Unpacking the Real-World Challenges of a Oliver Wyman Report and JP Morgan’s mCBDC Models

In-depth review of the efficacy of proposed mCBDC models, highlighting key challenges in scalability, legal complexities, and geopolitical factors.

This article describes some significant shortcomings in a recent report produced by Oliver Wyman and JP Morgan about cross-border payment inefficiencies. They don’t claim to have produced unbiased academic research but JP Morgan issuing research that expresses positive views about itself doesn’t come as a surprise and would not bother me too much.

My concern is more fundamental: it lacks real substance and the required evidence supporting its claims about the inefficiencies of existing systems and the benefits of new proposals. So seeing a Congressman quoting from it in a hearing is concerning. Now acknowledging the existence of a report and its main headline only means exactly, a politician is aware of its existence. JP Morgan and Oliver Wyman of course have every right to publish their views as they see fit and argue for their vested interests.

But this report is problematic in a different way because there are critical areas where financial analysts and experts might be expected to produce such ‘report’s with a higher standard of rigor. Here is a high summary of what I mean exactly.

1. Basis for Cost Calculations: The report claims significant cost savings ($120 billion in transaction fees) associated with the use of mCBDC. However, it does not provide a detailed breakdown or methodology for how these savings are calculated. And there is thus little additonal knowledge to gain from reading this document other then written evidence that the guy running JP Morgans blockchain solution for payments thinks his solution is awesome.

2. Definition and Scope of Cross-Border Payments: The report lacks precise definitions: what exactly are they analysing and what did they exclude. How are these definitions used to filter and analyze the data? It uses in parts unsuitable datasources and makes unsupported claims that are then producing big headline figures.

3. Assessment of Existing Systems (e.g., CLS): The report critiques existing payment systems like CLS for not being efficient or transparent without providing a clear rationale or evidence supporting these findings.

4. Feasibility and Implementation Challenges of mCBDC: While the report suggests that mCBDC could solve many inefficiencies in the current system, it glosses over the significant regulatory, legal, and practical challenges involved in implementing such a system globally. And it goes even further. It recognizes the problem, states that as a result there will be a plethora of systems and business models, and simply turns the page, starting to explain a new reality where the problems identified are for unexplained reasons no longer relevant.

5. Incoherent Arguments and Contradictions: If there will be a plethora of systems and operating models logically, one would expect that more infrastructure should increase and not decrease cost. However, the report is seemingly oblivious to the problems identified.

Don’t get me wrong. I have nothing against either organization; quite the opposite, I admire them. They are respected institutions, and when they provide a detailed opinion on something, many listen—including myself. But this doesn’t mean they have a better insight into the future than you and me, nor necessarily a better understanding of how to make blockchain work. And that is a beautiful aspect of a more decentralized market.

Where Are My Prada Tokens?

Over the last couple of days, I have been trying to understand how the Aura Blockchain works, but it's time to admit defeat: I cannot grasp what I am supposed to do here. Aura Blockchain, associated with Prada and other luxury brands, supposedly enables tokenization that should indicate whether a product is authentic. Initially, this sounds like a good idea including the visually pleasing animation although some of the claims made about certain technical properties of blockchain are bit exaggerated or oversimplified that they become wrong or they are in fact wrong. One exmple, the Prada Blockchain says “Blockchains record actions in a chronological order” implying that this is now important to differentiate blockchain from traditional ledgers. Traditional databases also record transactions in a chronological order. For example, a banking system also needs to know if the money to pay for these expensive Prada items went out before or after your salary came in. In blockchain systems, transactions within a block are not individually timestamped in the order they occur. Instead, they are bundled together and added to the blockchain as a block. The entire block is given a timestamp when it is added to the chain, but this does not reflect the exact order of each individual transaction within the block. Annoying stuff like that.

In Latin, "aura" means "breeze," "air," or "a gentle wind." It's derived from Ancient Greek ἄηρ ("aēr"), meaning "air."

So, I recently had some clothes made by Prada, which usually come with a certificate mentioning blockchain. Until now, I have discarded these certificates, but this time I wondered, what cool things could I do with this blockchain? My experiments over the past few days suggest—nothing. I have a paper card that states,

“This authentic Prada product's certificate has been uploaded to Aura Blockchain […] to record and guarantee its integrity.”

Fantastic! But where is this uploaded record? I don’t know how one is supposed to access it, as my certificate lacks a certificate ID, product ID, or anything of the sort. It really only says: “I am a certificate”. And that’s it.

Someone must have determined that my jacket is authentic and issued a certificate to confirm this and ’tokenised‘ this info I suppose. But all I have I s a piece of paper that states as much, but it provides no links between

• this paper document (which lacks an ID, making it seem as though I could declare any item, including my oven gloves, an authentic Prada product just by attaching this piece of paper),

• my jacket (how do I verify that the jacket I have is the one that was authenticated),

or any blockchain records—assuming they exist and are uncorrupted.

