Traditional Financial Investments on Blockchain — How to Pay and Settle?
PART 3 of How IntainMarkets Addressed Institutional Concerns Regarding The Blockchain Ecosystem?
An end-to-end digital transaction enabled by blockchain would involve:
- Digitizing the asset/security (‘on-ramp’ and ‘tokenization’ in blockchain parlance):
- Issuance (primary market investment):
- Settlement
- Administration and Servicing
- Secondary market
In this blog, we will discuss the challenges with settlement of asset-backed securities in the current blockchain ecosystem.
In absence of CBDCs, and little trust in crypto, stablecoins remain the only digital settlement option. The challenge is to find the optimal trade-off between two independent variables:
Integration and Automation — Current levels of integration with blockchain networks, supported by cross-chain bridges, digital custodians and wallets
Ease of Adoption — Acceptability of the payment mechanism and settlement process among financial institutions
USDC New — Natively minted USDC, issued by Circle against a bank wire
USDC Exchange — USDC purchased from an exchange
RLN — Regulated Liability Network, Digital Asset settlement initiative involving 8 leading banks, with NY Fed
There are, broadly speaking, five options:
A. Using cryptocurrencies, as is done for most other crypto investments
B. Using a CBDC, which is still mostly in concept or pilot stages
C. Use US treasury backed stablecoins like USDC by Circle, as an alternative to CBDC
D. Traditional (off-chain) settlement through existing banking systems, with trustees and custodians
E. New initiatives supported by regulators and FIs e.g., RLN
A. CRYPTOCURRENCIES
The first option is ruled out due to volatility and regulatory concerns. What has transpired in the crypto industry in the last six to nine months, has further eroded trust. This is a non-starter even though this is the best integrated with blockchain networks. It is not surprising that most DeFi platforms use cryptocurrencies to settle trades.
B. CBDCs
CBDCs can solve the digital asset settlement problem, but involve much larger issues related to legal tender design, monetary policy impact, privacy etc. As of now a US CBDC is not available and does not seem on the horizon. We have no influence either on the design or timeline, so this option is also off the table for us.
C. STABLECOINS — USDC
Within stablecoins, for the IntainMARKETS ecosystem, USDC by Circle is the only option. It is backed by US treasury, with reserves audited by Grant Thornton. But, we still need to address concerns of financial institutions related to FIs having wallets and
USDC’s market price has had a standard deviation of under $0.003 in the last 2+ years. But to further address concerns about buying USDC on exchanges, IntainMARKETS is looking at two options:
1. Freshly minted USDC on payment by an FI — Provides for an investor initiating a payment to Circle to freshly mint USDCs 1:1 against USD and complete the transaction. While this is a 1:1 minting, to mint USDCs, Circle needs a KYCed account in addition to other agreements. There are variations in this, each with its own challenge:
1.1. An investor can do the transaction via Intain’s omnibus account: But this may give Intain rights that many investors may not be comfortable with. It will also put IntainMARKETS in a grey area with respect to money transmitter license. Given, our conservative approach with respect to technology and regulations, we decided to drop this solution even though we used this during the testing phase.
1.2. An investor can set-up her own account with Circle: While this eliminates Intain’s involvement in the transaction, which is what we want, it will require the investor (and other stakeholders involved in investment and servicing payments) to set-up their own accounts. We are working with Circle on making this process simpler for FIs and this will be one option available to IntainMARKETS users by the end of Q1.
2. Native USDC is now also available on Avalanche through Coinbase. It is another option under evaluation, and we will make this available based on our risk evaluation and FI feedback.
Since IntainMARKETS is a permissioned network on an Avalanche subnet and native USDC is available on the Avalanche C-Chain (mainnet), a typical settlement would require using a cross-chain bridge. Here we trade automation for risk mitigation by requiring debit and credit confirmations from accounts to settle a trade, rather than automatically settle against a stablecoins, as is typical with DeFi industry. Thus, we eliminate any bridge related risk. In parallel, we will continue to evaluate the Avalanche Bridge but between innovation and risk mitigation, we will always choose the latter.
D. OFF-CHAIN SETTLEMENT
This is how trades are settled currently, via intermediaries like trust banks and custodian banks. There are no concerns with this settlement mechanism as this what the industry does now, so adoption is easy. But it makes the whole settlement process manual and with trustee/custodian confirmation message needed to settle a trade on IntainMARKETS. This is least fancy option, but it ensures that FIs will still benefit from digitized issuance and fully automated administration provided by IntainADMIN, without having to adapt to a blockchain based payment mechanism. It helps that leading Trustees and Custodians are Intain partners already as Admnistrators and Verification Agents, with more coming on-board soon.
FIs have given big vote of confidence to this approach. For obvious reasons, DeFi industry doesn’t think highly of working with financial intermediaries for traditional setttlemnt methods. A leading crypto influencer told us that this will make IntainMARKETS little more than IntainADMIN + Verification Agent. But then, same set of people had said IntainADMIN was little more than a workflow if there was no ‘tokenomics’, so we ignore and move on.
E. REGULATED LIABILITY NETWORK (RLN)
Given the pace of innovation, new payment and settlement options will continue to evolve. Among these, we are most excited about RLN.
We got introduced to it through our pilot with Wells Fargo . With the formal announcement of the Proof of Concept for an ‘interoperable digital money platform’, to ‘create innovation opportunities to improve financial settlements’, this is something we will track closely. We will explore opportunities of working with the banks that are part of RLN as IntainMARKETS’ settlement partners.
SUMMARY
Intain has always had a middle- and back-office oriented approach to digitization of structured finance as it makes enhancing (or at least maintaining) trust as prerequisite for any change. Hence, to begin with IntainMARKETS, will provide off-chain settlement as default settlement option. Additionally, we will facilitate FIs transacting through freshly minted USDC on their own accounts.
In parallel, during Q1, we will explore RLN as well as natively minted USDC in Avalanche available through Coinbase.
