An article explains how blockchain addresses the challenges of credit difficulties and trade finance for small and micro enterprises

This article was first published on June 4, 2020, on Sina Finance, with the original title "How Blockchain Empowers Small and Micro Enterprises ------ From Challenges to Practical Use Cases," authored by Jiang Jinze.

Small and micro enterprises around the world face challenges such as difficulties in obtaining bank credit, complex trade financing processes, and high barriers to adopting new technologies. Existing blockchain industry application cases have responded to these issues to some extent. Research shows that blockchain can bridge the $1 trillion gap in global trade financing for small and medium-sized enterprises in emerging markets, potentially becoming the economic engine of the 21st century, releasing value hidden in global supply chains for over a hundred years, and providing sufficient profit margins for companies offering related services.

In many countries, small and micro enterprises are the backbone of the economy. Their role is crucial for global economic and social development, with more than half of the world's population working in these companies. For example, in China, by the end of 2017, there were approximately 28 million small and micro enterprise legal entities and 65 million individual businesses, contributing to over 80% of national employment, over 70% of invention patents, over 60% of GDP, and over 50% of tax revenue, playing an irreplaceable role in addressing labor transfer, employment issues, diversifying product types, serving society, and promoting local stability and economic development.

However, small and micro enterprises face many significant challenges. Among them, the most daunting is the issue of difficult and expensive financing, as well as inefficient loan procedures and a lack of necessary information for effective business operations. The World Bank (2017) report pointed out that 20% of small and micro enterprises in high-income countries, 28% in middle-income countries, and 44% in low-income countries face similar situations.

The rise of blockchain technology offers new opportunities for small micro-enterprise financing, a long-standing issue in China's economy. Additionally, the application of smart contracts and identity management technologies enables enterprises to optimize existing business processes and develop new business opportunities.

However, small and micro enterprises are limited by their size and resources, and the application of blockchain technology presents high barriers, a topic that will also be discussed in this article.

I. Small and Micro Enterprises and Current Challenges

Small and micro enterprises hold an important position in China's economic operation and social development, playing an irreplaceable role in promoting market competition, increasing economic vitality, advancing technological progress, and especially providing employment opportunities. For a long time, small and medium-sized enterprises have made significant contributions to China's economic and social development, but as China's economy enters a new normal, the "difficult and expensive financing" problem faced by small and medium-sized enterprises has become increasingly prominent, and increasing opportunities to obtain loans is key to creating new jobs and boosting economic growth.

Bank Credit

This is a major issue, especially for small and micro enterprises. For startups, the opportunity to obtain low-interest loans from banks is very limited; they often rely on internal funds or cash borrowed from friends and family to start and operate their businesses. This is why many new or ongoing small and medium-sized enterprises cannot last long. Due to a lack of funding, the average lifespan of private enterprises in China is only about 3 years, less than half that of the financially developed United States and one-third of Japan.

Since the financial crisis of 2008, banks have essentially become more risk-averse, resulting in a relatively low tolerance for loans to small and micro enterprises. According to estimates by the International Finance Corporation (IFC) in 2018, 65 million companies, or 40% of micro, small, and medium enterprises (MSMEs) in developing countries, have unmet loan demands, with an annual unmet financing demand of $5.2 trillion, equivalent to 1.4 times the current global MSME loan level. The East Asia and Pacific region accounts for the largest share of the global financing gap (46%), followed by Latin America and the Caribbean (23%) and Europe and Central Asia (15%). The unmet loan ratio varies significantly between regions. Particularly in Latin America and the Caribbean, as well as the Middle East and North Africa, the proportion of the financial gap compared to potential demand is the highest, at 87% and 88%, respectively. About half of formal small and medium enterprises cannot access formal credit. Considering informal enterprises such as individual businesses, the financing gap will be even larger.

Trade Finance

Another challenge for manufacturing small and micro enterprises is obtaining trade financing. Trade finance, like many forms of credit, is a key element for the success of small and medium-sized enterprises, but this key is not always easy to obtain. Small and micro enterprises face many barriers in seeking funding, especially in accessing traditional trade financing products. Over the past decade, trade has undergone significant changes. However, trade finance has not. The $1.5 trillion trade financing gap is caused by insufficient data. The industry still heavily relies on paper and follows outdated processes and procedures. As a result, typical trade financing transactions remain filled with cumbersome and time-consuming procedures, making such processes too expensive for small and micro enterprises. This is especially impactful for export-oriented small and micro enterprises in Asia.