How does this guarantee authenticity? And Prada, please, no more cheap paper cards! If you create this secret or fake blockchain solution, I can’t tell which one it is, then I want nice leather-bound certificates!

What should I do now? I must admit, I am confused and torn between thinking,

‘It is not possible that a savvy corporation would launch a system that has absolutely no functionality,'

and feeling,

'Enough, I can no longer keep trying to use my phone as an RFID detector—maybe there isn't even a chip or QR code involved even though some pictures on their website gave me that idea.'

And if I can’t make this work, how is someone not interested in blockchain and tech supposed to manage this? Fortunately, I know some wonderful people at Prada. This situation must be thoroughly investigated, and I shall report back. Andiamo!

Open Issues From The Subcommittee investigating blockchain technology in banking

My last article dealt with the Subcommittee Hearing on Digital Assets, Financial Technology and Inclusion which took place on June 5, 2024.

SAB 121: When 1 = 2 = 1 or Lawyer Speak and Accountant Speak Don’t Match

The transcript notes the following commentary made by Congressman Stephen F. Lynch, Massachusetts:

A report by Oliver Wyman found that in 2020, it cost $120 billion to move $23 trillion across borders, and that a multicurrency CBDC could cut costs by 80% down to about $20 billion.

CBDC is quite a political issue in the US: Republicans don’t favour CBDC but are generally more supportive of crypto (usually for all the wrong reasons), and Democrats such as Congressman Lynch take the opposite stance (also usually for another set of wrong reasons). Hearing this statement made me wonder what miraculous report this must be that allows Oliver Wyman to claim resolving all cross-border payment inefficiencies and take a staggering $100 billion off the expenses list and meet the expected standards and rigour of research in financial services.

You know, A $100 billion! Not $94 billion, not $102.5 billion either.

No: exactly $100 billion!

This is usually a clear telltale sign that the numbers are a bit “massaged” to tell a story but should not be considered exact figures; instead, one could think of them as directional figures. Let's check it out.

Andiamo! Oliver Wyman’s Report On CBDC

This report comes with a strong title and can be downloaded here:

UNLOCKING $120 BILLION VALUE IN CROSS-BORDER PAYMENTS

How banks can leverage central bank digital currencies

The report actually has this subtitle and, interestingly enough, the authors did not forget about it and provide an answer towards the end of the report. So, how banks can leverage central bank digital currencies

“[..] commercial banks with strong technical capabilities, such as JP Morgan with its Onyx blockchain technology, could become private CBDC issuers on behalf of central banks […]”

Historic Reference Point

At the turn of the 19th to the 20th century, John Pierpont Morgan (hence “JP” Morgan) became notorious for acquiring companies and pursuing a business strategy characterized by aggressive consolidation and the creation of monopolies.

The U.S. president, William McKinley, was assassinated in 1901. He was known to oppose regulatory intervention dealing with these monopolistic structures. The story goes that the assassin was a factory worker who lost his job in a JP Morgan takeover. I have not checked this, so it could be true or not, but it makes a good story.

This changed history because it meant that the ‘veep’ Theodore Roosevelt, a proponent of progressive reforms and determined to tackle the monopolistic practices of big businesses, became president. A few months into his presidency, he directed his Attorney General, Philander C. Knox, to file a lawsuit against the Northern Securities Company.

The Northern Securities Company was a large railroad trust formed in 1901 by J.P. Morgan and James J. Hill. It controlled several major railroads, including the Northern Pacific Railway and the Great Northern Railway, effectively creating a monopoly over rail transport in the Northwestern United States.

The case was argued before the Supreme Court in December 1903 and was decided in March 1904. In a 5-4 decision, the Supreme Court ruled in favor of the United States, ordering the dissolution of the Northern Securities Company. The court held that the company’s formation was an illegal restraint of interstate commerce.

This historical context highlighting J.P. Morgan's legacy in shaping many core aspects of markets should make us think when we read a sentence like this. So let’s read it again quickly:

“[..] commercial banks with strong technical capabilities, such as JP Morgan with its Onyx blockchain technology, could become private CBDC issuers on behalf of central banks […]”

Oliver Wyman? Who else has capabilities to manage blockchain technology in banking and what makes the stuff Onyx has so powerful and why is it a good idea for a commercial bank to do this ‘on-behalf-of-central- banks-work? That’s not elaborated at all in this report.

