How to process Stablecoins and Tokenised Deposits

Simon Taylor, who is one of those who I think really gets the FinTech space and its impact on financial services just posted: “Stripe just declared war on banks with their stablecoin financial accounts.” That alone is worth a read. I want to explain where banks will struggle with processing Stablecoins. And I’ll throw in a few words on things Tokenised Deposits too for free.

Why is this an important topic?

I am reminded of early days in things Bitcoin. Most banks looked on it as evil and said to their clients: “no, we won’t buy It or custody for you”. A few took the neutral view and said: “sure, we’ll process that for you”. To illustrate; I have my “bank account” at UBS, who at least in the past said “no to crypto” and my small, modest crypto related holdings at Swissquote who said: “yes to crypto”.

What’s new or changing?

“How do we process that?” That is a question which has to be answered every time a financial institution starts to think about a new product. Given we are thinking of Stablecoins as something close to cash or a bank balance, let’s just consider what a bank would need to do.

The two basic kinds of processing inside a bank are for i) cash and ii) securities, which is even used for money market instruments. There are also processes for commodities and derivatives. Let’s stick to the first two.

For accounting and books & records, a tokenised deposit is just another nostro or correspondent bank account. Let’s illustrate this: any business, be that an FI or a corporate, might have a USD account at JP Morgan. In the chart of accounts there is Nostro called “JPM USD” and any balance will roll up to “cash” in the chart of accounts. A tokenised USD deposit, be that a balance on Kinexys at JPM, or anywhere else, is just another account. Banks have processes to decide which business is booked versus which Nostro. If you want to know how this works, go look at how FX trades in your shop are selected to settle via CLS Bank.

What a tokenised deposit isn’t is a different currency; it’s an account like a Nostro. So too are the accounts at CLS Bank.

Whether a bank holds fiat USD or a tokenised deposit, any long cash is an asset, and it is explicitly in the balance sheet whether that cash belongs to the bank itself or its clients. And no matter who the asset belongs to, it affects the Leverage Ratio for a bank, i.e. how much capital it needs.

In simple terms: any financial institution could process a tokenised deposit in its books using legacy infrastructure.

Now, let’s move to Stablecoins. Do we think we should process them as i) cash or ii) securities? Yes, the SEC has said stablecoins which do not pay interest are not securities, so if you are a bank you might choose to process Stablecoins as simply cash accounts. Let’s unpack this: if just one client had 100k in USDC and you kept this at say, Zodia Custody, you would show an asset of cash of 100k, which you would reconcile to a statement from Zodia and you would show a liability of 100k to the client. Certainly works, but all on the Balance Sheet.

If instead you think that client Stablecoin holdings should be off balance-sheet, then you would elect to use your securities processing. Now it gets tricky. In securities processing as we know it, the client buys an asset vs. an amount of cash in a single currency.  Standard processing will certainly not allow you to process a client buying an asset vs. a payment of a Stablecoin. There might be a work around by having a client have a dedicated account with a balance of USD in USDC or USDG. But I’ll leave it at ‘awkward’.

At this point, the creative minds reading this might say: “Ha. No problem. Buy the asset vs a suspense account for a fixed amount of USD and then sell the stablecoin vs. the same fixed amount of USD". Some of the banks use something not totally dissimilar in FX processing for something called “In-Out Swaps” in CLS. Super special stuff and for only a handful of trades. As a general rule, when you hear “suspense account”, you should be on high alert. Stories we could tell, as it were.

Now, to be clear, legacy tech is just fine and dandy for processing a tokenised money market fund vs. fiat. The fund would be “just another ISIN”. 

Looking at the Stripe announcement. They are not subject to all the controls and risk reporting that banks are, and they don’t have a load of legacy tech. For any corporate Stripe can hold the balances, process them and report them. Any business with a lot of cross-border activity could use this to better control the trade lifecycle using Stablecoins and on-chain processing. I am reliably informed that Glencore are a shining example of how the new is being used in existing businesses.

In conclusion

In mu opinion, banks will struggle to process Stablecoins in their legacy tech stack, so I think we are likely to see “Bitcoin and banks all over again”. Most will simply not do it, there will be a few who work it out, some might be legacy banks, others might be start-ups. They will do well and attract assets away from traditional banks.

Thanks for reading. Please do let me know what you think of these notes. Feedback via the comments would be great.

Author

Olaf Ransome is a liquidity and financial services expert. He is the founder of 3C Advisory  You can message Olaf directly here.