Modernizing and securing direct deposit systems with blockchain-based stablecoin settlements

At Coinbase, we’re working hard to help update the financial system by building trusted products that expand the utility and adoption of crypto, because we believe crypto and blockchain technology have the ability to increase economic freedom and opportunity around the world. Coinbase chose to become a public company in the US because we believe the US would best be served by embracing this fundamental innovation, but we’re also focused on international markets, many of which are moving forward with strategies to become “crypto hubs.” A key part of fulfilling this commitment is building technologies that help update the financial system in a manner that prioritizes consumer rights and security. One way we’re doing this is by improving the way that millions of Americans receive their compensation today by providing an alternative to Automated Clearing House’s direct deposit (more commonly known as ACH) with settlement via stablecoin cryptocurrencies. There are several shortcomings of the ACH direct deposit system, and blockchain-based stablecoin settlement can address these issues, while providing additional consumer protections. 

ACH Direct Deposit: Understanding the Process

The ACH network was established in the 1970s to replace paper checks with a secure, efficient, and cost-effective money transfer system in the United States. Today, the ACH direct deposit process involves several steps.

1. Initiation, where employers provide relevant information following National Automated Clearing House Association (NACHA) guidelines; 

2. Transmission, as employers send the ACH file to their bank (known as  Originating Depository Financial Institution, or ODFI) in scheduled batches, causing delays;

3. Clearing, where the ACH operator sorts and transfers transactions to Receiving Depository Financial Institutions (RDFIs); and 

4. Depositing, where RDFIs decode the information and deposit funds into employees' accounts, subject to potential delays based on the RDFI's policies.

Considering the stages and timing involved, the total ACH process from initiation to fund availability can take 1 to 2 business days. Weekends, bank holidays, and additional processing time required by the employer's payroll system can extend this timeline further.

Shortcomings of the ACH Direct Deposit System

There are several shortcomings in the ACH direct deposit system that hinder efficiency and consumer protection:

1. Multiple Actors: The involvement of multiple parties, such as the employer, ODFI, ACH Operator, employee, and RDFI, adds complexity and increases the time required for fund transfers. Any failure or exception handling at any step can lead to additional delays.

2. Lack of Standardization: The mechanism for transmitting ACH files between the ODFI and ACH Operator is not standardized. Each ODFI must integrate with the ACH Operator individually, leading to complexity and potential delays. Additionally, access to the rules and guidelines of the ACH network requires a payment to NACHA.

3. Slow Process: The ACH direct deposit system's overall speed is a significant concern. If a direct deposit is initiated at 4:45 pm on a Friday before a long weekend, the funds may not reach the RDFI until the following Tuesday at the earliest, subject to additional RDFI processing delays.

Benefits of Blockchain-Based Stablecoin Settlement

Blockchain-based stablecoin settlement offers a potential solution to the inefficiencies and consumer protection concerns of the ACH direct deposit system. Let's explore the benefits:

1. Delivery Times: Confirmation times for stablecoin transactions can range from a matter of minutes to a few minutes on Layer 2 Ethereum-based networks like Base, Optimism, or Arbitrum. This is in stark contrast to the 1-2 business days required for ACH direct deposits. 

2. Cost Savings: The economic inefficiency resulting from the slowness of ACH direct deposits can be estimated by calculating the difference in settlement times and multiplying it by the total transaction volume. Using the Federal Funds Rate of 5.08% and assuming an average direct deposit takes one business day, the estimated annual economic inefficiency amounts to a whopping $2.67 billion.

3. Minimization of Price Volatility: Stablecoins are cryptocurrencies pegged to a reserve of assets, minimizing price volatility; for example, USDC, a stablecoin pegged to the US Dollar. Blockchain is a decentralized digital ledger that records transactions within a network. Consensus mechanisms, like Proof-of-Work and Proof-of-Stake, enable agreement on the ledger's state, minimizing overall price volatility.

4. Elimination of Middlemen: Blockchain-based stablecoin transactions remove middlemen like ODFIs and RDFIs. Users have direct control over their assets in digital wallets, avoiding potential failures and delays.

5. Atomic Nature of Stablecoin Transactions: Stablecoin transactions are atomic, meaning they're all-or-nothing. Once confirmed by the consensus mechanism, transactions are irreversible and recorded on the blockchain.

6. Open-Source: Open-source blockchains offer transparency, trust, and easy composability. Developers can review, modify, and integrate with existing blockchain infrastructure, fostering innovation and efficiency.

Contrary to popular belief, blockchain-based stablecoin settlements offer similar security guarantees of ACH transactions, without compromising settlement time. While blockchains are inherently secure due to decentralization and cryptographic algorithms, additional measures have been developed to safeguard users and their assets:

1. Multi-party computation (MPC)-based crypto wallets: MPC-based crypto wallets distribute crypto asset controls among multiple parties. Even if one party is compromised, the assets remain secure as others can block unauthorized transactions. 

2. Multi-signature smart contract wallets: Multi-signature smart contract wallets function similarly, requiring approval from multiple parties for transaction completion, mimicking the dual control system in traditional banking. Escrowing smart contracts can also hold assets until specific conditions are met, preventing fraud and contract breaches.

3. Custodial Wallets: Custodial wallets provide added protection by entrusting a trusted third party with the user's assets. While this reintroduces an intermediary, it's important to note that such services are optional in the blockchain ecosystem and are chosen for convenience or extra security. 

The promise of increased security of blockchain-based settlement systems is further bolstered by ongoing legislative efforts. Currently, the United States House Financial Services Committee is considering legislation that provides comprehensive guidelines for stablecoin markets. The clarity and regulatory framework provided by such legislation, if enacted, would enhance the trustworthiness of blockchain-based stablecoin settlement systems. Such formalized oversight could help ensure the responsible issuance and management of stablecoins, enhancing their suitability as a viable option for efficient, secure financial transactions.

A strong alternative to ACH direct deposit

By offering blockchain-based stablecoin settlements as an alternative to the ACH direct deposit system, Coinbase addresses the inefficiencies and consumer protection issues inherent in traditional methods. The ACH direct deposit system suffers from complexity, lack of standardization, and slow processing times, while blockchain-based stablecoin settlements provide faster confirmation times, significant cost savings, and minimized price volatility. Additionally, the elimination of middlemen, atomic transactions, and open-source nature of blockchain technology contribute to enhanced security and efficiency. Ongoing legislative efforts to establish comprehensive guidelines for stablecoin markets further reinforce the trustworthiness of blockchain-based settlements. Coinbase believes that by prioritizing consumer rights and security, we can foster a future where financial transactions are not only efficient but also empower individuals and businesses with economic freedom and opportunity on a global scale.