In late 2017, amidst significant media hype surrounding blockchain and distributed ledger technologies, J.P. Morgan CEO Jamie Dimon deemed Bitcoin a fraud1. Nonetheless, the company had been extensively researching use cases of blockchain technology since 2015 while building Quorum: a private and permissioned version of Ethereum2.
On February 14th 2019, J.P. Morgan introduced the first prototype of its blockchain settlement product: JPM Coin, a stablecoin backed 1:1 by its fiat reserves.
Since the inception of Tether in 2014, several stablecoin projects have been launched to address the volatility inherent to cryptoassets. Most existing projects were either established directly (Gemini Dollar) and indirectly (USD Coin, Tether) by cryptocurrency exchanges, or by dedicated companies and foundations (TrueUSD, NuBits). In that regard, JPM Coin represents the first prototype of a stablecoin created by a traditional financial institution.
Stablecoins have several definitions. According to Binance Academy, a stablecoin can be defined as it follows.
“A stablecoin is a type of cryptocurrency that is designed to maintain a stable value, rather than experiencing significant price changes. Recently, these digital currencies have grown substantially in popularity as an answer to the high volatility associated with the cryptocurrency markets.”
Similarly, Investopedia defines it such as:
“Stablecoin refers to a new class of cryptocurrencies which offer price stability and/or are backed by reserve asset(s). In recent times, stablecoins have gained enough traction as they attempt to offer the best of both worlds – the instant processing and security of payments of cryptocurrencies, and the volatility-free stable valuations of fiat currencies.”
Throughout this report, we will refer to stablecoin as a cryptocurrency whose value is designed to follow the value of a specific fiat currency.
The primary function of existing stablecoins is to transfer value worldwide efficiently and at minimal cost without the price volatility inherent to Bitcoin or other digital assets.
Additionally, stablecoins provide convenience in conducting arbitrage between trading venues. Before stablecoins were massively adopted by exchanges, it was a complicated process to arbitrage BTC among exchanges as fiat transfers were slow to process (taking up to several days).
The first generation of stablecoins (Tether) aimed to provide a digital currency relying on blockchain without “volatile price swings” (Tether Whitepaper 2014).
While Tether was created as a fiat-collateralized stablecoin pegged to the US dollar, other primitive stablecoins (BitUSD, NuBits) relied on algorithms and/or non-fiat collateralization mechanisms to maintain their peg against a fiat currency.
The second generation of stablecoins (USD Coin, TrueUSD, Dai) is aimed at increasing transparency into the business model of the first generation of stablecoins. It includes the release of audits for stablecoins backed by fiat bank accounts and a clearer collateralization mechanism for non-USD backed collateralized stablecoins, such as Dai.
In comparison, JPM Coin seems to be the precursor of a third generation of stablecoins that targets a particular market segment: financial institutions. Relying on private blockchains, these stablecoins would only serve specific purposes such as improving settlement times and processes within financial institutions. From this perspective, the business model itself shifts from a pure profit-driven model to a business model designated to solve specific business use cases (e.g. improve the client experience for settlement and clearing operations).
Based on the current information provided by J.P. Morgan, JPM Coin might be a direct competitor to Ripple, which currently has a lead in this industry with over 100 institutional clients3 for its blockchain-powered alternative to SWIFT4.
Fiat-collateralized stablecoins have primarily the following features:
The total share of stablecoin volume continues to increase relative to total volume across the entire cryptoasset market, which reflects increasing demand to manage volatility inherent in other cryptoassets.
The stablecoin market continues to evolve as new models emerge, with a particular division between collateralized vs. non-collateralized approaches for maintaining a consistent price peg. Within collateralized models, both fiat and crypto backed models exist as a way to minimize volatility.
