, which leads to reduced costs and risks for all parties involved. Blockchain is built by blocks in chains, hence the name.

Each block contains time and sequence of the transaction as well as a hash - a digital fingerprint, unique for every block on the chain. Each block also contains the hash from the previous block, this links the blocks together and prevents them from being altered or that another block can be inserted between the two logged blocks (M. Gupta, 2020, p. 13- 14). Every time a new transaction happens in the blockchain network all participants with access to the chain will get an updated version of the ledger. The participants are called nodes and M. Gupta (2020, pp. 6-7) describes it as they all “act as both a publisher and subscriber” of the blockchain, meaning that they can both change the ledger as well as keep track of all the changes done by others.

M. Gupta (2020, p. 9) argues that one benefit of using blockchain in businesses is that it is time saving, so instead of having multiple interactions concerning one transaction where a central authority needs to verify it, a blockchain simply sends out the transaction to all nodes. Those in turn have to accept the transaction and when that is done the transaction will appear as a block in the ledger, reducing the transaction time immensely.

Another benefit with the technique is that it reduces costs by reducing intermediaries, eliminating duplication as all participants have access to the same ledger and creates less need for oversight as the network is supervised by the known participants of the network (M. Gupta, 2020, p. 9).

Satoshi Nakamoto is (are) the anonymous person(s) behind Bitcoin, in 2008 they published a paper called “Bitcoin: A Peer-to-Peer Electronic Cash System” which is the first paper written about Bitcoin and the phenomenon that would be called blockchain (Bitcoin, n.d.). In this paper they argue that in an electronic payment system the need for a trusted third party is replaced with cryptographic proof instead of human trust (Nakamoto, 2008, p. 1). Cong and He (2019, p. 1755) calls this a “decentralized consensus” and describes it as a digital copy of the real world transactions which have

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been accepted as the truth of all the agents in the system. That the majority of the nodes in the network needs to accept this truth before it becomes a part of the ledger is a key point for blockchain technology, Cong and He (2019, p. 1755) argues that advocates for blockchain technology believes decentralized consensus could reduce the transaction fees charged by the third party as well as improve the resilience of the system.

A blockchain network is based on a decentralized consensus mechanism, there are many different consensus mechanisms in use now, but this section will focus on the two most common ones - Proof of Work (PoW) and Proof of Stake (PoS) (Li et al., 2020, p. 842).

PoW is the mechanism that for example Bitcoin is built upon and it uses a “puzzle” to verify the credibility of the data, the puzzle could be an algebraic problem or such. Once a transaction takes place the puzzle will go out to all of the nodes connected to the network, the puzzle is usually computationally hard but easy to verify once solved; when one node (miner) has solved the puzzle it will be sent out to the other nodes for verification. 51 % of the nodes in the network need to verify the solution and then the transaction will be accepted, which is when the network will have reached consensus (Li et al., 2020, p. 842).

PoS on the other hand is a fairly simpler method than PoW that does not require as much computational power as PoW does. When a block is to be created in a PoS based network the network will charge the user a fee, if the transaction is accepted the user will get their fee back, otherwise it will be fined (Li et al., 2020, p. 842). One of the main critiques towards Bitcoin, that uses PoW, is its energy consumption. Bambrough (2021) writes in an article that the cryptocurrency is consuming as much energy in a year as the entire country of Sweden does. According to Li et al. (2020, p. 842) using a PoS mechanism could increase the throughput of the entire system and it could also decrease the energy consumption.

2.1.2 Public vs. private blockchain

There are essentially two broad categories of blockchain, private or public blockchain (Daj, 2018, p. 209). Public blockchain comes in a couple of different styles - permissioned or permissionless. A permissionless blockchain is open for everyone to read, write and accept blocks to the end of the blockchain. The most famous blockchain has a public permissionless structure, this blockchain being Bitcoin. The other part of public blockchain is permissioned blockchain, these are open to read by everyone but only authorized people can write or accept new blocks to the end of the chain (GSMA, 2018, p. 6). An example of a permissioned public blockchain is Ripple that enhances the technology to provide a simpler and faster solution for international payments (Ripple, n.d.). To make the difference more comprehensive, see figure 1.

