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DeFi and Credit Risk

JPMorgan (JPM) thinks it has found a way for developers of decentralized finance (DeFi) to use the ability of non-crypto assets to make money.

Tyrone Lobban, head of Onyx Digital Assets at JPMorgan, spoke to CoinDesk at Consensus 2022 in Austin, Texas. He talked about the bank's plans for institutional-grade DeFi and how much value is waiting in tokenized assets.

"Over time, we think that tokenizing U.S. Treasurys or money market fund shares, for example, means that these could all be used as collateral in DeFi pools," Lobban said. "The overall goal is to bring these trillions of dollars of assets into DeFi so that we can use these new ways to trade, borrow, and lend, but on the scale of institutional assets."

Institutional DeFi usually means putting know-your-customer (KYC) rules on crypto's permissionless lending pools. This has started to happen in places like Aave Arc and a project that Siam Commercial Bank and Compound Treasury just announced.

JPMorgan's plans to turn traditional assets into tokens point to a much bigger scale. Lobban said that Onyx Digital Assets sees two parts that work together to make bank-grade DeFi a reality.

One part is JPMorgan's blockchain-based collateral settlement system, which was expanded last month to include tokenized versions of BlackRock's money market fund shares. A money market fund is a type of mutual fund that invests in cash and highly liquid short-term debt instruments. Lobban said that $350 billion has been traded in this kind of application on the Onyx Digital Assets blockchain, which is settled in the bank's own digital token, JPM Coin.

The second piece of the puzzle is a new pilot called "Project Guardian" that is being run by the Monetary Authority of Singapore with JPMorgan, DBS Bank, and Marketnode. It tests DeFi that is easy for institutions to use with pools of tokenized bonds and deposits that can only be accessed by people with permission.

These forays into DeFi will use public blockchains and a permissioned structure similar to what Aave Arc and Fireblocks are doing in many ways. Lobban pointed out that one difference is that large financial institutions that are part of Project Guardian are checking customer information instead of DeFi platforms and crypto-native custody firms. In other words, a trader at JPMorgan has to show that he is allowed to trade for the Wall Street bank.

Verifiable credentials

Another difference is that permissioned DeFi is done in a new way, with digital identity building blocks like W3C verifiable credentials.

Lobban said, "We want to use verifiable credentials as a way to identify and prove identity, which is different from the way Aave works now." "Verifiable credentials are interesting because they let you give access to these pools on a large scale without having to keep a white list of addresses. Since verifiable credentials are not stored on-chain, you don't have to write this kind of information to blockchain, pay for gas fees, etc., like you would if they were.

Lobban said that JPMorgan hasn't decided with which DeFi platforms and counterparties it will work, but that it will be one of the well-known options. "It will come from the pool of tried-and-true protocols with high TVLs," he said (total value locked). But we still haven't decided which ones."

Lobban said that JPMorgan has been quietly studying digital identity in the context of blockchain and digital assets for the past two and a half years.

"If we can put this identity layer in front of DeFi that allows KYC-based access, then each of those protocols should be able to support institutions without having to make too many changes," Lobban said. "Do we have to set up separate pools with permissions and change the protocols that are already in place? Or will they work right out of the box?"

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