But at least they are transparent that JP Morgan provided authors to the report. This would explain why sections like the one I mentioned read more like corporate advertisement. So who ‘massaged’ the text? A senior person at Onyx, J.P. Morgan’s brand for certain blockchain activities, and some strategy people in APAC and the country officer of J.P. Morgan in Hong Kong, who seems to be responsible for some private banking business otherwise.

hmmm .. Technologists, Corporate Strategy, and Private Banking equals Correspondent Banking and Payment Expertise???

Now J.P. Morgan has marvellous payments subject matter experts and I am sure they helped, but if so, why not mention the actual authors in the author list? Or did you really not consult them ?

“I Work For JP Morgan”

This statement could have been historically about me, but that's not what I mean. JP Morgan had a TV advertisement, I believe in 1998, which I remember seeing several times on CNN. It was the reason I became interested in finance. It is a mix of Star Trek: The Next Generation and the movie Death Becomes Her because it brings selfishness and humanistic ideals into balance, and it is serious, comical, with a touch of melancholy.

Star Trek portrays a future without money where people cooperate freely and without a need for rewards because technology has overcome the problem of limited supply, while Death Becomes Her shows a fantastical comedy about the extremes of seeking fame and fortune. The ad is, in a strange way, anchored at this intersection. At the end, employees state in different languages, "I work for JP Morgan" and "Trabajo en JP Morgan."

There is no need for them to say why because we have just heard why and what the ideal is: being responsible and slogans like “integrity is performance.”

The financial crisis has impacted the reputation of banks, but regardless, I have a sentimental attachment to this video. At the time, I thought to myself, “Wow, I want to be like them.”

Working at a bank looks like sitting in a swanky office, saying “I work here” as often as you can and ideally in multiple languages, while making a dramatic face, and wearing some decent Prada outfits.

Not a bad career choice! Sign me up.

Here is the link to the video.

Oliver Wyman’s mCBDC Report Has Methodological Weaknesses

Let’s start with the few numbers they provide.

“Global corporates move nearly $23.5 trillion across borders annually.”

The source? Some WTO trade statistics. I would not be able to devise a robust formula to calculate payment values from import-export statistics.

The US Congressional Research Service (CRS) has published that

“the value of global cross-border payments is estimated to increase from almost $150 trillion in 2017 to over $250 trillion by 2027, according to the Bank of England. Correspondent banking represents a significant portion of this (for example, the European Central Bank reported roughly $746 billion worth of daily transactions channeled through correspondent banking arrangements within Eurozone countries alone in 2019).

Assuming there was linear growth, there should have been $180 trillion worth of cross-border payments in 2020, and let's say "significant" means half of it: $90 trillion versus $23.5 trillion. (Note: Correspondent banking is not the only channel for cross-border payments but it is a significant one.)

Oliver Wyman’s wording seems to suggest they are only looking at the activity of Global corporates, but doesn’t specify what qualifies as such, likely reflecting an internal JP Morgan client segmentation.

So, now it is impossible to say if the $23.5 trillion are correct, slightly off, or materially wrong.

Oliver Wyman then continues: These corporates

"predominantly rely on the wholesale cross-border payment processes of correspondent banking networks that cost approximately $120 billion in transaction fees.”

Alternatives exist, and Oliver Wyman admits that by referring to this chancel as the predominant one, but the report assumes now all costs in cross-border payments equate to correspondent banking costs.

And the basis for calculating the size of these costs is stated as ‘analysis by Oliver Wyman and JP Morgan.’ So, believe it or not, these are mystery numbers.

Now, the report says each transaction cost $27 USD. Plugging in the numbers:

• How many transactions, with a cost of $27 USD each, are needed to produce $120 billion in costs?

Approximately 4.44 billion transactions per year.

Based on this number and the $23.5 trillion, the average value of a transaction would be about $5,291 USD.

And $27 USD is about 0.5% of that. And since the report explains that this number could go down by 80%, we would be left with a cost of around 0.1%. Going from 0.5% to 0.1%: Is that a lot? Well, it depends.

In absolute terms, the reduction from 0.5% to 0.1% might seem small, but in relative terms, it represents an 80% decrease, which could be significant depending on the scale and impact of the original problem.

• For smaller amounts, transaction fees can form a significant portion of the total cost. This can make small transfers disproportionately expensive, which is particularly challenging for remittances where individuals often send relatively small sums back home.

• For larger transfers, such as those typical in corporate banking, the flat or fixed portion of transaction fees becomes less significant relative to the total amount. Here, the FX rates and related costs (like hedging against currency fluctuations) play a much more crucial role.

Conveniently, these costs are not analyzed in this report.

Secondly, if Oliver Wyman got the basis wrong—$23.5 trillion vs. for example $90 trillion—it would reduce the relative importance even further.

The CRS also states that ‘the correspondent banking market continues to be a concentrated market, with a few key players accounting for the majority of transaction volumes serviced.’ Since this report focuses on APAC flows, it could overstate the costs because transaction costs are informally higher for cross-border payments, with the market and currency being all factors.

