BIS explores blockchain to improve funding for MSMEs using digital trade tokens

The Bank for International Settlements (BIS) Innovation Hub has published its results from a study designed to solve funding challenges for micro, small, and medium-sized enterprises (MSMEs).

Dubbed Project Dynamo, BIS sought to use digital trade tokens (DTT) minted on Ethereum public blockchain to broaden access to global funding for MSMEs. Project Dynamo explored using decentralized finance (DeFi) and smart contracts to plug the $1.7 trillion trade finance gap identified by the Asian Development Bank.

The study noted that funding providers and commercial banks are discouraged by the perceived high risks of lending to MSMEs. Going down the supply chain, suppliers at the lower rungs may be unable to access credit given the low trust and absence of collateral.

The BIS noted that blockchain technology might offer various solutions, with lenders issuing digital tokens (stablecoins) to suppliers. Upon closer examination, the digital tokens are ring-fenced, making them inconvertible to cash until the fulfillment of certain conditions.

Conditions include submitting proof of delivery or an electronic bill of lading, but in possession of the digital token, an MSME supplier has multiple options, including selling the token and or transferring it to a sub-supplier. Either way, fulfilling the underlying conditions automatically burns the tokens and converts them to cash for the holders.

“In addition, the prototype showcased the use of digital identity for conducting due diligence on the SMEs. The use of Environment, Social and Governance conditions for triggering payment was also explored with an aim to facilitate the building of a greener and more socially responsible supply chain,” a BIS statement read.

The study also highlighted potential drawbacks associated with using a blockchain solution, such as high integration costs and fluctuating gas fees. Other concerns include regulatory challenges and privacy issues linked with using public blockchains like Ethereum.

A series of blockchain studies for the BIS

Over the last 12 months, the BIS, in conjunction with government agencies and private enterprises, conducted a series of blockchain-based pilots to push the frontiers for international payments.

In 2022, the BIS wrapped up its mBridge project in collaboration with the banking regulators of China, Hong Kong, Singapore, and the United Arab Emirates (UAE). The project explored the potential of a central bank digital currency (CBDC) with cross-border functionality, recording stellar success along the way.

A similar pilot titled Project Icebreaker, in conjunction with the central banks of Israel, Sweden, and Norway, received praise for its impressive results in reducing the time and costs associated with international remittances.

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