For non-collateralized models, many leverage algorithmic techniques to maintain price stability. While we acknowledge the existence of a variety of price stability models, this overview will focus primarily on the fiat-collateralized stablecoins. Many projects have issued and will continue to issue stablecoins backed by a variety of fiat currencies beyond the US dollar, such as EURS presented in the table below.
|NAME||BLOCKCHAIN||INCEPTION||COLLATERALIZED BY||CIRCULATING SUPPLY (FEB. 18)||JURISDICTION||ISSUES|
|Tether (USDT) ◆||OMNI||April 2013||Banked USD||2,031,129,386||British Virgin Islands||> Failure to produce quarterly audits5|
|TrueUSD(TUSD) ◆||Ethereum||Mar 2018||Banked USD, regular audits||205,590,114||US|
|Paxos Standard Token(PAX) ◆||Ethereum||Sep 2018||Banked USD, regular audits||114,311,518||US||> Recent controversy about discount for clients6|
|Gemini Dollar(GUSD)||Ethereum||Oct 2018||Banked USD, regular audits||76,490,852||US||> Recent controversy about discount for clients 5|
|USD Coin (USDC) ◆||Ethereum||Oct 2018||Banked USD, regular audits||244,620,016||US|
|Stasis EUR (EURS)||Ethereum (Stellar is being tested)||Aug 2018||Banked EUR, regular audits||30,979,207||Malta|
|Stable USD (USDS) ◆||Ethereum||Feb 2019||Banked USD, regular audits||5,781,823||US||-|
|JPM Coin||Quorum (Ethereum fork)||2019||Fiat currencies on J.P. Morgan deposits||-||-||> Prototype|
◆ symbol indicates listing on Binance as of March 1st 2019 Source: CoinMarketCap, Mosaic.io, Binance Research, Project Whitepapers
In addition to fiat-collateralized stablecoins currently in circulation, many companies and financial institutions are evaluating issuing their own stablecoins as a way to reduce counterparty / settlement risk and enable instant value transfer. Disclosed examples include GMO Yen, a yen-denominated stablecoin expected to be issued by Japanese Internet giant GMO in 20197, and Saga8, a stablecoin backed by a basket of fiat currencies.
In Japan, Mizuho recently released its prototype of a yen-denominated currency (“J-Coin”); this could impact up to 56 million of clients as a result of its various partnerships with domestic financial institutions9. Last year, Mitsubishi UFJ (“MUFJ”) was also reportedly working on its own digital asset backed by Japanese yen10.
Despite the increasing number of fiat-collateralized stablecoins in the market, Tether (USDT) is still the dominant asset by trading volume and market cap with a current circulating supply of $2,031,129,38611.
Nevertheless, it appears that new market entrants are slowly gaining share of global trade volume as they continue to be listed on exchanges. Projects also leverage strong industry brands, regulatory approvals, and substantial private investment to bootstrap their networks and initial circulating supplies.
In February 2019, excluding Tether (USDT), stablecoin volume was primarily spread across PAX, TUSD, USDC, and GUSD.
Whereas fiat-collateralized stablecoins represent a fairly straightforward business model with similar characteristics / mechanics, it is instructive to explore their similarities and differences, and if the nature of their business models impacts the magnitude of risks.
Fiat-collateralized stablecoins generally share similar business models and, therefore, are susceptible to similar types of systemic and counterparty risk.
Fiat-collateralized stablecoins typically profit in two ways:
However, interest-bearing stablecoins are likely to exist in the near future (e.g. USDD13), and existing companies will be pressed to share at least some of the aforementioned interest payments to their clients and / or offer a discount on face value for new token issuance of new clients. As a result, the entire stablecoin industry will likely face increasing pressure and extremely tight margins in the coming years.
Given the mechanics and business models of fiat-collateralized stablecoins, the key structural risk is stablecoins breaking their 1:1 peg against underlying fiat currencies.
As fiat-collateralized stablecoins are centralized in nature, several underlying structural and counterparty risks exist, and could potentially break of the 1:1 peg of a stablecoin:
Furthermore, stablecoin holders could potentially face redemption risk should centralized Issuers decide to reject account KYC, seize funds, or act maliciously.
JPM Coin is a prototype of a stablecoin that aims at “reducing clients’ counterparty and settlement risk, decreasing capital requirements and enabling instant value transfer” based on innovations in distributed ledger and blockchain technology.
