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The Promise and Risk of Bank-Backed Digital Coins

On Our Radar: Deals we are paying attention to, for their impact on industry.


Mitsubishi UFJ Financial Group Inc. (MUFJ), Japan’s largest bank, will roll out its digital token by the end of 2019, following JP Morgan Chase, the first major U.S. bank launching digital coin. While they have the potential to reduce banks’ structural costs and speed up transactions, bank-backed proprietary digital coins bear an inherent risk.


Bank-backed coins are not cryptocurrency. Cryptocurrency, e.g. Bitcoin and Ether, has an intrinsic value and open-access Blockchain. The JPM Coin and MUFG Coin are permissioned, which means the coins are owned by banks the public can’t mine the coins on their own.


While the JPM Coin is pegged to the U.S. dollar, the MUFG Coin is tied to Japanese yen. Unlike the JPM Coin, which is exclusively for institutional customers, the MUFG Coin will be used in retail stores as well.


Digital coins reduce bank structural costs in two ways. First, international remittance using digital coins can be completed instantly, whereas traditional wire transfers like SWIFT sometimes take more than a day to settle. Second, digital coins also provide a more consistent banking record, also known as ledger, regardless of different regulations and rules in different countries.


The JPM Coin only allows users to move money between JP Morgan bank accounts though, because it adopted a “closed loop solution”, explained Tim Sloane, director of Mercator Advisory Group’s Emerging Technologies Advisory Service. However, JP Morgan is not worried about the limitation because of its huge market share -- 80 percent of the companies in the Fortune 500 are JP Morgan clients, according to CNBC.


The promising digital coins do have an inherent risk, a safety threat stemming from blockchain’s anonymity and human nature.


Traditional banks perform a very important role: scrutinizing clients. Banks are supposed to grant loans only to those eligible and exclude remittance to terrorists and money laundry. Wire transfer systems, such as SWIFT and ACH, are interbank communication networks, whose members enjoy the trust that they execute the due diligence, Sloane, one of the creators of the SWIFT protocol, told Karma Network.


Trust is subjective. We experienced the financial crisis in 2008 and LIBOR Rate rigging scandal, both because of human greed.


Cryptocurrency revolutionized payments by eliminating bureaucratic opaqueness and human as gatekeepers. Every transaction using cryptocurrency is anonymous but could be viewed publicly forever. In other words, every transaction is on a public record, but we don’t know who carried out the transactions.


Michael Dowling, former chief technology officer at IBM’s blockchain arm, puts it this way: “The answer lives in removing humans entirely from the operational aspects of finance, open the gates of knowledge for how finance is operated, and delegate operations to machines that cannot be incentivized to cheat, who run on code and algorithms everyone can agree to and see.”


The JPM Coin enjoys the same trust that the public have in the JP Morgan brand. Operating in a trusted environment, banks understandably hold security standards lower than in an untrusted environment, where cryptocurrency operates. Banks are also incentivized to do so.


The blockchain of cryptocurrency employs rigorous algorithms, which require hours to compute. Banks are incentivized to speed it up by simplifying their blockchains. The reduced security on tech level are compensated by public trust in banks. Bank-backed coins put human involvement right back into cryptocurrency.


CitiBank abandoned CitiCoin in March. MUFG invested in a New York-based cryptocurrency compliance startup Chainalysis last week.


“I’m skeptical to (bank) coins, because there could be loopholes,” said Sloane.


Scarlett Kuang is a business reporter based in New York.

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