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Figure 1. Public blockchain. Based on GSMA (2018, p. 6)

According to GSMA (2018, p. 6) there are two types of blockchain when it comes to private blockchain as well - consortium and private permissioned (“enterprise”), see figure 2 for a visual overview. When it comes to the consortium only authorized participants can read and write in the blockchain, in the matter of accepting blocks to the chain only the authorized or a subset of the authorized people can do so. This method is usually the one used when there are multiple companies or sectors involved, an example of a blockchain like this is Corda which is a open source blockchain platform for businesses which helps enterprises to streamline business operations and helps to reduce transactions and record-keeping costs (Corda, n.d.). Corda is used for some of the trade platforms that we see today. The second type of private blockchain is the private permissioned, in this form the only one that can write and add blocks to the chain is the network operator, the visibility and the ability to read what is on the blockchain can be restricted to authorized participants or it can be fully private. This form of the blockchain is mainly used internally in companies (GSMA, 2018, p. 6).

Figure 2. Private blockchain. Based on GSMA (2018, p.6)

There are pros and cons to both public and private blockchain networks. According to Iredale (2021) the best features of a public blockchain is the high security, the open environment and the anonymous nature, however she argues that the fact that public blockchain are an open environment but also anonymous may lead to illegal activities

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such as money laundering. Further she argues that the reason for adopting a public blockchain is that it is true decentralization, there is full transparency and total immutability of the ledger. Iredale (2021) also means that the best features of a private blockchain is the high efficiency, full privacy and the stability. She discusses the main reasons to implement this sort of blockchain network and suggests things such as the low transaction fees, that it saves money and that it is easy to follow regulations.

2.1.3 Smart contracts

A smart contract is a set of agreements that is stored on a blockchain and governs business transactions (M. Gupta, 2020, p. 17). When Nick Szabo (1996) introduced the term “smart contract” he compared the technology with a vending machine - as soon as you make the transaction you will get what you paid for automatically. Shermin (2017, p. 506) describes that when a transaction is made the smart contract checks whether the transaction obliges the rules of the contract, if it does the transaction is validated, otherwise it is rejected. Li et al. (2020, p. 844) explains that each smart contract corresponds to a unique address, through this address the clients of the smart contract can interact through transactions etc.

Rosic (n.d.) argues that some of the benefits of a smart contract are; autonomy, there is no longer a need to rely on an intermediary such as a broker or a lawyer if the original smart contract is coded correctly; trust, all documents will be on a shared ledger and no one can ever say that they “lost” the contract again; speed, you do no longer need your pile of paper and manual documents; accuracy, there will be no manual errors that comes from filling in a pile of papers. Other than this Rosic (n.d.) argues that companies that deploy smart contracts will save money and always have a backup of their copies.

Petrov (2020a, p. 23) argues that the value of smart contracts comes from the ability to eliminate intermediaries, as well as the fact that when the blockchain smart contracts tie the transaction with the contractual terms the likelihood of a conflict between the parties will be minimized. Petrasic and Bornfreund (2016, p. 4) mean that smart contracts will be of interest to regulators in the future due their strong security features. They also explain that blockchain smart contracts can be of good use for artists, authors and musicians as they can use the technology to track their work without involving a third party. However, as the rules of the smart contract are based on codes and codes are written by humans, one cannot guarantee that the code will be free from human error or biases (Shermin, 2017, p. 507). GSMA (2018, p. 23) argues that failure to identify the person or company behind the smart contract, or coding mistakes in the smart contract, may lead to fraud. Therefore there needs to be some sort of identification of the smart contract users and GSMA (2018, p. 23) means that the smart contract could be anonymous but include some sort of credentials that are verifiable.