JPM Coin will be backed by fiat reserves from J.P. Morgan client accounts, and will likely initially be limited with US dollars but could theoretically be expanded to any currency on their balance sheet. If the pilot is successful, JPM Coin could conceivably exist in various forms, including JPMUSD (US-dollar backed), JPMJPY (Yen backed) or JPMEUR (Euro backed).
For this pilot project, J.P. Morgan is specifically targeting institutional clients such as banks, brokers, dealers and other large corporations primarily for settlement and value transfer use cases within a closed ecosystem. J.P. Morgan has made it clear that the intent of this pilot is to test stablecoins and blockchain technologies to improve internal processes, ultimately resulting in efficiency gains and cost reductions for its global client base.
While the use cases for JPM Coin differ slightly from that of other fiat-collateralized stablecoins, the mechanism by which coins are issued, transferred and redeemed is similar to those in existence. The core functions of JPM Coin is illustrated in the graphic below.
Source: J.P. Morgan
J.P. Morgan, one of the largest members of the Enterprise Ethereum Alliance14, created its own blockchain, Quorum, which is a fork of Ethereum.
JPM Coin will be issued on the Quorum blockchain, a permissioned network that includes a public / private state separation and allows transfer of private data between participants15. In contrast to the public Ethereum blockchain that is transitioning to a Proof of Stake consensus from a Proof of Work consensus, Quorum offers the choice of two consensus algorithms, Raft16 and Istanbul Byzantine Fault Tolerance17.
The Raft consensus algorithm is a Crash Fault Tolerance ("CFT") consensus, as opposed to Byzantine Fault Tolerance ("BFT"), as the node leader is assumed to never be malicious. All followers will then blindly replicate the entries proposed by the leader with no questions asked. If the node leader crashes, the remainder of the network will automatically elect a new leader after a set period of timeout, and the network will continue to function. When the crashed node recovers, it will become a follower and start replicating the blocks it has missed while offline. The Raft consensus only mints blocks when there are pending transactions, resulting in significant savings on storage when transaction load is low. A theoretical advantage of using Raft is faster possible block times compared to Istanbul BFT, as the former assumes that there are no malicious nodes, thus theoretically requiring less time to validate transactions. However, this may pose as a potential security risk to the network if the node leader turns out to be malicious.
Istanbul BFT (“IBFT”) is a practical Byzantine Fault Tolerance19 implementation that allows for greater tolerance in adversarial environments.
Thus, banks or counterparties with no previous business relationship can transact freely so long as fewer than 1 / 3 of the nodes are faulty.
IBFT utilizes multiple rounds of voting per block, and the voting validators also do not trust that the round’s leader or block producer is cooperating. As a result, IBFT has slower block times than Raft as the cost of removing the assumption of a trustworthy block leader. Though the block time may be theoretically slower, it is always constant. This allows more predictability for reaching certain block heights by a certain time, but also comes with the inefficiency of potentially mining empty blocks with no transactions — thus the choice of block time is a key factor to ensuring optimal network usage.
Since Quorum is a fork of the Ethereum blockchain, it does share some core pieces of technology with the Ethereum blockchain:
However, as a private, permissioned network, Quorum delivers a value proposition and design that also differ from the Ethereum blockchain in a few notable ways:
JPM Coin has the potential to dramatically impact both existing financial institutions as well as the broader cryptoasset market given the size of its balance sheet, industry influence, and extensive global network of partners.
Broadly speaking, J.P. Morgan's stablecoin project will initially target efficiency gains and risk reduction in clearing and settlement functions, as well as cost reductions across core back office functions.
Cost reduction: JPM Coin has the potential to dramatically reduce costs for institutional clients, as transactions between institutional clients can be executed without pre-established trust given the transparency and auditability of transactions that is native to a blockchain architecture.