Cash Flow Issues

The inability to obtain funds in a timely manner continues to cause significant harm to small enterprises, stifling growth and causing cash flow difficulties. In fact, statistics show that due to the recent COVID-19 pandemic, small and medium enterprises in China saw their first-quarter operating income drop to 50% of the same period last year, with over 80% of small and medium enterprises facing cash flow issues. Businesses need cash flow to repay debts, pay rent, employee salaries, or cover any other business expenses. For smaller companies, the ability to obtain new credit often determines their survival.

Limited Alternative Financing Channels

Today, these small and micro enterprises often seek other forms of financing to obtain funds and alleviate their cash flow issues. In earlier years, P2P lending systems became an alternative to bank loans. However, this channel has been gradually shut down in China in recent years due to risk issues. Crowdfunding has filled market gaps in certain areas but is primarily focused on tech startups, making this new financing avenue inaccessible for most small and micro enterprises in other sectors.

Personal Information Data

Personal identity and data control are of utmost concern for internet companies, as most interactions between customers are controlled through centralized platforms storing usernames and passwords. Such platforms are vulnerable to hacking, where hackers may access and misuse user data. Subsequently, it becomes easy for individuals to forge documents and identity proofs. Even without hackers, large internet companies that possess vast amounts of user data may misuse user information, creating unfair competition for small and micro enterprises and potentially stifling innovation.

Adoption of New Technologies

Another major challenge faced by many small and micro enterprises is how to respond to new trends in digitization and automation. Large companies typically have the capability to respond promptly, experiment, and develop new products and services, thus benefiting from new technologies like blockchain. While they encounter problems, these solutions (including blockchain) may become the answer. However, many small business owners find it difficult to start using new technologies or develop new strategies for emerging trends due to their company's small size, lack of manpower, and funding, resulting in marginal returns that are far less than those for larger enterprises.

Use Cases

Blockchain itself is a solution to these challenges. This technology can address issues in the fields of funding and trade finance. Although blockchain is inherently suitable for money-related businesses, it can also be used to solve many inefficiencies. Secure and reliable data transactions and smart contracts can optimize supply chains and improve customer satisfaction through automated services.

Trade Finance

Especially for small and micro enterprises looking to seek trade financing overseas, blockchain may change the game. Based on blockchain's transparency and consensus mechanisms, it can replace outdated verification and inspection steps, making trade financing products more efficient.

A new study conducted by the World Economic Forum and Bain & Company indicates that blockchain technology can play a major role in narrowing the global trade financing gap, enabling trades that were previously impossible. Another finding is that small and medium enterprises in emerging markets (mainly in Asia) will benefit the most from adopting blockchain technology, indicating the potential of blockchain beyond developed markets and large enterprises.

The Asian Development Bank predicts that the global trade financing gap currently stands at $1.5 trillion, accounting for 10% of the value of goods traded, and is expected to grow to $2.4 trillion by 2025. However, the results of this new study suggest that this gap can be reduced by $1 trillion through the effective use of blockchain technology.

A well-known case is the "People's Bank of China Trade Financing Blockchain Platform," initiated by the People's Bank of China, built and operated by the Digital Currency Research Institute and the Shenzhen Central Branch of the People's Bank of China. It went live for trial operation on September 4, 2018. The platform is based on the underlying blockchain technology independently developed by the Digital Currency Research Institute of the central bank, integrating data from various banks and related enterprises, and aggregating the cash flow, accounts receivable, and data from industry and commerce, judiciary, and taxation of the borrowing enterprises.

Supply Chain Finance

Blockchain technology may also help address the issue of obtaining supply chain financing. Simply put, its logic is to allow multiple participants in the supply chain to jointly participate in a consortium chain, witnessing and sharing data during the transaction process to eliminate information asymmetry among parties. By transferring loans, it weakens the resource allocation asymmetry formed by the resource advantages of large enterprises over small enterprises in the supply chain.