Regarding smart contracts and their validity in Sweden there should be no problem per se as the formation of contracts is technology neutral (Bergsten and Vallin, 2021, p. 6).

However, Swedish regulation requires that the parties should exchange declarations in some form, if the smart contract is electronically automated this could pose a problem as there is too little human interaction for it to actually count as a binding agreement.

Additionally, when the parties do not meet in person to sign the contract the contract is seen as a distance contract, this includes all electronically concluded contracts (Bergsten and Vallin, 2021, p. 6).

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2.1.4 Drivers

A lot of the literature today argues that blockchains may have a disruptive influence in areas such as finance and governance (Shermin, 2017), traceability (Hastig and Sodhi, 2019, p. 950) and supply chains (Chang et al., 2019, p. 2094). According to a survey Deloitte (2020, p. 4) conducted in 2020 managers are continuously increasing the value of implementing blockchain in their businesses, where 55 % of the managers said that blockchain was amongst the five top strategic priorities, in 2018 this number was 43 %.

In this study 88 % of the managers stated that they think “Blockchain technology is broadly scalable and will eventually achieve mainstream adoption” (Deloitte, 2020, p. 5), compared to 84 % in 2018. As much as 84 % of the managers further stated that they think their corporation will lose competitive advantage if they do not implement blockchain, an increase from 68 % in 2018 (Deloitte, 2020, p. 5).

According to Yi (2020, p. 377) trust is the groundwork of the financial market. With increased transparency comes increased trust, Misra (2018) argues that the coding and encrypting of blockchain increases transparency as well as the trust of the information sharing. Blockchain can increase transparency in many sectors such as supply chains (Cole et al., 2019, p. 469), transactions (Nakamoto, 2008), the securities market (ESMA, 2017, p. 26) and supply chain finance (Du et al., 2020, p. 1046). ESMA (2017, pp. 6-7) argues that a decentralized technology could have better resilience against cyber-attacks, if one of the nodes in the network breaks down the data is still easily accessible from the other nodes in the network, but they also state that the resilience in a big blockchain network is yet to be tested.

Nakamoto (2008, p. 6) mentions that in the Bitcoin network the public can see when someone is making a transaction to another, but the public cannot see who the parties involved are. The author(s) compares this to the stock exchange, where one can see transaction information such as size and time of the trade but one cannot see the buyers or sellers. Nakamoto (2008, p. 6) separates the “traditional privacy model” from the “new privacy model”, see figure 3 for a graphic overview. If you made a transaction with the

“traditional privacy model” your identity would be joined with the transaction, a trusted third party would handle the transaction and the counterparty would get the payment, the information about this chain's existence would however not reach the public. In the so- called “New Privacy Model” the identity would be concealed from the public but the transactions would be fully public and transparent (Nakamoto, 2008, p. 6).

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Figure 3. Visual representation of the Traditional Privacy model and the New Privacy model. Based on Nakamoto (2008, p. 6).

However, ESMA (2017, p. 11) argues that even though transparency is one of the main benefits of a blockchain network, one needs to be able to protect private and sensitive information. If everything were fully public, such as inventory levels or recent trades, there will be people exploiting this. This could lead to market manipulation or other unfair practices such as price manipulation or to front-run² if there is no one there to safeguard the information shared. Nevertheless the transparency that comes with the technology could be used for preventing fraud due to better traceability of transactions, the blockchain technology could also be used for areas such as anti-money laundering and

“know your customer” (ESMA, 2017, p. 11). ESMA (2017, p. 6) also sees the implementation of blockchain in the securities market as a tool to enhance supervision and reporting functions, both at firms and regulators with better shared data and risk management. Nonetheless they also warn about the fact that too much decentralized supervision might be less effective than centralized supervision (ESMA, 2017, p. 6).

