Banks could soon start to experiment with fractional reserve versions of tokenised assets, such as stablecoins, in a move that challenges crypto industry norms.

That’s according to two analysts who spoke to DL News about how banks are warming to blockchain technology and the speed and efficiency benefits it brings.

Currently, the vast majority of stablecoins in circulation are fully backed by fiat currency. But this model is inefficient compared to banks, who are able to lend out most of their deposits to generate profit and only hold a fraction in reserve.

If banks can issue tokenised dollars which play a similar role to fully collateralised stablecoins, but only hold a fraction of the reserves against them, that could give them a huge advantage, Will Beeson, founder of stablecoin infrastructure firm Multiliquid, told DL News.

Several major banks have signalled their intention to roll out their stablecoins in recent months.

In June, Société Générale announced its intention to launch a US dollar-pegged stablecoin while Bank of America CEO Brian Moynihan signalled his firm is also looking at creating a stablecoin once key legislation passes.

JPMorgan has also announced its own stablecoin-style offering called JPMD.

Uncharted territory for crypto

Fractional reserve banking is a widely-used system where banks are required to hold only a fraction of their deposits in reserve, lending out the rest. It permits banks to use otherwise idle funds to generate returns, and to make more money available to grow the economy through loans.

On paper, it sounds precarious — if all customers decide to withdraw their cash at the same time, the bank goes bankrupt. To keep the system from collapsing, governments mandate banks hold a certain amount of funds in reserve and provide insurance on bank deposits.

Banks experimenting with blockchain-based fractional reserve offerings will have to be extra careful, James Brownlee, co-founder at stablecoin infrastructure firm Harbour, told DL News.

To ensure banks have enough money in reserve for customers who need to withdraw it they follow battle-tested reserve requirement calculations.

But tokenising deposits on blockchains impacts those calculations, Brownlee said, drawing on his years of experience working for UK banks.

It might not necessarily be a detriment, though. Allowing for a much broader and distributed base of holders for bank deposits could actually decrease risks, Brownlee said.

Tokenised deposits

One potential solution is for banks to differentiate between so-called tokenised deposits and stablecoins.

Stablecoins have the connotation of being 100% backed by the fiat currencies they represent. Top stablecoin issuers Tether and Circle follow this model, and stablecoin regulation in multiple countries mandates stablecoins must be fully backed by cash or close cash equivalents.

Tokenised deposits, on the other hand, are more like a claim on a deposit at a bank which uses a fractional reserve system.

When JPMorgan announced its stablecoin-like product, the bank was careful to call it a tokenised deposit, Brownlee said, which is basically an IOU on bank deposits which are fractionally backed.

As clarity comes out in terms of the role that banks will play in the issuance and usage of tokenised dollars, the distinction between fractional reserve requirements versus full reserve requirements will have important implications, Multiliquid’s Beeson said.

Brownlee laid out one possible way banks could meld the existing fractional reserve systems they use with crypto.

When making transfers between customers and banks, fully backed stablecoins will be necessary.

But once funds reach their destination at a bank, they could switch over to being only partially backed. That’s because once money is in a bank account, it benefits from government insurance.

“Money at rest, in many cases, certainly in G7 countries, the US, and Europe, will be these kinds of token deposits,” Brownlee said. “Money in transit will be stablecoins — fully backed.”

“What they want is the dollar in the bank account,” he said.

Tim Craig is DL News’ Edinburgh-based DeFi Correspondent. Reach out with tips at [email protected].