But based on these few checks, it already highlights a need to be very skeptical of how representative they are since it's unclear how their sample data was used to estimate total market volume and some data points seem to be off.

Then it shows in an exhibit a market overview and lists CLS and a few others, and declares all existing initiatives as either not being efficient or not transparent, and again doesn’t define what that means. There is typically no evidence to support their claims, with exceptions where the evidence is not convincing. For instance, arguing that CLS has a weakness because it is hard to add more currencies is surprising insofar as it is indeed a complex and often lengthy process: but why? The reason is not the absence of blockchain. It has to do with global coordination, legal frameworks, and central bank access policies and liquidity management. A global CBDC corridor would run into exactly these issues.

Not surprisingly, initiatives that involved JP Morgan more prominently receive a 100% success score. Of course, very subtle!

Then they say there are three technical models:

• RTGS upgrades (model 1),

• bilateral CBDC lite (model 2),

• and full-scale mCBDC (model 3).

“There is no optimal model among the three and, as such, we expect them to co-exist.”

Okay, we went from trying to replace correspondent banking with a new model to now the parallel operation of three new models!

• Model 1: 'It suffers from the same challenges of the correspondent banking network, with high transaction costs.' So, this should not be used to argue we get 80% lower fees, I hope?

• Model 2: 'It sacrifices scalability.' Which is the same as saying this is not an option.

• Model 3: This is perfection but 'it mandates coordination at the highest level on topics of governance and the setting of harmonized legal and regulatory standards.’ And since the volumes are concentrated, adding a small currency involves most of the same work but doesn’t change much in the bottom line hence not ideal to invest in. This is generally characteristic for this industry. Interdependencies that need careful analysis to implement change since you can’t switch off your current activity. This being one of many important mCBDC challenges that need to be factored in.

And then they talk about some supranational organization managing this arrangement and governing it. But who? Under the present geopolitical circumstances, this is unlikely. And monetary policy is highly critical for the ability of countries to take sovereign decisions on their economic policies.

And there is nothing of substance on how this problem would be suddenly easier by saying we are building a CBDC instead of a single global RTGS system.

One thing I would highlight that I found very surprising and flawed.

So in order to achieve atomic settlement, they propose this:

Transaction pre-validation within the network: Incorporation of final beneficiary checks and/or sanctions pre-screening within the corridor network design to ensure payment certainty upon transacting.

And this is the solution to everything. But it’s not a solution. It is saying we solve all problems by starting processing after all these problems are solved. And then they propose to extend this to things like FX, so everyone involved receives a price request and immediately quotes a price that the buyer likes and then says, 'take as long as you like: my quote is good for as long as you need.' This is such a naive idea. Yes, if all banks adhere to the same business process and standard, it would be really easy to automate it. And that’s the proof of why mCBDC can save us 100 billion. Come on!

And they do not give a fair assessment of the legal complexities, the risks, the liabilities for failing to comply with AML, for instance. And they do not draw the right conclusions as a result. So, this pre-validation idea. Either the bank performs sanction screening, finds it okay, then the funds need to go. If now mCBDC comes along and says, 'hold it - this is pre-validation,' then the bank will have to screen again because information changes in the real world. If a screening determines it’s okay, it may no longer be okay in an hour because you have learned something in the meantime. The practical hurdles to make this work are significant, yet it is the precondition for any hope of cost saving.

I find this all very unconvincing and muddled.

We get three new models: 1 as 'inefficient' as today, 1 that is more theory because you can't scale, and a third that has unrealistic business assumptions, and by migrating to this, we save a 100 billion dollars.

What kind of analysis is this?

Discussions on implementing global financial systems like mCBDC should carefully consider not only the technological possibilities but also the extensive regulatory, legal, and practical challenges that accompany such significant changes to the financial landscape.

And as someone who has worked in the US, Europe, and Asia, and often faced the need to pay some tax abroad, I have suffered through the most absurd problems associated with correspondent banking, with payments being stuck without anyone being able to tell for a week or two where exactly and looking with my relationship manager at MT Files searching for clues. Or a large US bank taking two weeks to process a USD debit only to find out that my transaction was outsourced to another bank, but by manually pushing a message through another front end, we could try to have the payment processed by the bank I banked with. Situations like these show that this is not the most efficient and elegant solution.

To effectively address the issues and overcome the mCBDC challenges, we must first understand what’s driving them and take what we learn seriously and test if we have a comprehensive understanding of all relevant facts, and then allow ourselves also the freedom to explore the feasibility of some radical alternatives. This requires a much more rigorous analysis than what is currently presented. In my view, the information provided is insufficient even for a basic kick-off meeting.