With trillions of dollars transferred annually, tokenized money is the undisputed leader in tokenization adoption—dominating the digital asset space far beyond traditional banking while proving its superiority vs the traditional settlement rail.
Banks are now racing to catch up, eager to integrate tokenized money into their offerings and avoid getting left behind.
But what should banks focus on when designing and launching their own tokenized money products?
In this week’s newsletter, we break down the key considerations:
• Intra vs. Inter-bank tokenized deposits
• On-chain vs. Off-chain settlements
• Full-stack vs. Modular integrations
Let’s dive in.
Intra vs Inter Tokenized Bank Deposit
One of the most high profile live tokenized deposit products in the market right now is JPM Coin with billions in daily usage. You can learn more about JPMorgan’s Digital Asset strategy here.
JPM Coin is built on JPMorgan’s own permissioned Onyx blockchain and it allows for qualified corporate customers of JPMorgan to make 24/7 cross-border payments in USD and EUR.
It is focused on enabling intra-bank 24/7 payment but it cannot enable customers to do the same thing with customers of other banks.
The advantage of this approach is the relative ease with which banks can set up its own internal tokenized deposit product and offer it to customers who want to do 24/7 payments across banks’ global branches.
The downside is that while intra-bank or non-interoperable tokenized deposits products are useful, they are limited in application.
So how do we make them more useful? By enabling inter-bank tokenized deposit products.
To do that, we need a consortium of banks agreeing to be on a single blockchain. One of the well known examples of this is the Regulated Liability Network.
Regulated Liability Network is a potential financial market infrastructure project. First proposed by Citigroup, regulated liability network is a consortium permissioned blockchain infrastructure that members of the financial services sector and the Federal Reserve Bank of New York have conducted as a proof of concept in 2023.
Instead of intra-bank transfers, the onboarded and qualified financial services providers, including banks, are able to send each other tokenized money in the form of tokenized central bank money via RLN.
While this allows for more fluid money transfers across financial systems, this faces the considerable challenge of getting enough participation from banks to reach sufficient scale. Otherwise the tokenized payment between banks may hit walls whenever a transfer involves a bank outside the network.
The good news for RLN is that major banks and payment providers are signing on. For example, in April 2024, large British banks including Barclays, Citi, HSBC, Lloyds, NatWest, Nationwide, Santander, Standard Chartered, Virgin Money as well as card firms Mastercard and Visa, have all signed on to a pilot exploring potential customer benefits and technology and legal issues.
Offchain vs Onchain Money Settlement
However not all consortium network approaches involve settling payment transactions in tokens representing money issued by central banks across the blockchain.
German Banking Industry Committee published a whitepaper exploring a shared blockchain system that aims to enable seamless token transfers between banks but leaves the actual money settlement with traditional banking rails, i.e. bank wires.
Whilst tokens are used as a means to record transactions from Bank A’s customer X to Bank B’s customer Y, transfers of tokens do not reflect the final settlement between Bank A and Bank B. The settlement is done separately via bank wire transfers in the old fashioned way.
This is similar to the current Fnality’s setup with banks in the UK. Fnality is designated as a financial market infrastructure by the Bank of England and is regulated as such. It holds an omnibus account at BOE, prefunded by its member banks. It is connected via the usual CHAPS payment rail. When one of its bank members sends tokens to another bank on the network, a CHAPS transaction is initiated where money is transferred for settlement.
In this model, tokens act much like messages in a messaging chat group. Sending them across a blockchain system takes advantage of blockchain’s programmability, always-on and immutability features.
The advantage of this setup is that it avoids the legal and political can of worms issue that is CBDC. While an extensive discussion about the pros and cons of CBDC is beyond the scope of this article, it is suffice to say that it is a very hairy issue.
Full-stack vs Integrations
Of course, the more interoperable a tokenized deposit system is, the more powerful its impact and reach.
However, given the current lack of interoperable tokenized deposit infrastructure across the globe, it is not a far stretch to say interoperability is a hard problem to solve. Beyond the technical challenges of integrating a complex web of legacy systems that make the current financial system work, there is a plethora of cross-border legal and regulatory issues.
On the other hand, if every blockchain initiative needs to be connected to every other payment infrastructures, we are probably not going to get to see the full benefits of tokenized bank deposits any time soon. Too many executives, technologists and organisations need to spend too much resources to arrive at a convoluted solution.
As key guardians of the global financial system, BIS, MAS and World Bank are trying to spearhead collaborative efforts that tackle the issue of interoperability through coordinated global efforts.
See the chart below for comparison between fully fledged unified ledger, payment messaging and permissioned ledger approaches.
This concept of Unified Ledger has been further refined by the BIS. Underpinning its vision for a interconnected tokenized financial system, BIS introduced the concept of Finternet where multiple financial ecosystems interconnected with each other, much like the internet, designed to empower individuals and businesses by placing them at the centre of their financial lives. You can read the full vision paper here.
Disclaimer: This content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.
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