JPMorgan's challenges if it offers crypto as collateral

Bloomberg

JPMorganChase is exploring plans to offer loans backed by clients' cryptocurrency holdings, such as bitcoin and ethereum, as early as next year.

It's a move that could dramatically expand the role of crypto in the credit market across the entire banking industry, given the competitive pressure resulting from the bank's size and influence.

"Competitive pressures are changing the calculus. JPMorganChase can't be seen as lagging behind its peers," Aaron McPherson, principal at AFM Consulting, told American Banker.

The bank's plans were first reported by Financial Times. The signing of the stablecoin-focused Genius Act and the House of Representatives' recent bipartisan passage of the cryptocurrency-focused Clarity Act is drawing more attention to the digital asset market and how mainstream financial institutions will enter or expand their roles in stablecoins, bitcoin and other cryptocurrency.

The risk for banks

If JPMorgan were to allow crypto as collateral for loans, the potential borrowers would want to use large bitcoin or ethereum holdings to free up cash, with the bank holding more crypto than the amount of the loan.

Given cryptocurrency's well-known volatility, the challenge for JPMorgan would be determining the amount of crypto to hold as collateral above the loan's value.

"While volatility is a concern, I think with the right coverage ratios this is a great business model," Tony DeSanctis, a senior director at Cornerstone Advisors, told American Banker. "I view this more like a margin loan than a traditional banking secured loan. I think the opportunity is significant but will take some pretty specific and unique underwriting."

While the Genius Act provides clear legal guardrails for stablecoin issuance and it also signals a greater government acceptance of cryptocurrencies, Eric Grover, principal at Intrepid Ventures, told American Banker.

"I don't think, however, that that means banks have to offer asset-backed loans against cryptocurrencies," Grover said. "Banks have to worry about the view their regulators take on business they do. While cryptocurrencies aren't a financial asset and have no intrinsic value, they do have demonstrated market value."

Read more about cryptocurrency. (Cryptocurrency | American Banker)

If banks can see the risk or volatility of that market value, they can secure loans against it, Grover said. "The riskiness of the underlying asset would be different than lending against a business, stock portfolio, car, or trove of premium wine, and the percent of value you'd lend against and how it was priced would reflect that."Not all experts think banks should jump into using cryptocurrency as loan collateral. Lending against bitcoin and ethereum is a bad idea, given their tendency to lose value, McPherson said.

Offering crypto-related services such as custody have much less risk, particularly with stablecoins, he said. The risk for collateral is different between stablecoins and general cryptocurrency. The GENIUS Act is specific to stablecoins, which are inherently less risky, Aaron Press, research director at IDC, told American Banker. If the stablecoin is properly coined and managed, there is no reason to treat it differently than cash when calculating a customer's assets, Press said.

"I could see, perhaps, a small discount added to account for conversion costs," Press said. "That's different from bitcoin or many other cryptocurrencies, which can be very volatile."The Clarity Act, as yet unpassed, may provide some comfort to banks when dealing with other types of crypto assets, Press said. "But it will still be a judgement call as far as how those will be valued as part of a risk assessment."

JPMorgan and crypto

JPMorganChase did not comment on the FT report. In addition to allowing bitcoin and ethereum as collateral, JPMorgan is also planning to accept bitcoin ETFs as collateral for loans, according to a June 4 Bloomberg article.

While JPMorganChase CEO Jamie Dimon has been publicly critical of cryptocurrency for years, the bank has been expanding its digital asset strategy with several moves to use crypto and adjacent technology to streamline payments.

During this month's JPMorgan second-quarter earnings call, Dimon said the bank will be involved in stablecoins, both through its JPMorgan deposit token and a bank-issued stablecoin. Dimon said there is a need to be aware of how fintech companies are using stablecoins to create accounts and tap payments and rewards, and it is important "to be cognizant of that," and the only way to be cognizant is to "be involved." But Dimon also said, "I don't know why you'd want a stablecoin as opposed to just a payment."

The bank's permissioned USD deposit token, JPMD, can support payments on Base, a blockchain that is built within Coinbase.

A deposit token is a digital asset that is a claim on a deposit at a licensed depository institution, such as a bank. Deposit tokens are issued on a distributed ledger, or the structure that underpins cryptocurrency. That makes deposit tokens easier to transfer between consumers or businesses, particularly across national borders.

Deposit tokens, which are backed by a customer's own deposits, are viewed as an alternative to stablecoins, which are backed by reserves that are supposed to be U.S. dollars, Treasuries and related "stable" assets.

JPMorgan and other large banks are already active in deposit tokens. As early as 2022, JPMorgan developed Liink, a payment information network with dozens of banks that expanded into JPM Coin, a digital currency JPMorgan launched in 2019 to support faster processing over a distributed ledger. "Exchanging value, such as money, between different parties over a blockchain requires a digital currency, so we created the JPM Coin," the bank wrote in an FAQ at the time."

Dimon has been critical of unregulated cryptocurrencies, but he has been willing to experiment with stablecoins and proprietary coins," Press said.