The USDF Consortium has decided to switch to a technology infrastructure using private, permission-based blockchain to address bank regulators' concerns about heightened risks associated with public, open blockchain networks.

The bank consortium was launched in January 2022 and aimed to use blockchain technology to improve operations in financial services. It initially used a public, open network called the Provenance blockchain developed by Figure Technologies Inc., letting banks mint USDF tokens to reference U.S. dollars and transfer the value on the blockchain between counterparties.

"I think the banking agencies over the past six months have made really clear that, even though there are ways to manage the risks associated with engaging on public, permissionless chains, they aren't comfortable with banks doing that, so we have moved and built out a private permissioned version of Provenance," said Rob Morgan, CEO of the USDF Consortium.

The technology implementation of the switch is relatively easy because the two blockchain systems are based on the same technology stack developed by Figure, Morgan added. Now, the consortium is awaiting for regulatory approval to take it live.

"The technology is built, and we are working with the bank agencies to help make sure they understand what it is and that they have clarity on it," Morgan said.

Banks that want to engage with blockchain technology are required to obtain written approval from the Office of the Comptroller of the Currency, financial institution letters from the Federal Deposit Insurance Corp. or performance approvals from the Federal Reserve, depending on their primary federal regulators, Morgan noted.

Regulators supervise banks' engagement with digital assets on a broad term. In a Feb. 16 report, the FDIC reiterated the definition of digital asset activities as efforts to "make payments or investments, or transmit or exchange funds or the equivalent thereof, that are issued or represented in digital form through the use of distributed ledger technology."

As of January, the FDIC was aware that 136 insured banks had ongoing or planned crypto-asset-related activities, up from 80 as of October 2022.

The consortium currently comprises vendor Figure, fintech investment firm JAM FINTOP, as well as nine bank members and participants, including New York Community Bank, a unit of New York Community Bancorp Inc., National Bank Holdings Corp.'s NBH Bank, FB Financial Corp.'s FirstBank, Webster Financial Corp.'s Webster Bank NA, Synovus Financial Corp.'s Synovus Bank, Amerant Bancorp Inc.'s Amerant Bank NA, Atlantic Union Bankshares Corp.'s Atlantic Union Bank, ConnectOne Bancorp Inc.'s ConnectOne Bank, and Primis Financial Corp.'s Primis Bank.

While New York Community Bancorp closed the acquisition of Flagstar Bancorp Inc., the Office of the Comptroller of the Currency, or OCC, asked the combined entity to obtain a new approval if they were to retain the investment made by New York Community Bank in the USDF Consortium.

Public vs. private blockchain

The USDF Consortium's decision to make the switch comes as banks and regulators have been experimenting with the blockchain technology and honing their understanding and skills to manage risks.

In a joint statement Jan. 3, the Fed, FDIC and OCC wrote that "the agencies believe that issuing or holding as principal crypto-assets that are issued, stored or transferred on an open, public, and/or decentralized network, or similar system is highly likely to be inconsistent with safe and sound banking practices."

Since inception, what the USDF Consortium proposed was to facilitate payments in a permissioned environment, even if the blockchain was to be a public system, Morgan said. It means the USDF tokens could only be minted, transferred and burned in digital wallets where banks have conducted know-your-customer due diligence.

With the new private blockchain, the banks will engage with the USDF tokens in the same way but in an environment entirely separated from other parties in the broader blockchain ecosystem. The consortium will perform a gatekeeping function to ensure all validators on its private blockchain are trusted entities, Morgan explained.

"One of the things that the banking agencies think is important here is we have contracts in place with all of those counterparties where you can hold them to performance," Morgan said.

Not catering to cryptocurrency

Even though cryptocurrency is among the most broadly adopted applications of blockchain, banks are developing other uses for their blockchain-enabled payment networks.

The USDF Consortium has always been more focused on building an industry-agnostic blockchain platform to provide banking services, Morgan said.

Currently, the most active blockchain-enabled payment networks tend to be intrabank systems, such as Signature Bank's Signet, Silvergate Capital Corp.'s Silvergate Exchange Network, and Onyx by JPMorgan Chase & Co., where the two counterparties of a transaction have to use the wallets and payment rails provided by the same bank.

Instead, the USDF Consortium is exploring an interbank structure to expand the reach of its payment platform among different banks in the consortium.

"Our interest is just in helping create the common rules of the road," Morgan said. "In many ways, what we're building looks more like the ABA routing number for how banks communicate on chain than it does a full technology product."

Exploring applications of tokenized deposits

Through the exploration in the past year, regulators and the banks appear to have more clarity on the distinction between stablecoin and tokenized deposits.

The consortium initially categorized USDF tokens as stablecoin, in part because its value is pegged to fiat currency, but over time has clarified that USDF is deemed tokenized deposits. Stablecoin is typically backed by a reserve of assets and used as an on-ramp in crypto trading, whereas tokens such as USDF or Onyx's JP Morgan Coin reference deposits on the banks' balance sheet and can be used in general wholesale payments.

"A bank deposit is, whether it's recorded on chain or whether it's recorded on traditional ledgers, is just a liability of an insured depository institutions, not an asset," Morgan said.

Payment rails benefit from the network effect because existing customers tend to take their counterparties to the same rail, which has driven the adoption of Signature Bank's Signet and Silvergate's Silvergate Exchange Network in the cryptocurrency industry. The USDF Consortium wants to create the value of network effects in business-to-business payments and has taken a close look at the construction and industrial segment, Morgan said.

There is also interest in use cases that do not rely on a large network effect, such as managing the payments associated with loan participations between banks using blockchain technology, Morgan added.