‘Settlement Coin’ is All About Banks, Not Blockchain
Why would anyone want to use a coin issued by four large banks bailed out in 2008?
That's a question that many are asking after UBS, Deutsche Bank, Santander, BNY Mellon and ICAP announced last week that they had teamed up with blockchain developer Clearmatics to create a new digital currency. In a joint press release, the new consortium said that the "Utility Settlement Coin" would be used to clear and settle financial market trades on a blockchain.
But while it would be easy to see this as an alternative means of settlement using a private currency owned, issued and backstopped by the members of the consortium, that's not what the consortium is planning.
From the press release, here is Clearmatics CEO, Robert Sams:
"Cash is a leg to almost every trade, so this project is key to unlocking the benefits that the industry can gain from distributed automation technology in clearing, settlement and collateral management."
This explanation is less than clear, so let me translate. The consortium aims to speed up central bank settlement processes and reduce the need for banks to maintain expensive collateral to meet short-term liquidity needs in real-world currencies, so that banks can increase the frequency of trading and make better use of capital.
Instead of waiting to receive real-world currency via a central bank real-time gross settlement (RTGS) systems, banks could simply issue Utilities Settlement Coins to meet their obligations and carry on trading.
Of course, as Hyman Minsky said: "Anyone can create a currency, the problem is getting others to accept it."
Not so ambitious
Why would other market participants accept a coin magicked into existence by a large bank in final settlement of an obligation in real-world currency? Well, they wouldn't, of course – unless the coin was issued and backstopped by a central bank.
So, the consortium proclaims that the new coin will be CENTRAL BANK money.
Hyder Jaffrey, head of strategic investment and FinTech innovation at UBS Investment Bank, said:
"Digital cash is a core component of a future financial market fabric based on blockchain technologies. There are several digital cash models being explored across the Street. The Utility Settlement Coin is focussed on facilitating a new model for digital central bank cash."
But which central bank? Could this mean the establishment of an international digital clearing union, with a digital international settlement currency independent of any country, replacing the US dollar and decapitating the global ambitions of the IMF's SDR? Could the Utilities Settlement Coin become Keynes' bancor, in a form of which he never dreamed?
Although, the fact that this new international settlement currency would be native to a private blockchain owned by a consortium of large banks might give us pause for thought. UBS, Deutsche Bank, Santander and BNY Mellon would effectively become the world's central bank.
Sadly, this scheme is not so ambitious.
Buried in the press release is this:
"USC is a series of cash assets, with a version for each of the major currencies (USD, EUR, GBP, CHF, etc.) and USC is convertible at parity with a bank deposit in the corresponding currency. USC is fully backed by cash assets held at a central bank. Spending a USC will be spending its paired real-world currency."
So there would not be one single global Utilities Settlement Coin, but multiple coins. Each real-world currency would have its own Utilities Settlement Coin, with which it would be exchangeable at par.
Banks would deposit real-world currency at central banks and create an equivalent quantity of Utilities Settlement Coins for that currency.
Goodbye, bank reserves; Hello, Utilities Settlement Coin.
But this simply replaces one electronic reserve asset with another. So what is the point? This is where the blockchain comes in.
Bank reserves can't be used for settlement on a permissioned blockchain: they can only be used for settlement via a central bank RTGS system. In contrast, our Utilities Settlement coins – we assume – would be used for settlement on a permissioned blockchain collectively owned and managed by the consortium. A private settlement system for real-world currencies, effectively backstopped by central banks.
Now, why would this arrangement be of interest to a bunch of banks? What advantages would it give them over existing central bank RTGS systems?
The first advantage is speed. Since central bank RTGS systems use double-entry accounting, settlement is instantaneous, no blockchain verification protocol could possibly match the speed of a central bank RTGS system where both sending and receiving banks have accounts. But, RTGS systems are merely the core of settlement processes that can take days to complete.
There is a legacy of delays from the days when processes were manually-intensive and banks and brokers could earn interest on money sitting in clearing. Now, they no longer need an army of clerks to process settlements, and in these days of negative interest rates, clearing delays are more likely to cost them money. No wonder they want to speed things up.
However, getting industry-wide agreement on moving to same-day settlement is like pulling teeth (even moving to T + 2 has taken years to implement). So, it looks like our consortium banks want to take matters into their own hands. Blockchain gives them a technical excuse to bypass the existing moribund processes.
There is another reason, too. Reserves and collateral are low-yielding assets that clog up bank balance sheets. Banks would really like to find a means of settling without having to pledge collateral at central banks. In fact, ideally they would like not to have to use central bank money at all.
So, although the Utilities Settlement Coins would be backstopped by central banks, once the majority of banks agreed to accept the Utilities Settlement Coins (aka joined the consortium), the banks could simply dispense with central bank money.
As Matt Irvine at Bloomberg points out:
"But for many purposes – for example, just doing more transactions with other banks – the pseudo-dollars are just as good as dollars. If every bank signs on for this, then they can go out and buy more securities with their pseudo-dollars, and rarely need to bother with the Fed."
Until, that is, everything started to go wrong, when banks would once again claim the Fed's backing.
After all, these are central bank coins, aren’t they? And by that time there would be FAR more of them in existence than cash assets backing them. This is how fractional reserve banking develops.
So, this is not fundamentally a story of cool blockchain technology superseding ancient creaking central bank processes. No, it is a story of banks trying to circumvent the capital and liquidity regulation that aim to prevent market freezes and bailouts such as happened in 2008.