How could banks fit into decentralized finance? They could start by playing a role in staking, some industry observers say.
The concept of staking, in which participants in a blockchain network pay an ante, run nodes of the blockchain on their own computers, help validate transactions and are rewarded for doing so, is becoming more popular in decentralized finance, or DeFi. Some say this is a natural place banks could participate in the future.
One person who says this is Diogo Monica, president of Anchorage Digital Bank in San Francisco.
"You're not just being rewarded for helping the network run the node," Monica said. "You might be paid more than the IT costs that you have of running a node. But now you have an interesting guarantee that these transactions are correct because there's a computer inside of your IT closet run by your IT staff that all of the transactions are saved on. The network can't fool you into doing something wrong because now you literally own one of the nodes. So from a security perspective, you want this as a bank and you're being paid to run it and even being incentivized to run it."
Having multiple banks run nodes on a blockchain also makes the blockchain resistant to failures, he said.
Monica has experience with this. Anchorage started out as a storage technology startup focused on secure yet accessible storage of cryptocurrency private keys. It was granted a national trust bank charter from the Office of the Comptroller of the Currency in January 2021. It was the first bank to have staking listed as a banking activity in its OCC charter.
On Thursday, Anchorage and the Provenance Blockchain Foundation, a network that now includes 50 bank participants, announced they have a staking relationship. Anchorage has had a partnership with Provenance since March through which it is the institutional banking custodian for Provenance's hash token. Anchorage now allows clients to stake this hash from qualified custody. This means they can participate in the consensus mechanism while their assets are still under the custody of Anchorage Digital Bank.
Bank participants can now buy a stake in the Provenance blockchain, run a node of it and receive fees for doing so.
There are several reasons banks might be interested in staking, according to Monica Summerville, head of capital markets at Celent. They may want to build a service or join a consortium building a service on a particular blockchain like Provenance. They may want to participate in the governance of that blockchain, "which can be attractive if you are building applications on the blockchain as you can input into the technology roadmap," she said. There's the passive income they can earn. Some banks might want to offer clients a staking service, as a way to earn passive income on crypto tokens. In a recent Celent survey of institutional investors, 77% of those surveyed said they would want to access staking pools for enhanced yield on crypto assets.
"If banks are interested in offering blockchain-based services and would consider interacting with a blockchain protocol directly by hosting or running a node, then proof of stake can be a more attractive consensus mechanism than proof of work due to the former requiring significantly less compute power so more environmentally friendly," Summerville said.
The proof-of-work consensus mechanism used on the bitcoin blockchain consumes as much electricity as the entire country of Australia. This is a major reason many Ethereum blockchains have shifted to proof of stake.
But there are also risks to banks in providing staking.
"From a very big picture standpoint, I would say that this administration is very focused on the risks that it sees in digital assets," Steven Lofchie, a partner at the law firm Fried Frank and founder and manager of the legal website Fried Frank Regulatory Intelligence, said in an interview. "There has been a constant series of warnings from the major parts of the administration that digital assets may be used for money laundering or to evade sanctions or that they are a threat to financial stability. Even if one does not agree that the risks are as substantial as the regulators believe, firms have to concede that the regulatory view on digital assets is not a friendly one."
Every firm has to make decisions as to its regulatory relationships, Lofchie noted. "Those decisions go beyond, does this activity comply with law? That's the base level. There's a lot more to regulatory relationships than whether you comply with law. So every firm has to consider, if the OCC and the other regulators are skeptical of digital-asset activities, how does that affect my calculation not only as to this particular activity, but as to my general relationship with the regulators?"
Evolution of the Provenance blockchain
Mike Cagney, who was the founder and CEO of SoFI and is now CEO of Figure Technologies, and his wife June Ou, who also worked at SoFi and is chief operating officer at Figure, developed the Provenance blockchain and set up the Provenance Blockchain Foundation.
So far, the bank members use it to buy and sell mortgages and home equity lines of credit. The name Provenance is a nod to an important element to securitization that went missing during the mortgage crisis: the ability to know for sure how a mortgage originated and how it got to the place it is today.
