© 2016 Bloomberg Finance LP
Fnality, a London-based company is banking on blockchain technology to usher in an era of digital financial markets. They are betting that the financial markets are going to tokenize. Fnality intends to be there when that happens. In fact, they intend to spur the transformation.
According to Fnality’s chief executive officer, Rhomaios Ram, “if the markets are moving to a new model, they will need a secure infrastructure for digitizing payment and settlement on a global basis. We are creating a new financial market infrastructure, a new payments system [for wholesale banking].” Wholesale banking refers to lending and borrowing between banks, or with large customers such as the government, pension funds, and big corporations.
Ram continues, “our two areas of focus right now are establishing a digital currency capability in each currency, and coordinating and orchestrating with business applications, such as tokenized exchanges, issuance platforms, collateral and trade finance, that want to use this new payment functionality.”
Backed by a consortium of financial institutions, including some of the world’s most important banks: Banco Santander, BNY Mellon, Barclays, CIBC, Commerzbank, Credit Suisse, ING, KBC Group, Lloyds Banking Group, Mitsubishi UFJ Financial Group Inc., Mizuho Bank, Ltd, Nasdaq, Sumitomo Mitsui Banking Corporation, State Street Corporation, and UBS, Fnality will offer the Utility Settlement Coin (USC). Notably, the USC will be fully backed by cash collateral held in accounts at central banks around the world. To start, the USC will represent five different currencies: U.S. dollar, euro, UK pound sterling, Japanese yen and Canadian dollar. The cash collateral ensures that the value of the USC remains stable, while the Fnality platform enables interoperability through its connection to any blockchain network or legacy system.
Ram notes that the Fnality platform will not supplant systems that are currently in place for traditional banking. Their plan is to create a financial infrastructure to serve the digital marketplace that is to come. The USC will allow banking participants to engage in exchange for value transactions, to include cross-currency transactions, without many of the traditional intermediaries and their associated costs. Banks will be able to clear and settle transactions virtually instantaneously, improving efficiency, and reducing cost and risk.
Michele Curtoni, VP Digital Product Development & DLT at State Street says, “increased interest in digital assets [is] underpinning the evolution of wholesale financial services, [which] creates a need for digital cash in the form of cash on ledger. We believe Fnality is proposing a solution to [meet] this need. Fnality stands out as it is focused to provide a wholesale, multi-currency and instant payment solution leveraging a counterparty risk-free payment model. These properties meet our requirements for a successful model. Digital assets such as the ones proposed by Fnality have potential to deliver improved settlement efficiency, reduced risk and better client experience.”
Participating banks will deposit cash collateral with Fnality’s account at the central bank, providing the backing for the USC on the Fnality platform. They may leave a specified amount in the account, or add currency to the account on an as needed basis. Ram suspects that banks will measure their liquidity needs each day. And, since USC can be held and used 24/7, it will likely impact the way banks manage their liquidity and change the way they settle foreign exchange.
The idea for Fnality started at the end of 2015. At the time, Clearmatics, which provides the design of the blockchain system, and UBS considered how to enable efficiencies in the financial markets. They created a consortium to explore the idea, and Ram joined as its chair.
The Linklaters law firm has been advising on the project since its inception, first as legal counsel to the consortium of banks and now with respect to the legal/regulatory implications of the USC and the Fnality platform. Harry Eddis, Global Fintech Partner, Linklaters, offers that “the march towards digitalizing assets can only succeed with equivalent digital payment rails. USC is the payment rail solution at scale, utilizing blockchain technology to vastly improve settlement discipline.”
Ram explains, that “if you are going to tokenize finance and trade settlement, you will also need to tokenize the payment system. Tokenized markets have three essential ingredients: tokenized assets, tokenized new exchanges or price discovery mechanisms, and a tokenized means of payment. To do this, the cash leg of the payment must have the same credit quality of a central bank, and it must allow for settlement finality.” Those became the two fundamental design goals in the creation of the USC.
There are many in the crypto sector who thought that payment systems would be transformed by cryptocurrencies such as ether and bitcoin, but that doesn’t seem to have occurred for numerous reasons, chief among them their volatility. Stable coins, such as Tether or Maker’s Dai, have also proliferated as a potential solution for digital payments. But they too have not been widely adopted on an enterprise basis.
Fnality’s strategy of engaging directly with central banks is promising. The Bank of England’s governor, Mark Carney famously expressed that “consortia, such as [Utility Settlement Coin] . . . can drive efficiency and resilience in operational processes and reduce counterparty risks in the system, unlocking billions of pounds in capital and liquidity that can be put to more productive uses.”
That’s what Fnality is counting on.
It is in the process of opening accounts with each of the central banks. Ram concedes that “it is a long and expensive process. There are extensive regulatory requirements.” He anticipates having at least one account established by early next year with currency live by summer of 2020.
Ram offers that today’s market infrastructure has become complex. Market participants are forced to rely on multiple intermediaries: custodians and correspondents. That results in liquidity and cash being split into many buckets. Further, regulators require that both credit takers and credit givers have large liquidity buffers in order to ensure banks can survive if credit is less available.
“With the Fnality System and the USC, we can make a virtue out of necessity. USC fulfills the need for an on-chain payment asset and can also function as the payment asset for many different business platforms, which will allow for simplification of liquidity management,” says Olaf Ransome, Fnality’s Chief Commercial Officer.
The development of USC will undoubtedly create a streamlined system of payments and settlements for the world’s biggest and most important banks, yielding untold and cascading benefits. But it portends something more. It provides evidence of an inevitable and driving force towards scalable, decentralized, peer-to-peer financial systems.
For the Fnality platform to succeed however, it will need the support and cooperation of core institutions in the private and public sectors, namely banks and regulators at the central banks. From all appearances, Fnality has created a sound and compelling business model that will gain acceptance by the requisite parties worldwide. And, once the Fnality platform is operational, it likely will seek to expand to other areas. This, in turn, will spur additional demand for digitized assets.
Bitcoin may have started the blockchain technology sector with its innovative system for transferring digital value. But the Fnality payment and settlement system builds upon that innovative structure to enable peer-to-peer payments and settlements on an institutional level. This will change everything.