2.1.5 Obstacles

ESMA (2017, p. 3) lists some challenges for the implementation of blockchain in the securities industry, however these challenges stem from the technology itself and can be applicable to more areas than the securities industry. One of the first challenges they mention is that it needs to be broadly adopted by market participants for it to work (ESMA, 2017, p. 7) and the technology also needs to be able to interoperate with current market standards (ESMA, 2017, p. 3). When the market starts to implement blockchain there needs to be a governance framework to be able to safeguard the participants, information and the technology of the network (ESMA, 2017, p. 7). ESMA (2017, p. 5) further states that quicker settlements of the security transactions would require big changes to the current market practices, which could lead to increased risks and costs.

Li et al. (2020, pp. 843-846) argues that blockchain is overall a very secure technology, but there are some security risks as well, firstly there is the 51 % vulnerability; from a PoW based view this means if attackers have over 51 % of the computing power of the

2 To use insider information to be able to earn money on securities where they know the price will change.

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system they will be able to gain control over the entire network as it is based on a consensus mechanism. Same goes for PoS but then the hackers need to have control of over 51 % of the coins of the network. Secondly there is the private key security, the identity of a participant in a public blockchain is set by a private key, if this key is lost or stolen there is no way to get it back. Another security issue that the authors bring to attention is the use of cryptocurrencies in criminal activities, Bitcoin has for example been used for money laundering or for purchasing illegal objects online as it is anonymous (Li et al., 2020, pp. 843-846).

According to Li et al. (2020, p. 846) there are some specific risks when it comes to Blockchain 2.0. As mentioned earlier Blockchain 2.0 is the development of smart contracts, one example of the security risks here are criminal smart contracts, where someone makes a smart contract with the purpose to do something illegal, this could for example be leakage of identities or theft of someone’s private key. Smart contracts are essentially based on codes written by humans, therefore there could be human errors included in the smart contracts. Other things that could count as risks of smart contracts are things such as under-optimization, meaning that the smart contract is not used in its best way. Li et al. (2020, p. 851) argues that in the future one should try to combine the PoS and PoW mechanisms to get a more efficient and less energy demanding blockchain network, they also mention that Etherum is currently looking into this solution.

The key risks of blockchain identified by ESMA (2017, pp. 10-13) are operational risk, cyber risk, fraudulent activities and systemic risk. They believe that operational risk is most likely to occur as errors in for example smart contracts, this could have big consequences if the error goes undetected for too long. However, operational risk could be mitigated through standardization and automatization. Cyber risk was also mentioned and the biggest concern regarding blockchain was that it is still at the development stage and largely untested. As long as the blockchain is limited in size ESMA (2017, p. 13) sees no systemic risk in the technology; however, when the system grows the systemic risk might increase, especially with the use of smart contracts that have automatic triggers that sell or buy products at a specified price.

ESMA (2017, p. 11) further discusses the risk towards the fair competitions and orderly markets, they argue that patents on the technology might lead to a monopoly like situation if it is not handled properly. Furthermore they discuss that one of the main benefits of blockchain technology, namely transparency, could lead to market manipulation or unfair trade practices. Even though blockchain technology is a big step forward for transparency one needs to be careful and still protect some of the privacy of the users, that is why the public blockchain of today are cryptographed and anonymous; one can see that another one holds what it claims to hold, but one cannot see the person or company behind it (ESMA, 2017, p. 11).

An (2020) discusses the problems of deciding on regulations when it comes to blockchain and which party is the one that is to be considered liable in different situations involving blockchain, since there are a number of parties involved. The problems here are mostly due to the fact that blockchain is a decentralized technology and that in some instances it is not possible to identify who the errant miner is even if it would be decided that they are the ones liable (An, 2020, p. 542). The current situation puts a lot of responsibility on programmers, especially considering that they are not required to have an accounting and/or law degree, but are creating products and services that are inherently connected to those subjects (An, 2020, p. 557).