Large traditional core enterprises often have their own upstream suppliers and downstream distributors. The application of technologies such as the internet, big data, and the Internet of Things gradually shifts their information flow, data flow, logistics, and business flow information from offline to online management. With the addition of blockchain technology, it can better record and trace this information, gradually extending and transmitting its credit value to long-tail customers on the chain, helping them obtain more financing opportunities.

On the blockchain, both suppliers and demanders can access necessary transaction information in real-time. Each step of the supply chain process is timestamped and verified by the parties, meaning the information is accurate, immutable, and cannot be lost. Increased visibility may also mean that enterprises will have more available accounts receivable financing solutions. This transparency can lead to faster transaction processing, improving suppliers' cash flow and potentially resulting in lower financing rates.

Smart Contracts

One of the most attractive features of blockchain is its ability to provide smart contracts for small and medium-sized enterprises, which can define agreements like traditional contracts but also bypass intermediaries, automatically executing and enforcing pre-agreed terms. Some labor-intensive business processes can easily be replaced at minimal cost.

For example, in supply chain finance, small enterprises can have their accounts receivable data from core enterprises recorded on-chain in real-time, forming collateralized assets, with smart contracts disbursing loans in real-time according to pre-set conditions, theoretically requiring no human intervention throughout the process.

Peer-to-Peer Lending

The P2P lending business outside of the Chinese banking system once reached a scale of trillions. Objectively speaking, this business model has broadened the financing channels for small and micro enterprises, pooling idle funds from society, allowing small enterprises and individuals with significant financing needs to obtain the required funds more conveniently and efficiently. However, the rapid development of the industry and the lag in regulation have also accumulated significant risks, bringing considerable negative effects to society.

The incorporation of blockchain technology could potentially revitalize this industry. Borrowing matching platforms can establish an on-chain database for the entire lifecycle of debt generation, issuance, subscription, updating, trading, and redemption based on blockchain technology, using smart contracts as a hub and cross-verification of data as a foundation, with information flow and capital flow mutually corroborating, establishing a new financing platform of mutual trust among P2P companies, funders, banks/third-party payments, external data services, and regulators.

Startup Financing

Blockchain makes it easier and quicker for small and micro enterprises (especially startups) to raise funds through equity. Startups can more conveniently split and sell equity using their tokens, avoiding cumbersome paperwork. For investors, tokens are easier to trade and offer better liquidity than traditional equity, making it easier to engage investors.

For example, the Republic project, invested by Binance, raises funds for small enterprises in two forms: one is small equity crowdfunding for non-qualified investors, and the other is large private placements for qualified investors. Both models are issued in token form, and as of May 2020, it has helped 191 enterprises raise funds.

Identity Management

Blockchain may change the game in the online identity verification arena. An increasing number of small and micro enterprises are conducting business online, leading to a demand for enhanced online security. The risks of identity theft and fraud can be eliminated by using decentralized identities (such as blockchain). It allows for a more effective and reliable way of identifying individuals without the need for third-party involvement. In addition to the benefits in verification reliability, the speed at which checks can be executed is also significantly faster. This can help businesses accelerate processes and make them more reliable.

Plans/Projects to Help Small and Micro Enterprises Apply Blockchain Technology

To address the various challenges faced by small and micro enterprises in seeking blockchain solutions, an increasing number of small and micro enterprise-centered programs have been launched.

Blockchers

Blockchers is a project conducted in collaboration with Zabala Innovation Consulting, Innomine, Alastria, and the Frankfurt School of Finance & Management Blockchain Center, which has received funding from the EU Horizon 2020 research and innovation framework program through EU Grant Agreement No. 828840. Blockchers aims to promote the innovative application of blockchain and other distributed ledger technologies (DLT) among small and medium-sized enterprises across Europe. For small and medium-sized enterprises and startups, it accelerates the funding process for real-world use cases of blockchain technology in traditional sectors.

One of Blockchers' main tasks is to facilitate the connection between traditional small and medium-sized enterprises and DLT industry experts (as technology providers), and "realize the benefits and opportunities of DLT to implement practical use cases in various verticals."

The European Commission has selected the Alastria blockchain ecosystem as the technical partner for the Blockchers project. They will provide blockchain infrastructure for startups participating in this EU project to develop blockchain solutions for small and micro enterprises.

