In starting its own cryptocurrency, JPMorgan Chase is taking an idea made popular by Ripple — that cross-border payments can be handled faster and more cheaply if they’re conducted as crypto transactions rather than as messages between correspondent banks sent via Swift — and running with it.
But instead of requiring banks to use Ripple’s controversial and volatile XRP currency, JPMorgan Chase’s system will use its own so-called stablecoin — a digital token that will always be worth one U.S. dollar — backed by the bank. The payments will run on JPMorgan Chase’s Quorum blockchain, rather than the XRP distributed ledger or the Swift network.
In theory, JPMorgan's move is the best of both worlds, having the speed and cost advantages of Ripple, Earthport and other fintechs that have espoused the use of digital currencies for international payments, while limiting the risks of using XRP and a distributed ledger some say has control issues.
The only hitch? Banks and their corporate customers will need to trust JPMorgan. The question is whether they will.
JPM Coin vs. XRP
As articulated by JPMorgan Chase, JPM Coin is a digital coin designed to make instantaneous payments using blockchain technology.
“Exchanging value, such as money, between different parties over a blockchain requires a digital currency, so we created the JPM Coin,” the bank wrote in an FAQ.
This is exactly what Ripple’s XRP was created to do. But XRP is controversial for several reasons. The one most stated in public by bankers is that its price is volatile.
“Very few banks" will use cryptocurrencies in international payments, "if any at all, because of the market risk that cryptocurrencies carry,” said Manish Kohli, global head of payments and receivables at Citigroup.
There’s uncertainty about who owns and controls XRP. Ripple’s founders created 100 billion XRP in 2012, when the company was called OpenCoin. Ripple currently owns just over 60% of XRP. In December 2017, Ripple locked 55 billion XRP into a series of escrows. It releases one billion XRP a month and sells some of it to the public to fund its business.
Ripple’s founders gifted themselves large chunks of XRP and have grown wealthy through those holdings. When one founder, Jed McCaleb, announced plans to sell off all his XRP, Ripple sued him and got him to agree to give two billion XRP to charity and to put the rest of his 5.3 billion XRP in a custody account at Ripple. He is allowed to sell a small percentage of his holding each day.
Ripple's current CEO, Brad Garlinghouse, also owns a large chunk of XRP. The company will not say how he obtained it.
Meanwhile, Ripple insists it has nothing to do with XRP. This is most likely due to the many lawsuits investors in XRP have filed against the company, claiming that XRP is a security and the company violated state and federal law by failing to register XRP with the Securities and Exchange Commission before selling it to retail investors. XRP is also completely unregulated.
JPM Coin, however, is designed to fufill the same mission of XRP, but with a stable value and clear ownership. JPM Coin, Chase says, will be backed by U.S. dollars held at the bank. The bank is also seeking regulatory input. “As we move towards production we will actively engage our regulators to explain its design and solicit their feedback and any necessary approvals,” the bank says on its website.
But other than JPMorgan Chase itself, what other institutions are likely to use a digital currency owned and controlled by a rival?
Oliver Bussmann, former group CIO at UBS and current CEO and founder of Bussmann Advisory, said he expects the 157 banks that are currently members of JPMorgan Chase’s Interbank Information Network to accept JPM Coin. These are banks that already use JPMorgan Chase as a correspondent bank, and using its digital currency and cross-border payment system will help them track risk and error rates.
“For a real-time execution, you need a digital currency, because with the digital currency you have the real-time handshake between the parties,” Bussmann said. “Using a stablecoin that’s not depending on the market situation is a solution.”
Banks in Singapore already do something similar, he said. The central bank, the Monetary Authority of Singapore, issued a digital currency that local banks in Singapore use to exchange tokens with each other instead of clearing payments through the central bank.
“It’s all about simplification and real-time execution,” Bussmann said.
Ripple has been trying to build a similar scenario where XRP enables liquidity and real-time execution.
