Last week US bank JP Morgan Chase announced that it has trialled a new digital payment token called JPM Coin. The token is designed to speed up the settlement of transactions between the bank’s institutional clients.
The move by JP Morgan adds to the competitive pressure on central banks in one of their key roles—guaranteeing the safety of payments in the wholesale money markets.
Around the world, central banks keep the payments system functioning by means of so-called real-time gross settlement (RTGS) systems. These systems ensure that payments between one counterparty and another are simultaneous and irrevocable.
However, the fact that RTGS systems operate only at a national or regional level means payments are only certain to be matched against each other within the relevant jurisdiction.
The absence of global real-time settlement creates risks, particularly when payments are being sent between financial markets whose working hours do not overlap.
For example, in the 1970s, the failure of German bank Herstatt after a series of unsuccessful currency speculations triggered a cascade of unsettled payments at its US banking counterparties, threatening a broader financial collapse.
However, the technology pioneered by the cryptocurrency bitcoin appears to offer another way of overcoming such settlement risks.
Bitcoin, launched in 2009, showed that transactions can be recorded in a shared database called a blockchain, with no single party needed to act as the ultimate guarantor of the payments record.
JPM Coin is a digital representation of a fiat currency
Although JP Morgan’s CEO has been outspoken about the drawbacks of bitcoin, the bank says its new payment token uses blockchain technology to help its clients make money transfers or pay for securities transactions.
JPM Coin is a digital representation of a fiat currency like the US dollar, and is redeemable on a one-to-one basis with the underlying currency.
The technology behind JPM Coin is called Quorum, a permissioned version of the cryptocurrency ethereum.
In a permissioned blockchain, only a specific subset of the blockchain network’s participants is allowed to generate and approve transaction records.
By contrast, in permissionless networks like bitcoin and ethereum, any participant can propose a new version of a blockchain’s transaction history.
JP Morgan’s initiative is one of many competing blockchain projects focused on the improvement of the world’s payment and settlement systems.
These include projects in development from Digital Asset Holdings, SETL, R3, Axoni and Clearmatics, which collectively count many of the world’s largest banks as investors, partners or consortium members.
JP Morgan is an investor in Digital Asset Holdings, while it joined and then left R3.
Central banks could issue digital tokens
Central banks may also enter the digital token race. In a report published in January the Bank for International Settlements noted that central banks could in future issue restricted-access digital tokens for the wholesale settlement of interbank payments or securities transactions.
However, while several central banks have discussed plans to introduce their own blockchain-based currencies, these have so far failed to move beyond the pilot stage.
JP Morgan is coy about the potential applications of its new digital currency.
On its website, JP Morgan says that it is still too early to assess the ultimate impact of blockchain on its own custody, clearing and settlement businesses.
However, the potential rewards for JP Morgan and the banks involved in other blockchain projects are clear.
In 2016, consultancy Oliver Wyman said that blockchain technology could save banks $15-20bn per year by cutting the infrastructure costs involved in cross-border payments.
The JPM Coin project is at an early stage: the bank says it has so far trialled a payment using the digital token only between one client account and the bank’s own account.
“Central bank money may stop being used for settlement”
However, last week’s press release announcing the arrival of the new digital token adds to the pressure on central banks to get moving on blockchain-based reforms to the existing payment systems.
Speaking to New Money Review last year on condition of anonymity, a member of a bank-backed blockchain project hinted at a potential shift in the wholesale money market’s infrastructure as a result of central banks’ cautiousness in backing the new technology.
“If they don’t engage with initiatives like ours, central bank money may stop being used for final settlement and we’ll go back to the older world of private money settlements,” the spokesperson said.
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