Bank to Basics: USC Project Seeks to Disrupt Traditional Wholesale Banking

On June 3, the Utility Settlement Coin (USC) project, one of the most ambitious crypto-based initiatives in mainstream finance, announced that it had taken the next step in its progression: the creation of a new company called Fnality International and the completion of a 50 million British pound ($63.2 million) Series A financing round.

The momentum for USC has been growing since 2015, when the initiative was launched by financial giants UBS, BNY Mellon, NEX, Santander and Deutsche Bank, along with blockchain startup Clearmatics. It’s important to note that USC is not a digital currency that individuals can invest in or use to make payments. The essence of the USC project is to create blockchain-based cryptocurrencies to make it easier for international banks to settle various transactions between each other. According to Fnality, USCs are 100% fiat-backed currencies held in respective central banks “with convertibility into fiat currency at par guaranteed at all times.”

In an interview with Baker McKenzie, Hyder Jaffrey, head of strategic investment and fintech for UBS, one of Fnality’s founding shareholder companies, said the project could well function as a catalyst for a future in which banks commonly issue their own virtual currencies, as there are not yet central bank digital currencies (CDBCs):

"Perhaps we might expect a CDBC timeline of 5-10 years, maybe even longer. We don’t want to wait that long to realise the benefits digital currencies can bring to banking, so we are looking to launch USC in 2018. It is essentially a stepping stone to a time when central banks might issue their own digital currencies."

At first, five fiat currencies will be supported — CAD, EUR, GBP, JPY and USD — although Fnality indicated that other currencies will be added in the future.

How will USC improve banking?

As it stands, banks that wish to carry out international transactions face a convoluted and often time-consuming process as the funds pass through a network of clearing houses and foreign exchange markets if the banks are using different currencies.Third-party involvement may increase fees, in addition to prolonging the time it takes to process international transactions. As a result of the complex way in which international transfers are carried out, they may take a full day to process under the current system.

HSBC’s head of fintech partnerships and strategy, Kaushalya Somasundaram, commented that USC represents an opportunity to improve on the current transaction infrastructure:

"The settlement coin will be a collateralized digital currency, backed by cash assets at a central bank, which allows us to transfer ownership easily through the exchange of USCs, thus reducing process complexity and the time taken for settlement."

The method proposed by USC seeks to streamline and reduce settlement, counterparty and systemic risk. As per USC’s scheme, banks seeking to carry out international transactions transfer the required amount to the country’s central bank. Once this has been received, Fnality issues the equivalent amount in USCs and deposits them into the necessary commercial bank for the other party. This balance is immediately deposited to the clients’ personal account in the required local currency. Although this system may appear complex, Fnality CEO Rhomaios Ram believes the process could well become almost instantaneous.

Laura Noonan, United States banking editor for the Financial Times, gave her take on the latest USC developments on the paper’s June 4 edition of the “Banking Weekly” podcast. Noonan outlined the general idea behind USC, emphasising its wholesale banking focus:

“What they’re looking at is whether they can make the trading system safer and faster by using coins to settle trades instead of the traditional digital money transfers. They basically spent about three years looking into this issue. Having done a lot of research, they think that coin would indeed be a faster and better way to transfer money between banks.”

Noonan elaborated on how USC would work with central banks to create coins for different currencies, which would help stymie any potential volatility:

“So, you would have different coins backed in different currencies. If you wanted to do a euro trade, that would be done in the euro settlement coin that would be backed by euro at the ECB. If you wanted to do a dollar trade, you use a dollar coin and that’s backed by dollars at the Fed. That also takes away the volatility of the currency issue.”

Guy Libot, senior general manager of shared services and operations at KBC, said in a press release that USC represents an opportunity to simplify liquidity management:

“USC will be an enabler for tokenized markets and also offers a significant opportunity to simplify liquidity management, using one digital cash asset for as many settlement needs as possible. It opens the door to 24/7 peer to peer wholesale payments in different currencies.”