Blockstart

To ensure that small and micro enterprises can try "whether and which blockchain solutions will help solve their operational problems," the European innovation consulting firm Bax & Company has established the Blockstart project. The aim of Blockstart is to enhance the competitiveness of small and micro enterprises in the fields of health, agri-food, and logistics by providing business support, identifying, and testing business opportunities from blockchain innovations. Partners from an international ecosystem composed of business networks, incubators, and blockchain experts will work together to test the market readiness of different blockchain solutions in real-world environments. Blockstart will help small and medium-sized enterprises enhance their competitive position by using blockchain technology.

Dutch Logistics Project

Additionally, there is a project in collaboration with Windesheim University of Applied Sciences and the RDM Knowledge Center and Sustainable Port City project, aimed at researching opportunities for small and medium-sized enterprises in the Dutch logistics industry to benefit from blockchain logistics applications, focusing on projects involving small and medium-sized enterprises active in cold chain transportation, including pharmaceuticals, transportation, freight, and warehousing.

They attempt to answer questions posed by small and micro enterprises, including: What impact does blockchain have on their business models? What understanding should they have of blockchain's potential? Can blockchain technology improve their logistics processes? And how can blockchain technology create incremental value for their companies?

National Blockchain Service Network (BSN)

The National Blockchain Service Network (BSN) is hosted by the National Information Center, co-organized by China Mobile Communications Group Co., Ltd., China UnionPay Co., Ltd., and the Blockchain Service Network Development Alliance. The BSN platform integrates the operating environment, cloud resources, network communication, and access interfaces required for blockchain applications into a one-stop solution for blockchain application development, deployment, and management. Traditional methods of building a blockchain environment initially require an investment of over a hundred thousand yuan even when using the cheapest cloud server models, creating a high barrier for small and medium enterprises. In the same application scenarios and resource configurations, BSN may only cost a few thousand yuan. BSN provides a multi-layered framework platform, making development easier, typically requiring only traditional programming languages to get started with blockchain development, allowing small and medium enterprises to apply new technologies and innovate their businesses at low cost and quickly.

Binance China Blockchain Research Institute "Digital New Infrastructure, Lighthouse Plan for Hundreds of Cities and Thousands of Enterprises"

One of the largest blockchain ecosystems globally, Binance, also launched a blockchain enterprise alliance program in China in June 2020, attempting to improve the awareness of various entities regarding blockchain technology, establish unified standards and norms, and integrate industry resource allocation by forming a consortium of technology service companies. This aims to help both startup blockchain enterprises grow rapidly and assist various entities in quickly connecting with suitable blockchain technology services.

The alliance's recruitment direction includes industrial blockchain partners, such as various city development zones and entrepreneurial parks, and enterprises with blockchain technology application needs; the second recruitment direction is high-quality blockchain startups. The alliance plans to support over 1,000 blockchain industry partners globally in the next two years and is expected to invest hundreds of millions of yuan as a special support fund.

II. Blockchain Platforms Centered on Serving Small and Micro Enterprises

To help increase the adoption of blockchain across multiple industries and inspire enterprises to leverage the potential of this technology, global developers have created many open-source collaborative blockchain platforms, such as Hyperledger and Ethereum. Their primary goal is to allow enterprises to build customized blockchains that meet specific needs, rather than having companies solve problems on their own. In recent years, platforms specifically targeting small and micro enterprises have also emerged, such as Republic and We.Trade.

Republic (Small and Micro Enterprise Crowdfunding Platform)

Republic is one of the star projects invested by Binance, founded in 2016 and has raised $16 million from institutions such as AngelList, Binance Labs, and ZhenFund. The project operates within a compliant framework, raising funds for startups by putting their equity on the market in the form of tokens. Previously, most startup equity was owned by a few Silicon Valley venture capitalists, who profited significantly. To date, Republic has helped over 190 small and micro enterprises raise over $100 million in user investments, with a success rate of 90% for financing projects, and over 500,000 investors are active on the platform, with a low investment threshold of $10.

