Blockchain is undoubtedly the most talked about technology in the last decade. It is considered a revolutionary breakthrough technology that has tremendous potential to solve issues across industries. However, there have not been real practical developments taken place in the past that can be termed as technological progress in solving real-life problems. This has hindered the mass adoption of blockchain technology, especially in the financial sector by the major institutions such as governing central banks, investment banks, etc. As a result, the venture capitalist market lowered the funding of blockchain-based innovations by 35% or less than $3 billion till early 2020
In the last 20 years, various industries have leveraged different technologies to bring efficiencies and cost savings to their business ultimately reaching the goal of wealth creation. Financial institutions are no exceptions to this. Adoption of ATMs was started a long ago and the banking system has seen various evolutions till online banking system. However, the processing of global wholesale payments across the border or the international transfers is complex and difficult. Since it comprises multiple stakeholders and governing bodies, it is an extremely tedious process to solve and hence too costly too. But the volumes of such transactions are huge such as $5 trillion+ day-to-day international transfers. This system of international stakeholders, banks, regulators, legacy IT architectures, and lack of real-time audits requires a time-efficient cost-effective solution that provides security against frauds or unnecessary rejections.
On December 10, 2020, JP Morgan announced it have completed a live intraday repo transaction that was fully executed using its blockchain framework. The repo transaction was executed between JPM’s broker-dealer and its banking entity, and it showed an immediate settlement with maturity in few hours rather than the usual duration in days. Before that, on October 27, 2020, JPM officially launched its new business unit named ‘ONYX’ that was targeted for innovating and commercializing blockchain-based solutions along with JPM Coin, a strategic offering as virtual currency.
DEBT SECURITIES TRANSACTION - A repo trade is also known as a repurchase agreement made as to the short-term borrowing for the financial institutions or central banks. In a repo, one party sells an asset (usually fixed-income securities) to another party at one price and commits to repurchase the same or another part of the same asset from the second party at a different price at a future date or (in the case of an open repo) on demand. If the seller defaults during the life of the repo, the buyer (as the new owner) can sell the asset to a third party to offset his loss. The asset, therefore, acts as collateral and mitigates the credit risk that the buyer has on the seller.
Although an asset is sold outright at the start of the repo, the commitment of the seller to buy back the asset in the future means that the buyer has only temporary use of that asset, while the seller has only temporary use of the cash proceeds of the initial sale. Thus, although a repo is structured legally as a sale and repurchase of securities, it behaves economically like a collateralized or secured deposit.
Repo transaction lifecycle
Through these processes, a repo trade is executed. However, it involves multiple parties with documentation, agreements, exchange of information, securities, and cash. The entire process takes a couple of days to get settled with risks of fraud. In case of a bilateral execution of the trade, each party must enter their settlement instructions into the system.
In a tri-party repurchase agreement, there is an involvement of an independent custodian that ensures seamless transaction. The custodian collects the collateral from the borrower with allowing control of the securities to the borrower. At the same time, it assures the lender of the collateral with required asset quality. JP Morgan with BNY Mellon manages the tri-party repo market in the United States. The repo market provides a widely used form of secured financing, however, current operational limitations prevent the meaningful use of such financing to meet intraday liquidity needs. Using blockchain enables borrowers and lenders to execute shorter-term, intraday repo transactions with real-time, simultaneous transaction settlement, creating new ways to access intraday liquidity. Both collateral and cash legs of the repo transaction were settled using blockchain, with the cash leg leveraging JPM Coin. The important part is, strategically, the offering will be made available in production to external counterparties in the U.S. – some of which have already simulated transactions on the new application. J.P. Morgan developed the solution and tested its viability by conducting trades between two of its affiliates, alongside successful simulations of trades with Goldman Sachs and other entities, with BNY Mellon as the tri-party agent.
This real-world problem solution using emerging technology shows how by leveraging the new technology, new capabilities can be created. Capabilities such as digital asset ownership, atomic settlement of trade, faster go-to-market strategies, easy scaling of the platform, and lesser effort for go-live products can be obtained.
IIN to LIINK – A STRATEGIC MOVE
JP Morgan launched an Interbank Information Network or IIN in 2017 to speed up the global financial transactions. It was a network of more than 400 banks and major financial institutions that was intended to resolve payment validation problems while initiating transfers. Any error in the validation costs huge to the banks and hence holds critical importance for the stakeholders in the network. JP Morgan changed the name of this entity to ‘Liink’ after the launch of its blockchain-based business unit ‘Onyx’. Of course, the bank could charge a little fee for such validation via its platform but the cost of transaction delays or cost of re-processing the transaction is much more than that of fees. As per the Fintechtris website, user firms could save almost 50% of their current costs of payment processing within a short period. By using distributed ledger technology, JPM has created a more transparent and more operationally efficient network of information exchange that consists of hundreds of financial institutions in the world.
BUSINESS VALUE WITH DIGITAL INNOVATION
The many years of investment into developing the blockchain framework for financial transactions would benefit JP Morgan in the future. The investments of the company can be explained through the 4-asset classification method.
Infrastructure: Developing the basic digital infrastructure of the blockchain framework including the JPM Coin has brought the valued business integration for the firm. The live trade shows that the network works between its different business units. Since it's developed by JPM’s BU, it gives them the flexibility to expand and reduce their marginal costs of business through ONYX.
Transactional: It gives JPM the necessary bandwidth to allow other participant banks and institutions to be part of the network it strengthens the utility of the ONYX. It cuts operational costs for all of its participants, reduced transaction times to a great extent, and hence increases the throughput immensely to the benefit of everyone in the network.
Informational: Since the ONYX & JPM Coin is based on DLT technology, it brings necessary transparency, information exchange, and regulatory control in financial transactions. The integration of various complex entities and the bureaucratic procedure of cross-border transactions is improved providing faster cycle time with better trust between the counterparties.
Strategic: In my opinion, the most beneficial asset class for JP Morgan with their ONYX innovation is the strategic class. JPM, by investing their valued resources into R&D and developing this framework with a live demonstration, has proved an extremely potent innovative product. No wonder, banks such as Goldman Sachs, Deutsche Bank, BNY Mellon have approached JP Morgan to participate in the framework and get mutual benefits. The competitive advantage gained by JP Morgan in such a niche technology would add business value to their future objectives.
THE SCALABLE MODEL - Comparing the development of the framework with the organizational models for IT functions, the ONYX seems to be a scalable model. It has provided JP Morgan the required flexibility and cost advantage to carry out the business or trade efficiently. JPM created a separate BU with a separate CEO for this development keeping the IT centralized and leveraged its cross-unit asset utilization. This BU shows the strong presence of IT in the JPM business decision-making process. The model serves global businesses including other participants and cross-border transactions involving multiple entities at a time.
It is considered that successful organizations usually deliver one type of value to their customers. It could be operational excellence, or customer intimacy, or product leadership. However, in my point of view, the use of blockchain in solving a business problem of financial trading has provided JP Morgan a combination of all three values. It has brought operational excellence in the system by reducing operational cost and cycle time of a trade, it has appealed to various other banks to participate in cultivating deep relationships, and it created a product leadership in emerging technology for JP Morgan.
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