Blockchain lenders blow cobwebs off old IOU system
Bitcoin has shown that money can be moved around the world without banks. The underlying blockchain technology is now being applied to the humble promissory note – one of the oldest credit instruments in the world, dating back centuries.
This content was published on February 17, 2022 – 08:00
I don’t know what the Templars would think of their 12and century scroll contracts receiving the cryptocurrency treatment. To put it more specifically, electronic promissory notes are now being used to lend stablecoins, which are digital tokens backed by “real” assets.
For example, Swiss tech companies CLST and FQX recently helped engineer a $5 million loan to Singapore-based crypto trading firm Amber Group, using the Algorand blockchain.
In exchange for a promissory note, Amber took possession of a loan of USDC stablecoins, which are backed by US dollars. Blockchain enabled the simultaneous exchange of the loan and the promissory note (known as “atomic settlement”) without the delay and cost of the manual clearing and settlement process.
The whole affair took place without a banking license in sight.
On top of crypto-assets
The blockchain-compliant electronic promissory notes (eNotes) were generated on the FQX platform, which is based on the “Swiss Trust Chain” distributed ledger technology (DLT) system operated by the Swiss public telecommunications provider Swisscom. .
CLST connects borrowers and lenders of cryptocurrencies and stablecoins. It’s a similar model to fintechs in traditional financial markets, like Instimatch, whose digital platform connects corporate lenders (i.e. banks) with institutional borrowers (i.e. local councils). In the case of CLST, the money exchanged is purely digital and circulates on blockchains in the decentralized financial market.
There is a lot of this digital money. In late 2020 and into 2021, the value of bitcoin and other cryptocurrencies skyrocketed. This meant that many blockchain projects relied on treasuries worth a lot of money. And they are willing to lend some of it to other blockchain companies to trade or invest.
The problem with cryptocurrencies, however, is the volatile nature of their value. Since March 2020, the price of bitcoin has risen from around $5,000 to over $60,000 and is now trading at just over $40,000. This makes bitcoin a dangerously risky collateral against lending. This is why lenders often require an amount of cryptocurrency collateral that exceeds the value of the loan.
And this acts as a brake on the whole market, says the CLST. That’s why the fintech, founded in Zurich late last year, believes more loans should be unsecured – or generated without collateral.
It may seem like a huge risk, but the unsecured EU money market in the traditional financial world amounts to around 140 billion euros per day, according to the European Central BankExternal link.
Cryptocurrencies, of course, are riskier because prices are so volatile. One way to mitigate risk is to use stablecoins. Another is to give transactions a more secure legal footing with promissory notes.
Other crypto platforms in different parts of the world also allow unsecured crypto lending, such as Maple Finance and Truefi. Swiss banks SygnumExternal link and Credit Suisse are developing eNote strategies leveraging FQX while Switzerland’s SIX Digital Exchange (SDX) is also integrating the technology.
CLST, FQX, and Amber claim to have ushered in the first purely crypto lending using the same legal instrument as the Templars.
Considering the amount of energy both fintechs and banks have devoted to blockchain-based finance, it looks like the movement of capital through this medium is about to take off. Last year, crypto trading firm Alameda Research announced that it was raising $1 billion in stablecoin loans.
Even such august entities as the Bank for International Settlements, the Swiss Stock ExchangeExternal link and the Swiss National Bank agree that the cross-border flow of capital in the traditional financial market needs an efficiency overhaul.
That’s why the three organizations, along with many established banks, are exploring DLT alternatives.External link – including the possibility of stablecoins issued by the central bank.
The entry of incumbent financial institutions into the crypto asset market has caught the attention of regulators and the Financial Stability Board (FSB).
This week, the FSB issued warnings about the growing use of unregulated stablecoins and the decentralized financial system which pose “a number of regulatory challenges and threats.” These include hacks, money laundering, and dangerously high credit levels within the system.
US crypto lending firm BlockFi was recently fined $100 million for running an unauthorized securities trading business.
The reaction from regulators shows that a notion originally inspired by bitcoin has now come to fruition on a large scale.
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