We.Trade Platform (Trade Finance)

We.Trade is a blockchain-based trade finance network initiated by a consortium of 12 banks, including CaixaBank, Deutsche Bank, Erste Group, HSBC, KBC, Nordea, Rabobank, Santander, Societe Generale, UBS, Eurobank, and UniCredit, developed using IBM blockchain technology. It aims to make it easier for small and medium-sized enterprises to trade with other companies across Europe. The project manages, tracks, and ensures the authenticity of domestic and international trade transactions by integrating information from all relevant parties (i.e., buyers, buyers' banks, sellers, sellers' banks, and carriers), thereby simplifying the trade financing process for small and micro enterprises. Providing more effective European trade financing and credit channels for more companies will enable them to grow their businesses by expanding into new markets and establishing new trade partnerships. Earlier this year, We.Trade announced that it was collaborating with the Hong Kong blockchain trade finance platform eTradeConnect, planning to work with some insurance companies and more banks in financing scheduled for September.

People's Bank of China Trade Financing Blockchain Platform

This platform was initiated by the People's Bank of China and is a financial technology infrastructure built and operated by the Digital Currency Research Institute and the Shenzhen Central Branch of the People's Bank of China, which went live for trial operation on September 4, 2018. On January 7, 2020, the central bank disclosed that the trade finance blockchain platform had been operational for multi-level financing of supply chain accounts receivable, cross-border financing, and other businesses, with a transaction volume exceeding 90 billion yuan. Previously, Xinhua News Agency reported that as of October 31, 2019, 29 banks participated in promoting the application in Shenzhen, with 485 branches and 1,898 enterprises conducting business.

The platform is based on the underlying blockchain technology independently developed by the Digital Currency Research Institute of the central bank, integrating data from various banks and related enterprises, and aggregating the cash flow, accounts receivable, and data from industry and commerce, judiciary, and taxation of the borrowing enterprises. Earlier this year, the People's Bank of China also announced plans to establish a blockchain-based trade financing platform for the Guangdong-Macao Greater Bay Area.

Traxia (Trade Finance)

Traxia is a distributed global trade finance platform. The planned new system based on blockchain will be used to assess the creditworthiness of small and micro enterprises, bridging the gap between banks, small and micro enterprises, and data providers. Traxia creates debt securities that institutional investors can trade by converting invoices and letters of credit into digital assets. This represents a new asset class that was previously only accessible to banks and high-priced P2P lending platforms.

Tencent Digital Identity Solutions

In 2019, Tencent launched a decentralized entity identity technology solution based on a consortium blockchain, providing distributed entity identity identification and management, as well as trusted data exchange protocols, aimed at promoting cross-departmental and cross-regional identity verification and data collaboration.

The use of cryptography and blockchain technology in the electronic identity field has two major advantages. First, users can have greater control over how and when their personal information is used, significantly reducing the risks associated with storing sensitive information in centralized databases. At the same time, blockchain networks can enhance privacy levels through cryptographic systems. For example, zero-knowledge proof technology can share and verify credentials or identity information without disclosing any information. This means that even encrypted data can still be verified for authenticity. In other words, you can use zero-knowledge proof mechanisms to prove that you are of legal driving age without revealing your actual age or that you can enter age-restricted venues.

Another advantage is that blockchain-based electronic identity systems are more reliable than traditional methods. For example, using electronic signatures to verify user authenticity is relatively easy. Additionally, blockchain systems make information tampering more difficult, effectively protecting information security.

Other Blockchain Platforms for Small and Micro Enterprises

In 2019, an alliance of 11 Indian banks jointly launched the country's first blockchain fund targeting small and micro enterprises. The goal is to improve lending to "companies that are prone to default" by enhancing transparency. It is reported that in the initial phase, participating banks will establish a real-time network for supply chain suppliers from across India, allowing them to complete registration on the platform and digitize information, after which the banks under the consortium will be organized on the blockchain to process their business transactions.

In 2018, the Hong Kong Monetary Authority (HKMA) made a similar commitment and launched eTradeConnect, a blockchain-supported platform aimed at addressing various challenges that hinder connections between banks and small and micro enterprises.

In the second half of 2017, the Monetary Authority of Singapore (MAS) and the Abu Dhabi Global Market (ADGM) reached a cooperation agreement aimed at creating a blockchain-driven cross-border trade and finance platform for small and medium-sized enterprises to easily access funding.