USC project gives birth to Fnality International

More than two years on and the backing for USC is growing. According to a press release published on June 3, USC’s project partners have now become founding shareholders in Fnality International. The fledgling company counts some of the industry’s heaviest hitters as founding shareholders, including:

In the Fnality press release, Ram announced the launch and outlined the company’s primary objectives:

“We are delighted to launch Fnality, the commercial realisation of the USC Project. Working with our founding shareholders, we will start the regulatory approval process right away and look forward to connecting to the first business applications as soon as possible. USC will be an enabler for tokenised markets and also offers a significant opportunity to simplify liquidity management using one cash asset for as many settlement needs as possible.”

Fnality refused a Cointelegraph request for details about the latest investment. However, Series A funding rounds are usually only held once the product in question has established a solid reputation and presents a decent opportunity for investor return. Fnality did tell Cointelegraph that the investor response was broad and indicative of demand for the product:

“Investment was from banks globally and from Nasdaq, a financial market infrastructure and market technology provider. The broad interest shows the overall conviction in our industry that we need to look at tokenisation and peer-to-peer markets.”

Ram echoed the sentiments of this promising investment stage in an interview with the Financial Times, stating that any initial insecurities have been assuaged by the flood of capital from investors:

“When we started out...this project has basically been about R&D, we didn’t know if the characteristics [we wanted to achieve] were possible. The funding signals that it is possible. The investors believe it is possible based on the evidence they have seen.”

The projects’ ambitions appear to have grown in line with support for their product. With the founding of Fnality, the project will now encompass legal, regulatory, operational and technical issues, and is set to draw up a regulated network of distributed Financial Market Infrastructures (dFMIs) that will support the international exchange of value transactions. Fnality will also ensure that all transactions are conducted in accordance with local settlement finality laws and regulations.

Lee Braine, the chief technology office at Barclays, told the Financial Times that, although the bank’s confidence in USC had grown “meaningfully,” he expected the impact to be gradual, stating that “this ultimately is a market transformation over time.”

Fnality has also stated to Cointelegraph that innovation in the financial world often takes time, and even when there are prominent issues, solutions can sometimes take years to be successfully implemented:

“Thinking through what financial services needs as infrastructure requires both consensus and time. These things do not happen quickly; Bankhaus Herstatt collapsed in 1974, CLS, the market infrastructure to address the settlement side of the FX industry’s shortcomings, went live in 2002.”

How is the project being received?

Cowen Washington Research Group foresees little resistance for USC in the U.S., stating that banking agencies such as the Federal Reserve are likely to support the project as it seeks to simplify the complex, cross-border transaction process. Although the Securities and Exchange Commission (SEC) usually looms large as a hostile gatekeeper for U.S.-based crypto projects, Cowen analysts do not see this being the case for USC:

“The SEC is most worried when tokens are sold to individual investors. The issue is whether these are really securities that require disclosure. In this case, the USC is not being sold. It is merely a tool that banks can use to complete transactions.”

The lack of a consumer or individual investor angle leads Cowen analysts to believe that U.S. policymakers will also be supportive of the initiative:

“We see nothing that would trigger the ire of Democrats or Republicans on Capitol Hill. As a result, it is hard to see Congress holding hearings on the USC. And even if there was a hearing, it would likely be more informational than critical.”

Founder of Post Oak Labs and influential figure in the crypto community Tim Swanson tweeted his support for the project:

congrats to the @fnality and @clearmatics teams on the hard work at turning USC into its own capitalized entity: https://t.co/SCCPHdBQtksmall thread below:

As part of the same Twitter thread, Swanson outlined what he viewed as important characteristics of USC:

“In short: central bank reserves are held in a segregated account and tokenized so that they can be used for settling transactions. this is not commercial bank money.”

Swanson previously emphasised in an article published on fintechpolicy.org the fact that USC’s corresponding funds will be held exclusively in central banks differentiates it from other stablecoin projects, which use more risk-prone commercial banks:

“Even a deposit made by companies into a commercial bank account ultimately bears the credit risk of that specific bank: it could collapse, force a haircut onto depositors, freeze assets at the request of the court, decide to shut down accounts, and at least a handful of other issues.  We all witnessed the consequences of these risks first hand with the sorrowful collapse of retail and commercial banks during 2008 – 2009.”