Accenture, one of the largest global management consulting firms, provides an estimation of some additional sources of cost savings23:
Based on J.P. Morgan’s position as one of the world’s largest banks, even a small portion of total assets locked as fiat collateral for JPM Coin could make the institution the largest stablecoin issuer on a blockchain measured by circulating supply and total market cap.
For an illustration of the potential size of JPM Coin circulating supply, two scenarios were established to put in perspective the size of J.P. Morgan’s balance sheet (USD2.6 trillion) with the size of the existing stablecoin markets.
Beyond the aforementioned use cases, JPM Coin (or a similar concept) will also possess additional applications beyond traditional institutional banking clients.
A clearing house is “a financial intermediary responsible for settling trading accounts, clearing trades, collecting and maintaining margin money, regulating delivery of the bought/sold instrument, and reporting trading data.”24 For instance, they are typically responsible for managing margin calls in the largest segment of the financial industry: derivatives markets.
In the existing system, the clearing process is fairly slow and includes a lot of intermediaries. On top of that, the clearing industry is currently concentrated toward a few entities. As a result, the overall industry is quite obscure, which leads to a lack of public information for market participants. 25
The advantages of utilizing blockchain in the clearing process might include:
In this scenario, the deployment of a blockchain such as Quorum could help the industry to reduce systemic risks and make the overall clearing and settlement segment in the derivatives industry more efficient with lower costs, faster redemption/withdrawal time & increasing transparency.
Stablecoin entities (e.g. Trust Token, Circle) could work hand in hand with JPM coins (e.g. JPMEUR, JPMUSD), employing public-private cross-chain atomic swaps to issue their own stablecoins running on public blockchains, with key features such as:
In this scenario, J.P. Morgan would enjoy benefits from the increased use of public blockchain technology while transferring some of the risks and time costs (e.g. AML policies) associated with public blockchains to its corporate clients (stablecoin providers). An extra layer of auditing would also enable the bank to audit the fund origins (thanks to the swap between Quorum’s JPMUSD and Ethereum’s stablecoins) through public blockchain analysis. However it is yet to be seen whether atomic swaps could be implemented and if compliance costs outweigh the benefits.
While JPM Coin is still in its early days, Ripple has been developed for several years. It would be instructive and beneficial to discuss the differences and similarities between JPM Coin and its perceived direct competitor, Ripple.
Ripple is the company known for creating the XRP token, currently sitting at the No. 3 spot (USD 13.3 billion) amongst all existing crypto assets in terms of circulating market cap27, behind only Bitcoin and Ethereum. This company has been building a payment and exchange network called RippleNet, which relies on a distributed ledger database called XRP Ledger.
This network is an “exchange system for fiat currencies that focuses on global payment solutions for banks and other financial institutions” (Binance Academy).
The company has three core products: xRapid (relying on XRP and its distributed ledger), xCurrent, and xVia.28
|Blockchain||Private / Quorum||Public / XRP Ledger|
|Tradable on exchanges||No||Yes|
|Settlements||Internal clients (current)||Partner institutions|
|Collateralized by an asset||Yes||No|
|Smart contracts||Yes (Ethereum fork)||Not yet (but proposed29)|
The news release from J.P. Morgan mentions potential use of other blockchains.
Ripple is building a “frictionless” ecosystem aimed at improving the efficiency in settlement, exchange of currencies, and remittance worldwide. They are attempting to build an entire ecosystem revolving around its products, in which XRP would be a prominent component.
On the other hand, J.P. Morgan seems to be inclined in developing an enterprise whitelabel solution relying on its Quorum blockchain to help financial institutions to improve settlements.
However, while JPM Coin does have significant worldwide reach based on J.P. Morgan’s existing client base, the network is currently restricted to these internal clients only. It is highly unlikely that clients of a large competing bank such as Citigroup will be able to settle transactions using JPM Coin, especially if a Citigroup Coin is released in the near future.
As such, JPM Coin does not actually improve the speed or efficiency of transactions between the larger traditional banks, which currently rely on SWIFT. To add to this sentiment, it appears that Ripple has already dismissed the idea of a bank issued stablecoin30.