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ESMA (2017, p. 3) have not identified any regulatory constraints for the implementation of blockchain on a EU-level but they press the fact that each organization planning to implement blockchain needs to adhere to the national law, corporate law, contract law and so on (ESMA, 2017, p. 3). On privacy and governance issues ESMA (2017, pp. 9- 10) argues that there needs to be a framework for who is liable for respective parties, rules regarding approval or rejection of new participants of the blockchain and which laws to be used in case of dispute.

Bergsten and Vallin (2021, p. 3) states that there are no current regulations for the blockchain technology in Sweden, they argue that this causes one of the main barriers for real implementation of the technology due to the fact that it does not really fit perfectly into the regulations that exist today. This leaves the technology in a kind of legal vacuum and prevents bigger scale implementation. The Swedish Financial supervisory authority (Finansinspektionen) was asked by the government and some major financial institutions to create a regulatory sandbox³ to encourage the use of blockchain. However, Finansinspektionen decided against this with the argument that the innovations in the financial sector in Sweden are already strong and a regulatory sandbox could have adverse effects on the market competition. This was also the reason stated for not conducting any regulatory changes concerning blockchain (Bergsten and Vallin, 2021, p. 3).

2.2 Trade finance

According to WTO (n.d.) around 80 to 90 % of the world's trade relies on some sort of short term trade finance, however WTO (2018, p. 99) also found that around 60 % of all trade finance requests from small firms are denied by the bank. Meynell (2020) describes trade finance as an arrangement between a buyer (importer) and a seller (exporter) to mitigate risks, typically such an arrangement will include the buyer and the seller as well as the banks of each party. When the buyer and the seller come to an agreement of a sale, the banks can help with the funding and liquidity arrangements to conclude the contract of sale. The involvement of the bank for financing purposes benefits the entire supply chain involved in the transactions (Meynell, 2020). Bedford (n.d.) argues that trade finance is still a very paper intensive process and Petrov (2020b, p. 12) found that implementation of blockchain in trade finance might have the ability to reduce time and cost of the process, automate key processes using smart contracts, improve the operational security and eliminate unnecessary third party actors.

According to Demir and Javorcik (2020, p. 399) there are four types of financing terms when it comes to trade finance. The first one being cash-in-advance where the importer bears all the risk, this method is self-explanatory as it is when the importer pays for the goods before the ownership is transferred to the importer. There is also one method called open account where the exporter bears all the risk, in the event of an open account solution the importer will pay when the goods are delivered. The third type of financing terms discussed are called letter-of-credit (or documentary credit) and here the buyer shifts the risk to their bank for a fee, the importer's bank promises to make a payment to the exporter after certain criteria are verified, in this case the exporter knows that they will be paid and the importer does not have to pay in advance. The last method named by Demir and Javorcik (2020, p. 399) is documentary collection, and when this is utilized the exporter

3 A regulatory sandbox is a controlled environment where fintech companies and their innovators can test their products under supervision from regulators.

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assigns the task of payment collection to its banks which sends payment instructions along with other documents to the importer’s bank, this method does not ensure payment protection but is still a risk mitigation technique if used correctly. When the relationship between the buyer and the seller evolves, the terms and agreements of the payments usually tend to relax (ICC, n.d.).

Meynell (2020) calls the techniques mentioned above as “Settlement & Risk mitigation- driven instruments” and clarifies that these types of instruments provide trigger points for the payment itself or payment assurance. Deloitte (2016, p. 3) argues that smart contracts in supply chain and trade finance can streamline processes and make the entire process more efficient. As explained in the section about smart contracts they are automated contracts that come into work when a certain trigger point is reached, in trade finance this could for example be that the payment from the importer is sent automatically when the bill of lading is received.