“With all the activity, you can see correspondent banks like JPMorgan are coming under extreme pressure because their role as middlemen is in jeopardy, so now they’ve positioned themselves as 'Yes, I have a network that my clients can do business and provide real-time execution,' which on the Swift network is not the case,” Bussmann said. “That’s a game changer.”
Banks might also take comfort in the fact that JPMorgan Chase’s network is closed, and JPM Coin can’t be used outside the bank's network, Bussmann said.
“That means you don’t have these AML/KYC issues with cryptocurrencies," he said, referring to anti-money-laundering and know-your-customer rules.
But those outside that network — rivals to JPMorgan — aren't likely to use the Coin, according to Bussmann.
“The moment you accept the coin, you will route business" through JPMorgan Chase’s network, Bussmann said. That will lead to revenue for the bank.
“What it is right now is a great solution" for the correspondent banking customer base, he said.
Nelson Rosario, an attorney at Smolinski Rosario Law, said other banks won’t want to use JPM Coin, but may feel they must because JPMorgan Chase works with 80% of Fortune 500 companies.
“If you want to work with those companies, you have to use this,” Rosario said. “None of this will happen overnight, but there’s a nonzero chance this happens.”
Small banks especially may feel forced to use JPM Coin, he said, because they can’t create their own.
“The smaller the bank, the higher the chance they will use JPM Coin,” Rosario said. “Building your own digital currency requires engineering and resources small banks don’t have.”
Rosario worries that too many large banks will try to create their own digital currencies to compete with JPMorgan Chase.
“We’re headed toward a hellscape of infinite coins where it’s as bad as reward points, as people become more comfortable with this and banks like JPMorgan will do trials,” Rosario said. “We’ll have to go through a period of growing pains where every big bank will try to do this.”
The underlying technology, Quorum
JPMorgan Chase was the first bank to create its own distributed ledger, Quorum. It’s an Ethereum-based ledger that the bank offers as open source software. Some banks have experimented with creating their own blockchains using Quorum.
Other institutions have participated in tests with Chase on Quorum. For instance, last April,
But banks have also reportedly expressed queasiness about using a platform developed by a competitor. Unnamed sources told the Financial Times last year that “some rival banks may have been reluctant to use Quorum because it was so closely associated with JPMorgan.”
Bankers have also been wary of the XRP ledger, over which Ripple appears to have a great deal of influence, if not control.
The XRP ledger uses a consensus mechanism in which 150 “validator nodes” work together to validate new ledger entries every two to three seconds. Ripple operates seven of the validator nodes and says it doesn’t know who runs the other 143.
It will take the largest banks time to accept Quorum, Rosario said. But JPMorgan has a leg up on Ripple on this front.
“There’s an advantage to being a big player that says we’ve got this figured out rather than a startup sitting on billions of dollars in San Francisco,” he said.
Bussmann said that blockchain technology itself has already been proven to provide scalability and reliability. For instance, the DTCC has run 3,000 trades per second over its blockchain. The market is likely to go in the direction of blockchain technology.
“What we’re seeing is a market change triggered by Ripple and the correspondent banks in a defensive mode,” he said.
The challenge to Swift
Another question in all of this is, are banks ready to leave the Swift network and embrace blockchain and digital currencies in its place?
Bussmann pointed out that if they use JPM Coin and Quorum, banks will still have to do AML/KYC checks.
“It doesn’t remove the need on both end sides to do your normal homework,” he said. “The token here is just to accelerate the handshake between two parties.”
But in the bigger picture, “we’re moving into an interconnected world with everything in real time, where you need this kind of digital currency, either issued by a central bank or a coin, to accelerate those payment transactions in the traditional environment.” Bussmann said. “My belief is, it’s faster, cheaper and more reliable than the Swift environment, where you have an error rate of 10%-plus. Banks like JPMorgan especially want to be one of the first movers.”
