The Interesting Use Cases of JPM Coin
Enterprise blockchains making moves without the hype.
Introduction
While de-fi is gaining significant traction, enterprise blockchain is also making headways. JPM Coin arose out of the JPM Blockchain Center of Excellence last year. In this analysis, we take a look at some of the possible use cases of JPMorgan Coin to gain a sense of how enterprise blockchain in the financial world is gaining traction.
JPM Coin — What Is It?
JPM Coin is essentially a bridge between existing payment rails and blockchain networks, backed fully by JPM through its own balance sheet. For a good primer on the different types of stablecoins, check out Haseeb Quershi’s post for an introductory piece. For more in-depth analyses that touch on the macroeconomics implications, check out JPM’s report: The market implications of Libra and other stablecoins and Bank for International Settlements’ report on stablecoins.
The above diagram shows that JPMorgan has categorized JPM Coin as a “Sponsored” coin. This is different from how the crypto world sees it, which broadly sees any stablecoins issued 1-on-1 based on an underlying asset as “asset-backed.”
JPM Coin is different from other asset-backed stablecoins for two reasons. First, it is only available to JPM’s institutional clients. From this perspective, it’s almost not too different from an intra-firm bookkeeping system. Secondly, and arguably its more important feature, is that JPM Coin is sponsored by JPM, so it comes with all the guarantees of a big bank, such as FDIC insurance (if the deposit type is applicable), the system’s access to Fed daylight overdraft in times of stress, etc.
JPM Coin’s Benefits Over the Current System
- Exchange money in real-time without impact to the underlying account, transaction postings or reconcilement infrastructure with international transactions (where platforms and process differ).
- Global locations will be able to exchange funds in expanded operating hours without limitations from traditional posting infrastructure or differences in infrastructure across the network.
- Finality in settlement can be trusted, reducing transfer time and reconciliation costs.
- Corporate clients will not have to change their payment processes, cash management responsibilities or relationship management practices to benefit.
- Enabling interoperability to other blockchains (such as Ethereum), enabling a variety of use cases, some of which we will explain below.
Current Use Cases
Current Use Case #1: Instant Settlement for Intra-Company Cross-Border Payment
Cross-border payment is a rather dull but profitable market. In 2018, the total revenue of this industry was $231 billion. Assuming JPM Coin is only applicable in the B2B market, the market size is $149 billion. The revenue growth of the B2B segment is mostly volume-driven due to the low revenue margin (0.1%). Up until 2018, the sector grew at 4% per year and was expected to grow at 3%. However, the trade war and the recent coronavirus outbreak could push the growth rate into negatives.
Margins remains under pressure from the stiff competition:
- Fintech specialists: TransferWise and Revolut are building distinctive propositions in international payments and foreign exchange, capturing share from banks and driving down margins
- Banks that have not previously competed in wholesale PCM, such as Goldman Sachs, are now targeting the space
The full utilization of JPM Coin could make banking with JPM a lot more attractive for a corporation with a global presence. JPM Coin could enable instant intra-company cross-border transfer, making payment more efficient instead of relying on netting settlement over a long time (such as a month).
Current Use Case #2: Decreasing Cost of Intraday Liquidity
When trading derivatives, market price changes require banks to manage the derivatives’ underlying collateral constantly. This process is called derivative management. 73% of OTC derivative use cash as collateral. The process of transferring the cash collateral, also known as the settlement process, tie up the fund, causing the bank to have more cash on hand than ideal, as it could otherwise lend out that capital for profit.
By bringing value on-chain, collateral could be more easily swapped among different parties, shortening the settlement process and lowering the amount of cash tied up in the process. What this ultimately achieves is decreasing the amount of capital required for intra-day liquidity.
A 2018 report from Oliver Wyman states that for banks with $100 billion in liquidity reserves, intraday liquidity costs them $100 to $300 million annually. A 25% reduction in the intraday liquidity requirement could net savings of $25 to $75 million.
There is already a startup attacking this problem — HQLAᵡ is a financial technology innovation firm that leverages R3’s distributed ledger technology, Corda, to deliver liquidity management and collateral management. The Luxembourg startup enables efficient securities lending by allowing a transfer of assets or collateral swaps through a digital collateral registry. The platform was jointly developed with the Deutsche Börse Group, which is also an investor in HQLAᵡ.
Current Use Case #3: Improving Financial Ratios While Satisfy LCR Liquidity Requirement
After the financial crisis, the Basel Committee established the metric of liquidity coverage ratio to ensure that a bank can meet its liquidity needs in a severe stress scenario. (The above use case is also derived from this requirement, but we skipped the context for simplicity’s sake) The ratio of high-quality liquid assets (HQLA) to a bank’s 30-day expected net cash outflows must be greater than 100%. The calculation of the liquidity coverage ratio is quite straightforward:
Liquidity Coverage Ratio = High quality liquid asset amount (HQLA) / Total net cash flow amount
Liquidity requirement is costly to the banks: unsecured operational wholesale deposits is assumed to have a run-off rate of 40%, which means only 60% of those deposits can be counted toward HQLA. Looking at the diagram on the left, we can calculate that —since 40% of all operational wholesale deposit is assumed to run-off within a single month, 40%×20% = 8% of all deposits can never be lent out and must stay in the bank. A more extreme but less prominent category is unsecured wholesale funding beyond requirement provided by other legal entity customers, such as banks, securities firms, insurance companies, etc. The deposits from this category have a run-off rate of 100%. (You can learn more about the respective run-off rates for different types of deposits on BIS’s website)
All of the deposits that do not meet HQLA requirements are only liabilities to a bank as regulations dictate these must be fully funded and un-leveraged at all times, equating them to a huge opportunity cost for the banking sector. By utilizing immediate settlement and establishing another balance sheet, banks can make their cash-related financial ratios, such as return on capital, much more attractive. For one example, many global banks serve as the Vostro account for many smaller banks’ cross-border needs. Since the money flows in and out of balance sheet reasonably quickly, this substantial category receives the premium treatment of 100% run-off rate. A bank with a significant cross-border business can park the cash at an off-balance-sheet entity, thus improving the financial ratios. Tools like JPM Coin enables immediate settlement, which could turn an off-balance-sheet entity into an on-demand bank account.
Future Use Cases
Cross-Bank Cross-Border Payment
Cross-border transfer has been explored extensively by many central bank blockchain projects, one of which JPMorgan played an active part in. Using JPM Coin as the settlement instrument, JPM can facilitate cross-border transfers instantly.
Cross-Chain Securities Settlement
Stock exchanges are already implementing distributed ledger systems, such as the Australian Securities Exchange and Tel Aviv Stock Exchange. In this case, the blockchain on which JPM Coin operates could interoperate with the said blockchain to enable instant, atomic settlement of securities. Smart contracts can also automate interest payments, giving JPM clients faster settlement time than competitors.
These future use cases are only a glimpse of what is possible with JPM Coin. But they still relatively far from production as they require significant coordination among different stakeholders, such as central banks, stock exchanges, individual commercial banks, etc. But with the ecosystem maturing, cross-chain solutions becoming more prevalent, and entities like JPMorgan leading the effort, we will definitely see more enterprise blockchain adoption going forward.
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