Demir and Javorcik (2020, p. 406) found that flows that utilized risk mitigation techniques with a bank as an intermediary, such as letter-of-credit or documentary credit, was more resilient to the downturn in the economy due to the Covid-19 pandemic than flows that used other types of financing terms in Turkey. A big decline (27 per cent) in open account flows were found, additionally an even bigger drop of usage of cash-in-advance were found, the data indicated that this decline was 42 per cent. Since the subprime crisis in 2008 - 2009 trade finance has been limited in certain countries, this due to the decline in correspondent banking relationships. New anti-money laundering regulations and other regulations have driven these developments and they affect developing countries the most (Demir and Javorcik, 2020, p. 407).

2.2.1 Trade finance platforms based on blockchain

We.trade is a joint-venture company owned by 13 banks in Europe as well as IBM (we.trade, n.d.). They are live and operating since 2019, they are using DLT and smart contracts to enhance easier trade. We.trade’s platform is mainly used by SMEs to overcome challenges such as cyber-fraud, late payment of invoices or requests for pre- payments from sellers. They strive to enhance the cash flow for companies that use the trade platform and digitize the paper-based trade finance process (we.trade, n.d.). Nordea is the Swedish bank involved in this blockchain based trade finance consortium.

Contour is a decentralized trade finance network that focuses on digitizing trade finance, by making the process of letter of credits easier they believe that the trade will increase as it allows partners with limited trust to transact (Contour, n.d.a). Their network is built upon Cordas platform (Contour, n.d.b). Contour launched a live beta platform in January 2020 and released their official platform in October 2020 (Contour, n.d.c). One Swedish bank is involved in this trade platform and that is SEB.

Marco Polo is a distributed trade finance network that operates in a slightly different way from the networks mentioned above by keeping the nodes at the customers, this leads to more trade finance solutions than the other networks as the customers are able to design their own solutions (Marco Polo, n.d.a). The network has been operating since 2017 (Marco Polo, n.d.b). No Swedish banks are involved in Marco Polo, however two Nordic banks are involved, these being Danske Bank and DNB (Marco Polo, n.d.b).

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2.2.2 Supply chain finance

A subcategory to trade finance that is interesting for this study is Supply Chain finance.

Based on previous works such as Du et al. (2020), Choi (2020) and Chod et al. (2020) implementation of blockchain might mitigate risks and enhance SMEs ability to get funding. ICC (2020, p. 17) found that 54 % of the respondents in their Global Survey on Trade Finance sees supply chain finance as a priority of the bank in the direct future, in total 96 % of the respondents see supply chain finance as an area for development, where 54 % sees it as a priority within the next 12 months, 33 % as a priority within 1-3 years and 10 % in 3-5 years. Only 5 % of the respondents did not see supply chain finance as a priority in the future (ICC, 2020, p. 17).

According to PwC (2017) Supply Chain Finance is a shared benefit solution for suppliers, buyers and an intermediary. ICC (2020, p. 62) defines supply chain finance as “An umbrella term that covers multiple techniques, aims to address the vast majority of trade today that takes place on open account terms, with the remaining 10 % or so on the merchandise trade side enables through more traditional trade finance mechanisms such as documentary credit and documentary collections.”.

Du et al. (2020, p. 1045) describes Supply Chain Finance as a model in which banks connect upstream and downstream corporations in a supply chain to provide flexible financial products and services. Du et al. (2020, p. 1047) further describe it as a microfinance concept that applies only to the production links in a supply chain. The authors argue that participants in supply chain finance look at their own interest first in business co-operations, due to this the comprehensiveness of the information cannot be guaranteed. This causes asymmetric information in the chain, which can lead to lack of trust amongst the participants (Du et al., 2020, p. 1047).

The article written by Du et al. (2017) describes an experimental study where they implement a blockchain based platform that supports supply chain financing. When the study was concluded the platform had been running for approximately one year, over 500 supply chain companies had used the platform and the accumulated transactions were over 1.2 billion US dollars. They based their platform on a peer-to-peer trust mechanism which they argue leads to more trust and integrity (Du et al., 2017, p. 1057).

