What is USDF?

USDF is a Bank-Minted Tokenized Deposit Referencing Fiat Currency on Blockchain

USDF is a token that is minted exclusively by federally-insured depository institutions and represents a deposit at a USDF Consortium bank (i.e., “tokenized deposit”). The deposits will qualify for insurance up to applicable limits.

USDF operates on a permissioned basis governed by the USDF smart contract where USDF can only be sent to customers who have an established relationship with a USDF Consortium bank and have been through standard deposit-account opening processes, including such bank’s BSA/AML/OFAC processes.

USDF facilitates low cost, real-time, 24x7x365 bilateral settlement of transactions on the Provenance Blockchain and provides for the programmability of money.

To use USDF, the depository institution must be a member of the USDF Consortium. The USDF Consortium is a member-owned, operated and governed network of insured depository institutions to (1) coordinate the efforts of the depository institutions with respect to USDF and (2) promote the adoption and interoperability of USDF.

Tokenized Deposits vs. Stablecoins

Stablecoins are digital assets that are typically pegged to a currency, such as the U.S. dollar. A typical stablecoin issuer will receive fiat currency from a customer and invest the fiat into financial assets to earn some income off of the investment. The customer of the stablecoin issuer receives the stablecoin, which allows the customer to engage in purchases, sales and other transactions on blockchain.

Stablecoins have been in the news the last few years due to their exponential growth and concerns regarding the lack of regulation, prudential standards, and consumer protections. The current stablecoin market of ~$180 billion supports a cryptocurrency market of ~$2 trillion. Michael Hsu, Acting Comptroller of the Currency, likened this relationship to an “upside-down pyramid” in a recent talk, and noted the following:

Instability at the bottom of the pyramid is likely to cause the entire pyramid to become unstable. If there were to be a run on stablecoins, the entire crypto economy would likely be impacted, causing outsized losses for ordinary people owning crypto and potentially leading to a host of other knock-on effects.

Indeed, the regulatory environment for stablecoins remains very fluid, and it is uncertain where the regulators and legislators will go at this stage.

USDF provides a solution to the need for a well-regulated mechanism to transact on blockchain. As we noted, USDF is a tokenized deposit, which is fundamentally different from a stablecoin. The distinction is this: One is a new digital asset (stablecoins) and the other is a new digital format for exchange (tokenized deposits). USDF represents already existing deposits in centralized databases of different banking institutions on an open, decentralized, and distributed ledger. This ledger being the Provenance Blockchain. Indeed, the Liberty Street Economics team at the Federal Reserve Bank of New York noted that “it is useful to make a distinction between “money” — the asset that is being exchanged — and the “exchange mechanism” — that is, the method or process that transfers the asset.” And furthermore, the team noted the following on tokenized deposits:

Bank depositors would be able to convert their deposits into and out of digital assets — the tokenized deposits — that can circulate on a DLT platform. These tokenized deposits would represent a claim on the depositor’s commercial bank, just as a regular deposit does.

This is exactly what USDF does.

So What’s the Big Deal?

To understand the big deal, it’s important to understand the current situation. The current state of the U.S. financial infrastructure largely remains unchanged since the 1970s. Much of the improvement has been on the frontend, but ultimately feed back to outdated systems and processes that have been kluged together decade after decade leading to a financial infrastructure that has worked good enough, but is nearing its useful limits.

Robinhood’s restriction on trading of Gamestop shares in February of 2021 highlights the impact of the outdated financial infrastructure and process. At the center of this process is the Depository Trust & Clearing Corp. (”DTCC”), which is a clearinghouse that acts as a central intermediary between stock trades of buyers and sellers. After Robinhood executes a stock trade, the DTCC clears the trade, which means it updates the accounts of the different parties and prepares for the transfer of money and securities, otherwise known as settlement. The time it takes to settle a stock trade is two days, referred to as “T+2.” Because of this delay in settlement, the DTCC requires brokerage houses to post collateral for risks during this two-day period, which include volatility risk and trading on margin, among other risks. As the price of Gamestop and other “meme” stocks rose with increasing volatility and higher margin trading, the collateral requirement for brokerages like Robinhood grew drastically as well, forcing Robinhood to halt trading of these stocks to limit its growing collateral requirement. Reducing the settlement time to instant settlement or near instant settlement would drastically reduce these risks.

The Robinhood example is just one of many that illustrates how outdated financial processes built around old infrastructure are having a difficult time keeping up with customer demands, from traditional payments, to mortgages to debt and equity capital raisings.

