Crypto's next act will be less ostentatious
This post continues with more on JP Morgan’s blockchain projects here.
These days it seems like every financial company has a crypto team trying to figure out how to offer a blockchain product. This week software developer Steve Moser uncovered code and a logo image for PayPal Coin buried in the company's iPhone app. PayPal confirmed that they are thinking about offering their own stablecoin, but it is still just an idea, and the leak was unintentional.
Some of these experiments are likely to be more consequential than others. JP Morgan has been quietly building an intraday repo market based on its distributed ledger system. The project passed milestones in December 2020, when it completed its first trade, and in June 2021, when Goldman Sachs joined the network. JPMC says that daily volume is in the billions of dollars, still tiny compared to the broader repo market. But this is a core money market institution using blockchain near the center of the existing payment system, so it is an experiment worth watching.
Blockchain for intraday repo
How does JP Morgan's blockchain-based intraday repo work? The company operates its own blockchain, apparently based on the design of Ethereum, but not part of the public Ethereum chain. As on any distributed ledger, counterparties to the transaction must first exchange off-chain for on-chain assets. JPMC offers JPM Coin, its on-chain deposit token. (One could correctly call it a stablecoin.) Once all counterparties have moved their assets on-chain, they can participate in the intraday repo market.
The T accounts below describe a typical transaction. In the first step, the repo loan is created: JPM Coin is transferred from lender to borrower; a tokenized Treasury security is transferred in the other direction as collateral. The borrower can spend the money, by exchanging it for normal bank deposits at JP Morgan. This is illustrated in the second step. The borrower would need to get the money back by the time the loan ends, in order to have enough JPM Coin to repay when the transactions are reversed with interest (not shown in the T accounts).
The financial structure of the exchange is not different from other repo transactions, but both the money leg and the securities leg use on-chain assets. JPM Coin stands in for money, and the bank honors that promise by offering to exchange it for regular deposits. Similarly, the collateral for the loan is a tokenized Treasury security. Presumably JPMC keeps the underlying securities in custody and provides them on demand too.
Why bother with all of this? The big selling point seems to be the facilitation of intraday transactions. The regular repo markets operate on a daily schedule, with settlement and collateral allocation occurring at specific times during the day. But banks may experience payment flows during the day that create liquidity needs that cannot be met on the repo market's daily schedule. Speaking after Goldman's first trade on the network, a representative of the bank cited as motivations instantaneous settlement and precisely measured maturity (3 hours and 5 minutes, in that case), with interest calculated to the minute.
The technology allows instantaneous and simultaneous exchange, but first the assets must be brought into the digital ledger or tokenized. This tokenization—converting deposits into JPM Coin, for example—is a dealing function: JPMC is offering to make a one-for-one (or par) exchange between the two types of money, and similarly for securities. They are thus making the same promise as other stablecoin issuers, but because JP Morgan is a regulated bank, they stand a better chance of being able to keep that promise.
Bigger picture, what I see here is a core money-center bank, a systemic institution in the global monetary system, quietly adapting crypto technology to its own ends. The bank is offering intraday repo, a service for which there is actual demand. Blockchain technology is very much in the infrastructural background of this picture, secured by permissions and inside a private walled garden. Crypto's future is likely, in my view, to look a lot like this.