Swanson elaborated on other characteristics of USC:

“Another interesting characteristic of USC / Fnality is how the business, legal, economic, and technology model is tightly intertwined. because participation is P2P and requires "global state," you end up without an intermediary or a single-point-of-failure.”

Although the project could represent an important step forward for wider crypto adoption in the financial world, USC was not met with universal acclaim in the crypto community. Co-founder and partner at Morgan Creek Digital and Bitcoin advocate Anthony Pompliano published a tweet on June 3 that outlined his skepticism regarding the project:

The banks are trying to build their own bitcoin called Utility Settlement Coin (USC).14 firms.$63 million invested.4 years of development.Nothing to show for it....shocking.Long Bitcoin, Short the Bankers!

Although this project is clearly not intended to have an impact on individual investors, it’s not difficult to see how the lack of decentralization within the USC project would rile crypto purists. While this is certainly a big step forward for crypto and blockchain usage in the financial world, it’s hardly the democratic transformation that many in the crypto community have long been anticipating.

What are the prospects for impact?

Back in August 2017, Bloomberg’s Carline Hyde discussed the early signs of a thaw in relations between the crypto sector and banking:

“They’re tightening up on cybersecurity and this is where I think it gets interesting because banks have been slightly worried about the cryptocurrency speculation because a lot of it has been linked to not quite above board behaviour. But now the fear of fraud has been cut out and they’re really starting to show an area of growth and underlying efficiency for banks and huge disruption could occur for the financial industry.”

Although USC is not yet operational, Noonan said that this is definitely a project to monitor as it has major potential to disrupt the banking industry:

“Because you have big banks in there that allows them to achieve a level of critical mass. I think if this does in fact make trading safer and faster, it’s hard to see why other banks wouldn’t want to get involved. I think we should watch this space and we might be surprised how impactful this ends up being”  

Fnality told Cointelegraph through email that, although there is widespread support for the initiative, a few hurdles still lie ahead for the USC project:

“The central banks are aware of this initiative. Connecting use cases to each currency easily; that work is ahead of us, coordinating and orchestrating with both our shareholders and potential business partners, such as exchanges and trading venues to connect them to USC.”

KBC Senior General Manager ICT Rudi Peeters, also stated that KBC, one of Fnality’s founding shareholders, is bullish on blockchain:

“Blockchain is a magnificent technology that has the potential to disrupt every existing business model. Being a threat on the one hand, it offers huge opportunities on the other hand. For the financial world, realizing cash on ledger is a true milestone.”

JPMorgan Chase wields a rival coin

As blockchain and crypto solutions come in from the cold, other financial institutions are starting to implement coin initiatives. U.S. banking behemoth JPMorgan Chase (JPM) announced it will launch its own cryptocurrency in an interview with CNBC on Feb. 14.

Read more on this: Ordinary Stablecoin or XRP Killer? What We Know About JPMorgan Chase’s New Cryptocurrency

The token, dubbed “JPM Coin,” seems set to provide USC with some competition, as the multinational bank reported that its coin will focus on improving settlement efficiency. It appears that JPM Coin will first tackle settlements between major corporations, which also suffer from a similarly convoluted settlement process using the existing options, such as the SWIFT international payment network.

Umar Farooq, who is responsible for JPM’s blockchain focus, was optimistic about the potential for an increase in blockchain implementation at the bank:

“So anything that currently exists in the world, as that moves onto the blockchain, this would be the payment leg for that transaction. The applications are frankly quite endless; anything where you have a distributed ledger which involves corporations or institutions can use this.”

For now, it seems that JPM Coin’s usage will be limited to settlements, treasury services and securities transactions. However, Farooq mentioned that it could be worked into other areas of the company’s activities some time in the future. For now, only a relatively small amount of the total funds involved in the three areas will use JPM Coin. According to Farooq, “The applications are frankly quite endless; anything where you have a distributed ledger which involves corporations or institutions can use this.”