Choi (2020, p. 14) means that implementing blockchain in supply chains and supply chain finance will lead to increased expected profit if the service fee from the bank in a supply chain finance setting is sufficiently high, however, if the service fee from the bank is not sufficiently high, implementing blockchain might lower the expected profits (Choi, 2020, p. 14). Furthermore Choi (2020, p. 14) found that implementation of blockchain leads to decreased operational risks in all cases.

Ali et al. (2020, p. 161) found that the firm performance of SMEs improves when they are in a supply chain finance network. Furthermore they found that trade digitization has a positive significant effect on the performance of the firm, SMEs that have a high level of trade digitization are also more likely to improve their performance in the future. Ali et al. (2020, p. 161) argues that the firm’s performance is increased with the use of supply chain finance due to the fact that firms can optimize their working capital better and therefore afford to be more innovative.

Pan et al. (2021) investigated the link of peer-to-peer lending in a supply chain finance environment in China and came to the conclusion that the inclusion of bigger companies,

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so called core companies, in the supply chain finance have a positive influence of the funds that are to be paid to the SMEs as well. Overall they argue that SMEs are less likely to get funds when they are in financial difficulty due to their lack of history and credit score, which negatively affects their investments in R&D activities. The study concluded that with P2P lending the SME’s increased their R&D efforts and through that they indirectly improved their innovation (Pan et al., 2021).

Song et al. (2020, p. 10) found that trust and commitment amongst the supply chain network is a key factor to make supply chain finance efficient, they also found that the better relation the SME have with the financial service provider the better the working capital performance of the SME will be. Furthermore they argue that if an SME has strong operational capabilities the better their working capital financial performance will be (Song et al., 2020, p. 12). The operating capabilities are divided into two different categories; refinement capabilities and exploration capabilities. Refinement capabilities include for example order fulfillment and profitability whereas exploration capabilities include improvement of the enterprise and the ability to adapt the operations to keep a competitive advantage (Song et al., 2020, p. 13).

According to Song et al. (2020) the traditional signaling theory consists of things such as well-prepared historical financial statements and the ability to offer collaterals, however not all of the small and medium sized companies can offer this as they might have a limited history or limited resources. Instead the authors proposed an integrative signaling model that builds upon the relationship of the supply chain network. They further found that the main attributes of a well-functioning supply chain network is structural embeddedness and relational embeddedness, where structural embeddedness focus on the ties of the transactions in the supply chain network and relational embeddedness focus on the relation between the participants in the supply chain network (Song, 2020).

According to Chod et al. (2020, p. 4378) firms that need help with capital in order to run their operations in the best way often face information asymmetry, when they are unable to secure short-term lending their operating activities might suffer. In this stage supply chain finance would be advantageous as it would turn the suppliers’ accounts receivables into cash. Chod et al. (2020, p. 4379) argues that financing through a letter of credit, which means that the bank pays the supplier directly, involves significant paperwork, is time consuming, can be costly and sometimes a subject of fraud. The fraud may consist of suppliers sending false documentation to the bank proving that a good is shipped, whereas in reality the goods are not shipped (FBI, n.d.). Furthermore Chod et al. (2020, p. 4391) means that through implementing blockchain in a supply chain the companies in question will increase their creditworthiness.

Psillaki and Eleftheriou (2015 p. 1219) means that since the subprime crisis SMEs have faced financial constraints, these constraints have a bigger impact on the investing behavior for small and medium-sized companies than it has for bigger companies. Psillaki and Eleftheriou (2015, pp. 1226-1227) further argues that in bad times such as a crisis, credit is often denied to companies with higher agency costs. As mentioned before SMEs usually face the problem of information asymmetry, Song et al. (2020) suggest that using signaling in a supply chain network can help smaller companies overcome the

“informational gap” with the help of bigger companies with better credit history and information sharing processes.

ICC (2020, p. 59) asked the respondents about their expectations of the growth of supply chain finance for the next five years. 32 % of global banks think it will be a 50 % or

International Payments, Trade Finance & Blockchain: A qualitative study about the impact of blockchain implementation