The financing difficulties and high costs faced by small and medium enterprises in China have long been a concern, but overall, the pain points have not been systematically and effectively resolved. The Binance China Blockchain Research Institute is collaborating with several domestic enterprises and financial institutions to explore the use of Binance Chain, one of the largest asset circulation chains globally, to develop digital data, debts, and assets for small and medium enterprises, creating trustworthy world-class commercial digital assets, improving the quality and pledge rates of related enterprises' assets, thereby obtaining more funding sources and better interest rates.

III. What Advantages Can Blockchain Bring to Small and Micro Enterprises?

Blockchain has the potential to provide many unique advantages for small and micro enterprises, such as trust, speed, higher security, and reduced risks of identity fraud and hacking, thereby reducing time and unnecessary costs. This may enable them to address issues of financing difficulties, burdensome paperwork, and globalization (globalization based on blockchain platforms).

Funding

First, the opportunities for obtaining financing will be greatly increased, as blockchain records and verifies the authenticity of accounts receivable or contracts, allowing financial institutions to be more confident that this enterprise can receive funds in the future without collateral.

Globalization

Purchasing goods from distant buyers or paying overseas employees may become easier, and communities can operate through token points to strengthen user loyalty. Ultimately, this can help quickly and cheaply bring products and transaction services to market.

Safer Transactions

Security and transparency will also prove to be added value that blockchain brings to enterprises. For small and micro enterprises looking to expand overseas, using blockchain technology with secure communication can ensure greater security in their transactions.

Blockchain technology will help companies overcome issues related to information asymmetry, collateral requirements, a lack of sufficient credit reporting agencies, and internet data security and cybercrime. Thus, blockchain technology can ensure secure, automated, and efficient data transactions, which can be used to exchange private information, monitor logistics, or trace food sources.

More Cost-Effective Processes

Blockchain applications will simplify business processes and offer significant potential for reducing process costs and complexity. For small enterprises hosting services on the blockchain, significantly lowering indirect costs is a major advantage. Using blockchain means reducing the resources and time entrepreneurs spend on management tasks, which may help alleviate traditionally high security costs, KYC work, data storage, and other expenses. In addition to significantly reducing enterprises' investments in these activities, the saved costs can also be passed on to customers, making prices more competitive. This may enable small and micro enterprises worldwide to compete in a fairer competitive environment.

IV. Urgent Issues to Address ------ Regulatory Framework

Blockchain enterprises face uncertain regulations, which limit entrepreneurs' ability to innovate. A looming challenge is the legality of smart contracts and tokens, as well as the need for a global regulatory framework for establishing truly peer-to-peer cross-border credit, as cross-border credit may be legal in one country while not allowing enterprises or residents to participate in another.

A good regulatory framework should clarify the boundaries of rules, promote the adoption of technology, and prevent fraudulent activities, such as issues related to user anonymity in public blockchain transactions. Although the power and potential of blockchain and smart contracts are increasingly recognized in global business and political spheres, regulatory agencies may take some time to catch up, which is understandable, as historical regulation has always lagged behind innovation.

V. Conclusion

In simple terms, blockchain is a system for recording transactions. For centuries, in the absence of better methods, we have created various intermediaries to maintain the integrity of such records: banks, brokers, customs, and so on. Blockchain can replace these trusted intermediaries with technology, substituting digital trust for human trust.

However, despite the grand goals, it must be acknowledged that the development of industrial blockchain globally is still in its early stages. Large enterprises have not widely adopted blockchain, and serving small and micro enterprises will also take time, although we have already seen many cases demonstrating the potential of this emerging technology.

To this end, the most important task for the blockchain industry is to promote more enterprises to put their data on-chain and encourage customers to adopt more comprehensive solutions based on data. Blockchain has enormous potential; according to Allied Market Research data, in the supply chain industry alone, the market size of distributed ledger technology is expected to approach $10 billion by 2025, up from $93 million in 2017. A joint study released by the World Economic Forum and Bain & Company indicates that blockchain can bridge the $1 trillion gap in global trade financing for small and medium enterprises in emerging markets. It is evident that blockchain is expected to become the economic engine of the 21st century, releasing value hidden in global supply chains for over a hundred years and providing sufficient profit margins for companies offering related services.