A recent tweet by Ripple’s CEO Brad Garlinghouse31 confirms this view:
“As predicted, banks are changing their tune on crypto. But this JPM project misses the point — introducing a closed network today is like launching AOL after Netscape’s IPO. 2 years later, and bank coins still aren’t the answer.”
Looking back at the Ripple ecosystem and the xRapid infrastructure, XRP works in a similar manner as USD in the traditional financial system: it acts as the mediator currency between both fiat / crypto currencies and any fiduciary product (e.g. commodity, points, miles, etc.). This allows various closed system networks (such as JPM Coin) to interact with each other, with XRP acting as a bridge between these networks.
Overall, the two projects appear to have different focuses and potential applications in the short term. While there is currently no direct overlap on the functionality of the two initiatives, future developments on the reach of JPM Coin outside of its existing closed network will determine to what degree Ripple and JPM Coin will compete.
Stablecoins are used by both retail and institutional investors as an initial on-ramp for entering the cryptoasset markets through a fiat-to-crypto exchange. Institutional investors in crypto markets are typically comprised of asset management firms, venture capital funds and proprietary trading firms investing in digital assets who need a way to exchange fiat currencies for cryptoassets, or the other way around.
Large banks and financial institutions such as J.P. Morgan have a distinct set of advantages in issuing fiat-collateralized stablecoins, but these offerings will not displace liquid, publicly traded stablecoins in the near-term given their closed ecosystems built on private blockchains.
While JPM Coin does have the potential to materially impact traditional financial services (particularly in institutional client use cases such as clearing and settlement), it will have minimal impact on public stablecoins used by investors as a gateway to trade and interface with cryptoassets. Until JPM Coin’s availability extends to a larger set of commercial institutions beyond J.P. Morgan's own clients and, more importantly, expands the offering to public blockchains and trades on liquid exchanges (which could provide access to retail investors), it will have limited impact on cryptoasset markets.
Nevertheless, over the long term it is possible for JPM Coin (along with similar projects created by other banks) to have a disruptive impact on the entire stablecoin industry as they continue to expand its access and use cases.
Should JPM Coin turn into a successful experiment, corporations might consider private blockchains as a viable and attractive solution for their transactional needs. This could result in a shift of institutional investments from public digital tokens & currencies to technology providers of enterprise whitelabel solutions (such as a Quorum-tailored blockchain for their uses).
It is worth mentioning that today, it is unlikely that companies would rely solely on a public blockchain to manage their sensitive internal data. Hence pitting public and private blockchains head-to-head is somewhat of an artificial matchup that is less relevant than the broader discussion on whether centralized IT systems are to be replaced by private blockchain solutions within companies & industries.
The rise of this third generation of stablecoins may only be an intermediate stepping stone for cryptocurrency mass adoption. Stablecoins running on private blockchains will contribute to increasing awareness of the rest of the blockchain and cryptoasset industry in the long run.
Bitcoin was created to allow “online payments to be sent directly from one party to another without going through a financial institution.“ 32 Ten years later, the landscape of the cryptocurrency industry has undoubtedly changed dramatically and financial institutions have become one of the key prominent players in the future of blockchain - be it private or public.
It is very unlikely that JPM Coin will disrupt the existing stablecoin industry in the near term owing to its permissioned, private nature. Currently, stablecoins issued by banks are designated to serve a specific purpose and as a result, do not directly compete with the existing stablecoins.
While JPM Coin will be built on a private blockchain and initially restricted to use within the J.P. Morgan network, the initiative could cause other financial institutions to follow suit by creating their own stablecoin running on a proprietary blockchain. However, if banks were to work together to align their interests in the development of interbank settlement solutions, Ripple may suffer from increasing competition as these banks come up with their own syndicated blockchain solutions.
In conclusion, banks already are a main component of the fiat-collateralized stablecoin model as these financial institutions provide custody for the funds of stablecoin issuers. Given their size, scope and strategic network, large banks such as J.P. Morgan could potentially leverage both their large asset bases and partnerships to broaden the influence and impact of their stablecoin offerings.