The Provenance blockchain is being used to solve pain points in the mortgage process, Monica pointed out.
"The tracking of mortgages, the paying of mortgages, everything about the home-buying process is hair-pulling bad from a process perspective," he said. "It is just so ripe for disruption and everyone that touches it hates it so vividly."
With the use of a blockchain, "It's just like cutting through the middleman and saying, no, this is the one true source for this and it's cheap and it's efficient," Monica said. "And nobody can touch it unless you're adding value. What is the value that you're adding? And if you're adding value, then we'll allow you onto the network. No one is being paid to just push paper from left to right."
Morgan McKenney, CEO of the Provenance Blockchain Foundation, previously worked at Citi for 18 years and calls herself a recovering banker.
"I'm an OG of blockchain land, because I was running cross-border payments in 2016 when bitcoin and blockchain were first surfacing in the public consciousness," McKenney said in an interview.
At that time, Citi was looking into using blockchain or bitcoin to improve its cross-border payments business.
"As more financial and other assets go on-chain, obviously you need digital money to buy those," McKenney said. "My view is it will never be in bitcoin. It will be in fiat-linked money minted by banks."
The Provenance Blockchain Foundation maintains the blockchain software and is a participant on the network. But it doesn't control the network. Provenance creates USDF tokens that act like stablecoins but that the organization calls "bank-minted tokenized deposits."
"We are working to help financial services participants put their business flows on blockchain for business and customer value," McKenney said. "So we are an infrastructure to help them basically reduce cost."
In addition to cost reductions, using a blockchain increases transparency, increases transferability of assets and eases access to financial services, she said.
"Ultimately this is a new way to do finance," McKenney said. "You issue the financial asset natively on-chain."
The servicing, financing, trading and securitization of mortgage credit on Provenance is "the new digital assembly line of financial services," she said.
Another use of Provenance is private market securities.
"The equity of young companies sits on Provenance and you can issue equity easily, much more digitally, and then manage that cap table and then offer secondary trading opportunities," McKenney said. "So it's creating more liquidity. This is a new financial system. And what we're doing is ultimately disrupting a lot of intermediation that happens in finance today. People have to tell your bank to do something with the asset that you own. So you own the asset, but you don't control the asset. This is a participatory platform."
More recently, Provenance has been used for payments.
"I think if you ask anybody in crypto, remittances and cross-border payments are going to be the one number one use case because it's such an obvious one in which the internet is a lot better," Monica said. "Part of the reason for this is that if you think about it, a network effect by definition is the effect in which when you add a new participant to a network, all of the other participants benefit from that addition. So there's value being accrued. So they are very easy to become very valuable very quickly."
Blockchains like Provenance also have the benefit of instant finality, Monica said.
"That's super important," he said. "Instant finality means when I receive it on this account, I know it's mine and it won't be clawed back. And that's very different from ACH, very different from SWIFT. In ACH you have all the way to 40 days where things can be taken back. … In crypto it's seconds or minutes finality."
On Provenance, cross-border payments don't require accounts in foreign banks.
"Everybody has a wallet and you don't need to open an account with someone to send them funds," Monica said. This streamlines the process and reduces maintenance cost. "You can just fund it and there's a list of public addresses for each participant and you can send it. So that makes it very unique and very different and just tailored for remittances. I think it is a great use case."
Staking
In a proof-of-stake blockchain like Provenance, there is a consensus mechanism that lets computer nodes on the blockchain agree on which transactions are legitimate. It also lets members vote on any changes to a smart contract running on the blockchain.
Banks and others on the Provenance network will buy hash tokens generated by Provenance and put them in a virtual wallet on the network that will be safeguarded by Anchorage.
"The staking is quite important because you're putting something of value at risk," McKenney said. "People who are staking and putting their capital at risk can vote on things, can propose things, can write new smart contracts that help financial services be better."
Monica compares these stakes to putting down a deposit on a house.
"When you leave the rental, they have the deposit and they'll keep it if you did something horrible to their house," he said. "It's that type of insurance mechanism that that proof of stake actually uses to ensure alignment of the participants in the network. The reason why it's called proof of stake is because you have something at stake."
