Settlement Assets on Corda — Where to start
We received a few questions after we published the cash issuer reference guide. The questions ranged from, “So I can just use this to settle on Corda now?” to “Are you going to issue a stablecoin on Corda?”
It turns out that providing a settlement venue or cash-like asset on any platform is a regulated activity. So… no, you can’t just plug this in and “abracadabra, settlement!”
But this is the beginning (yes, still the beginning) of an exciting time in blockchain-enabled finance. This is an opportunity to rethink how to support and use critical financial market functions with new tools.
What’s in the box?
Todd’s post covered the technology tools we’ve made available to the public. The use of those tools is intentionally left open. We’ll outline a few services here, but you could certainly provide other interesting services with these tools. That is the strange beauty of open source software — we hope other people make lots of money using it!
From the big reveal:
Today we are releasing a cash issuer repository for Corda. This is a reference design for issuers of asset-backed settlement assets (aka ‘cash on Corda’ or ‘money on Corda’).
It shows how a small team of Corda developers were able to:
– Use a collateral account at a real bank
– Link transactions into that collateral account with a known (and presumably KYC’d) list of CorDapp users
– Receive fiat cash in the collateral account
– Immediately issue asset-backed token as a tradable asset (a ‘state’) on Corda
– Move these states between Corda nodes
– Request redemption from the original issuer
– Pay out from the collateral account
– Destroy the digital asset on Corda
What we released is an example of how to send commercial or retail bank deposits to a collateral account, issue that value as cash tokens on Corda, and redeem those cash tokens for commercial or retail bank deposits. It shows how we used APIs from Starling Bank and Monzo Bank to make this process automatic, fast, and responsive.
You could use these tools to issue a token backed by any asset, for any purpose — pretty cool! We’ll talk about this in a future post. For today, let’s stick with cash settlement. There are lots of CorDapps that want this service now and will need to solve for this critical piece of the process.
Tools in hand — What can you do?
Cash settlement usually requires three pillars: system supporters (FMIs) who host the settlement system and interface with regulators, access providers who represent end users in a settlement system, and asset issuers who stand behind the value of the settlement asset. All are important, but the third — providing the settlement asset itself — is what people think of first, and is the subject of this post. This year the blockchain market has focused on cash tokens, often called stablecoins. The goal with most stablecoins is 1:1 parity with a real-world fiat currency value. A stablecoin issuer enters a relationship of trust with the holders, promising to back coins issued with cash, assets, a combination of those two, or an algorithm for value creation and destruction.
Backing for settlement assets falls on a spectrum:
The assets held in custody accordingly vary across the spectrum. On the left side, the issuer backs the asset with the safest collateral possible. The settlement asset — in this case best considered as a depository receipt — is backed 100% by fiat currency and has the same trustworthiness, risk, and value as the cash held in the collateral account. That could be commercial bank money (which is itself backed by a fraction
of its value in assets), or if the issuer has a central bank account (and authorization to use the account for this kind of thing), central bank money. Holding cash in an account just to represent it elsewhere is of course deflationary and expensive, and that’s before you get to the regulator-imposed costs.
In the middle, an issuer might back the cash token with some hard assets like cash and gold, and some other assets like loans. This is how a bank operates today, and rules govern how each type of deposit (cash token in our case) must be backed by different tiers of assets, from no-yield reserves, to low yield government debt, to high yield & high risk loans.
On the far right, an issuer may back the cash token significantly with trust in the issuer and the currency. Yes, in reality the collateral is usually government debt and foreign currencies, but the issuer on this end of our spectrum is mostly saying, “Trust me.” Algorithmically-backed stablecoins fall into this bucket. Issuers promise to create and destroy purchasing power in the market as usage increases or decreases.
License & Regulation
Regulations define licenses and the assets that each type of issuer is required to hold.* (Not coffee money)
The left side of the spectrum is regulated as an E-Money Issuer, a Money Services Bureau, or similar. These firms are required to hold 100% collateral against cash tokens issued, and report on those balances. Most regulations require additional equity held in reserve.
The middle of the spectrum is the realm of banks. Banks are happily covered under many regulatory constructs, from Basel III to Dodd Frank. Banks are required to hold collateral against their deposits and their risk-weighted assets, such as loans. Cash tokens act like deposits in this model, and banks hold different tiers of assets against those tokens, ranging from central bank deposits, to gold, to riskier loans.
The right end of the spectrum in our current world is for central banks and clearing banks (those with accounts at central banks). Central banks aren’t regulated per se, but their actions create or degrade trust in the economies they support. Their utility and value is inexorably tied to the health of the economy they support. This is also where algorithmically-backed stablecoins attempt to generate this trust, starting with a small “economy” of users. They create or destroy money based on the same indicators that the central banks of the world track: inflation and velocity of money in the system.
Choose your adventure
We** wrote a guide for cash token issuers to test the boundaries of the technology and find out whether and how Corda could support cash tokens. We used the easiest, most addressable regulatory model as a foil: E-Money Issuers. But this is just one example.
Take this reference guide and examine your existing licenses, customer relationships, and business assets. A range of settlement assets will address a range of settlement requirements. You don’t need a securities settlement system to pay for coffee, and it doesn’t make sense to load up an E-Money account to settle a corporate bond deal.
So far, I have left Corda out of this post because cash settlement challenges are mostly about business and regulation, rather than technology. That said, central banks, regulators, and industry bodies have some relevant recommendations: satisfy settlement finality, use central bank assets when possible, reduce risk in DvP transactions, and close counterparty risk. Corda was explicitly designed to meet these requirements.
So, choose your adventure and read the label: Don’t fire this up without addressing the business and legal questions But most importantly, think about how Corda can provide a fundamentally better way to execute cash settlement.