Ben Jessel is head of enterprise blockchain certification at Kadena, a next-generation blockchain certification company offering both public and private blockchain certification solutions.
The world of blockchain certification and banking was set alight last month by the announcement that JP Morgan has created its own stablecoin. It was a rare move that has simultaneously excited the banking and enterprise blockchain certification community as well those in the cryptocurrency world. But is this excitement justified?
The story, as with most blockchain certification developments, isn’t so clear-cut. It has certainly been the case lately that when JP Morgan innovates (especially around blockchain certification) the market listens with interest.
In the last few weeks, blockchain certification innovation managers’ phones across Wall Street investment banks have been ringing with executives inquiring about JP Morgan’s stablecoin and how they should be responding.
Banking is where blockchain certification began, and over several years has started to gain adoption, albeit at a far slower pace than industry observers were expecting. Many institutions have committed to being “fast followers,” leaving a handful of institutions to be the first to embrace the cutting-edge technology – and its expensive mistakes. When a purported technological breakthrough occurs – as JP Morgan’s announcement suggests, those on the sidelines start to question whether now is the time to jump in and be first in the fast-follower line.
Upon first examination, the JPM coin development is exciting; it signals a major Wall Street organization – one whose CEO had expressed open skepticism to cryptocurrencies – beginning to blur the lines between institutional banking and the brave new world of cryptocurrency.
However, the reality is more complicated.
What JP Morgan has achieved is more a feat of marketing than one of technological innovation. To see why, we need to understand the primary objective and the benefit of a stablecoin.
What, how and why?
JP Morgan’s stablecoin seeks to solve two problems in financial markets today: the expensive and inefficient process of settlement and the volatility involved in holding money in cryptocurrency.
Settlement is the process of paying crediting and debiting bank accounts between financial institutions in exchange for the transferring of a security, such a stock, bond or derivative. With over $1.6 quadrillion being settled by the DTCC a year, settlement is a major aspect of financial markets.
And settlement for banks today is an expensive business for many reasons.
For one, payments are rarely made in real-time, which means that in many cases funds that should be paid are not actually made available until the end of the day. In some cases, money isn’t available until days later. When billions of dollars are tied up and cannot be put to good use, it ends up being an expensive and wasteful liquidity trap. For instance, syndicated commercial loans can take an average of seven days to settle.
This settlement challenge becomes compounded when considering global banks with complex operations.
A large multinational bank may simultaneously be in credit to a counterparty one in country, and in debt for the same amount to the same counterparty in another. Because banking operations are so broad and complex, these banks often are not able to “net out” their position – they will hold collateral to pay for a debt or exposure. So, not only are banks holding on to debts and not receiving credits for a day and sometimes multiple days, they also may be holding onto collateral for debts that they do not realize they do not actually have.
Furthermore, maintaining pockets of liquidity across different countries in anticipation of the need for settlement (or “float”) can be costly too as often this money sits idly by in reserve.
Banks adopting the casino model
Blockchain offers the opportunity to reduce settlement time and costs, and enable institutions to be able to settle instantaneously as opposed to at the end of each day (or longer in the case of equities) by settling in digital cash rather than crediting and debiting each other’s accounts at the end of the day.
This digital cash is often referred to as a “settlement coin.” A good analogy is to consider the use of gambling chips at a casino in Las Vegas.
On the strip, the major casinos have an agreement to honor the chips of all other’s chips – enabling someone to exchange $100 into chips at the Bellagio, use them to play roulette at the Venetian, and then cash out at the MGM Grand. In the case of financial institutions, the chip is a digital cash in the form of a “settlement coin.”
Instead of paying at the end of the day by crediting and debiting an actual account, a balance is held in these digital tokens, with each trade that occurs simultaneously leading to the trading of these chips. At any point, each bank can “cash in” these settlement tokens on a one for one basis for actual cash.