Then Comes Blockchain

The Satoshi whitepaper in 2008 with the arrival of Bitcoin in 2009 and then the Ethereum blockchain in 2015 brought in a radically new way of doing things. In the the simplest terms, blockchain technology is essentially a decentralized database with the following unique characteristics:

• Decentralized: no one entity controls the database
• Distributed: everyone has a copy of the database
• Immutable: records cannot be changed, only appended

With these unique characteristics, blockchain technology offers distinct value propositions:

• Displacing trust with truth: Since records are immutable on a blockchain when digitally native (i.e., records are entered directly onto the blockchain) and the blockchain is open to relevant parties, there can be a single source of truth with limited need for trusted third parties for custody or attestation in many situations. The blockchain allows everyone to know in certainty that an asset is in fact what is being represented at that time.
• Real-time, bilateral settlement: By acting as a transaction ledger, custody platform, and legal ownership registry, blockchain is able to offer real-time bilateral transaction settlement by eliminating traditional intermediaries and processes. This ultimately eliminates counterparty and settlement risk.
• Composability: Businesses and ecosystems thrive when they can leverage off of existing infrastructure (i.e., not having to reinvent the wheel). Similarly, blockchain technology allows for an open loop system where developers can build off of shared resources, and in certain instances, lead to new asset classes and industries.
• Enhanced security: Because blockchain is decentralized (no one entity has control over it) and distributed (many entities have copies of it), there is no single point of attack.
• Automation: This is largely done through the use of smart contracts, which are programs stored on a blockchain that run when predetermined conditions are met. Examples of smart contract automation include credit auditing for loans, KYC/AML compliance, trade settlement procedures, loan servicing procedures, certain due diligence procedures, custodian functions, and many more.
• 24/7/365: Another key benefit of blockchain is the ability to execute transactions 24 hours a day, 7 days a week, and 365 days a year, which may ultimately push the financial exchanges into doing the same.

Financial Assets Are Ripe for Blockchain Disruption

These value propositions align very well in certain industries, particularly the financial services industry where financial assets are essentially contractual claims and obligations that are recorded in centralized database ledgering systems of different siloed financial institutions with paper-heavy processes and records. By creating these traditional assets to be digitally native on an open blockchain, like the Provenance Blockchain, sizable efficiencies and cost savings can be achieved along with improved transparency and risk management.

Figure Technologies, Inc. has been at the forefront in this area, with the origination of mortgages on the blockchain, as well as issuing the first ever securitization backed by loans originated, serviced, financed and sold on blockchain, which produced over 100 basis points in cost savings. Recently, Figure announced the transfer of ownership of eNote mortgages to Apollo through Figure’s Digital Asset Registration Technologies, Inc. (DART), a combined lien and eNote registry system used in place of the “MERS” databases. And to facilitate real-time bilateral trading of digital assets on the Provenance Blockchain, Figure developed its Real Time Everything Marketplace (RTEM), as well as its Figure Equity Solutions

Supporting Increasing On-Chain Activities and the Need for Banks and USDF

We expect an increasing number of traditional financial assets will move onto the blockchain as time goes on and make up the majority of blockchain assets in the future. To put things into perspective, currently, the crypto market has a market cap of ~$2 trillion, while U.S. debt securities total $57 trillion, loans total $32 trillion, and corporate equities total $80 trillion, according to the Federal Reserve’s 2021 Q4 Z.1 Financial Accounts of the United States report. Do we think all of these financial assets will move onto the blockchain? Highly doubtful, but it’s reasonable to believe an increasing portion will. Figure has already started in the mortgage market, and we expect this to grow further. Extrapolate this out into other capital instruments in other industries and one can see where how big this can grow. In fact, the U.S. commercial banking industry could be the industry to see more of its capital structure instruments move on-chain given how highly fragmented, but highly regulated and standardized the industry is. Industry fragmentation and standardization lend themselves well to blockchain disruption, in our view.

So as blockchain assets grow and with an increasing portion coming from traditional financial assets, a medium of on-chain value exchange and ample liquidity will be needed. And this is where banks come in. Banks are the logical players to facilitate value transfer at scale with USDF on the Provenance Blockchain:

• First, by being a tokenized deposit versus a stablecoin, USDF can scale to the needed levels without tying up liquidity in the financial system. As a reminder, tokenized deposits are simply a representation on the blockchain of already existing deposits and can be viewed as an exchange mechanism (i.e., a way to transfer value). A stablecoin, however, is an asset that is supposed to be backed by safe and liquid assets, typically U.S. treasury securities, which means that those assets will be tied up with the stablecoin and away from other parts of the financial system.
• Second, banks are well-positioned to engage in this activity at scale. They are experienced in managing different types of risk, from operational, to credit, market and liquidity risks. Additionally, banks are highly regulated and subject to comprehensive supervision, are experts in payments, and are uniquely empowered with expertise in managing deposits.

Use Cases

We’ll end this post with some use cases that we see. It’s important to note that there will be different timelines for different use cases and new use cases will appear that we could never have conceived. Did anyone see the NFT market coming?

USDF can supplement customer wire, ACH, SWIFT and interchange payments

USDF provides cross sell opportunities and support innovative new products

STEVEN DUONG

Steven is the Director of Bank Partnerships at Figure Technologies and is focused on bringing banks into the USDF Consortium, as well as collaborating with banks on Figure’s products and services. Prior to joining Figure, Steven was sell-side research analyst covering East Coast SMID-Cap banks. Outside of work, Steven likes to cook, mountain bike, travel, play tennis, and walk his four dogs.

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