Blockchain lenders blow cobwebs from ancient 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 world’s oldest credit instruments, dating back centuries.

I’m not sure what the Knights Templar would make of their 12^th century parchment contracts being given the cryptocurrency treatment. To put it more accurately, electronic promissory notes are now employed to lend stablecoins, which are digital tokens backed by “real” assets.

For example, Swiss technology firms CLST and FQX recently helped engineer a $5 million loan to Singapore-based crypto trading company 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. The blockchain allowed the loan and promissory repayment note to be exchanged simultaneously (known as an “atomic settlement”) without the delay and cost of the manual clearing and settlement process.

The whole deal took place without a bank license in sight.

Flush with crypto-assets

The blockchain-compliant electronic promissory notes (eNotes) were generated on the FQX platform, which is built on the “Swiss Trust Chain” distributed ledger technology (DLT) system run by Switzerland’s state telecoms provider Swisscom.

CLST connects borrowers and lenders of cryptocurrencies and stablecoins. It’s a similar model to fintechs in the traditional financial markets, like Instimatch, whose digital platform links corporate lenders (ie banks) to institutional borrowers (ie local councils). In the case of CLST, the money being exchanged is purely digital and it flows on blockchains in the decentralised financial market.

There’s lots of this digital money about. At the tail end of 2020 and well into 2021, the value of bitcoin and other cryptocurrencies exploded. This meant that many blockchain projects were sitting on treasuries worth a lot of money. And they are willing to lend some of this out 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 yoyoed from around $5,000 to over $60,000 and now trades at a little above $40,000. This makes bitcoin a perilously risky collateral against loans. That’s why lenders often demand an amount of cryptocurrency collateral that exceeds the value of the loan.

Reducing volatility

And this acts as a drag on the whole market, says CLST. Which is why the fintech, founded in Zurich late last year, thinks more loans should be unsecured – or generated without collateral backing.

That might sound like a huge risk, but the EU unsecured money market in the traditional financial world amounts to around €140 billion 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 are also enabling unsecured crypto loans, such as Maple Finance and Truefi. Swiss banks Sygnum and Credit Suisse are developing eNote strategies leveraging FQX while Switzerland’s SIX Digital Exchange (SDX) is also incorporating the technology.

CLST, FQX and Amber claim to have ushered through the first purely crypto loan using the same legal instrument as the Knights Templar.  

Regulatory warnings

Given the amount of energy being devoted by both fintechs and banks to blockchain-based finance, it appears that the movement of capital by this means may be poised to take off. Last year, crypto trading firm Alameda Research announced it was raising $1 billion in stablecoin loans.

Even such august entities as the Bank for International Settlements, the Swiss stock exchange and the Swiss National Bank admit that the cross-border flow of capital in the traditional financial market needs an efficiency overhaul.

That’s why all three bodies, along with numerous established banks, are exploring DLT alternatives – including the possibility of central bank-issued stablecoins.

The entry of incumbent financial institutions into the crypto assets market has attracted the attention of regulators and the Financial Stability Board (FSB).

This week, the FSB issued warnings about the rising use of unregulated stablecoins and the decentralised financial system which pose “a number of regulatory challenges and threats”. These include hacks, money laundering and dangerously high levels of credit within the system.

The US crypto lending company BlockFi was recently fined $100 million for running an unauthorised securities trading business.

The reaction of regulators shows that a notion originally inspired by bitcoin has now come to fruition at scale.