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On the money: Could Facebook’s cryptocurrency transform the financial markets?

09:55 04/02/2020
Opinion: Charlotte de Montpellier, economist, ING Belgium

With 2.4 billion monthly users, Facebook and its various platforms, WhatsApp, Instagram and Messenger, have conquered social media. Now, the US company plans to revolutionise global finance by creating a new payment system via its own cryptocurrency: Libra. Facebook has brought together an impressive list of partners, including Visa, MasterCard, PayPal and Uber, and Libra is set to debut this year. But uncertainty reigns. Documents published by Facebook in June left many questions unanswered, in particular about the numerous legal and regulatory requirements as well as the protection of users’ data.

Based on blockchain technology, virtual currencies such as Bitcoin work on the basis of a network of computers or servers, called nodes, that together manage a large shared ledger of transactions. Libra founders have deliberately excluded certain characteristics of the Bitcoin model to avoid its defects. While the Bitcoin network is completely open and anyone with the necessary computer power can participate in the transaction verification process, the Libra network will be closed, with participation limited to the association’s member organisations. It also aims to shorten transactions to about 10 seconds compared to the sometimes maximum one hour required for Bitcoin. Initially, payments will pass via the intermediary Calibra, a Facebook app that functions like a virtual wallet. Users will need a form of identity to subscribe, and after verification Facebook promises the transfer of money will be “as easy as sending a message or a picture”.

Libra will be indexed to a basket of real currencies (including USD, euro, sterling and yen) aimed at guaranteeing stability and easy conversion. This differs from other crypto currencies, which suffer fluctuating value. By indexing the Libra to a basket of currencies, and not to one single currency, the founders’ goal is to position the new currency on the global market and for it not to be linked to one economy in particular. The association plans to buy currencies or risk-free assets, including government bonds, and accumulate them as a reserve. The aim is to remunerate founders with the interest produced by these assets, ensuring that transaction costs will be minimal for users. In practice this could be complicated.

The global offer of risk-free assets is limited. Interest rates on this type of asset are low or negative, which would result in insufficient remuneration to cover the cost of the Libra Association’s operation. As a consequence, the new currency will probably have to find other means of finance. The founders say their goal is to make payments possible online with instantaneous transfers of money around the world, almost without costs. Libra is thus positioning itself as an alternative to the traditional banking system or transfer services like Western Union. Facebook indicates that the new money is essentially aimed at people who are currently excluded from the financial system, the 1.7 billion people worldwide who do not have a bank account. Some populations could adopt it because of a lack of confidence in the stability of their domestic currency, which could lead to Libra interfering with local monetary policy.

The announcement of the launch of Libra raised regulatory questions. Facebook has faced waves of criticism and scepticism about data security, money laundering and consumer protection, and it is not yet clear how Libra will respect the rules applied to traditional payment institutions. Jerome Powell, the president of the US Federal Reserve, warned: “It cannot go forward without there being broad satisfaction with the way the company has addressed money laundering.”

Compared to banks, Libra and the Calibra wallet are evolving in a blurred legal environment, which implies major risks for the international financial system. With time pressures, in July, the G7, the IMF and the large central banks launched a working group to look into crypto assets linked to currencies. As a result, Facebook may have to postpone the planned launch of Libra later than the first quarter of 2020.

Libra has faced other criticisms relating to the use of personal information. Facebook already has access to considerable personal data belonging to its users. This could increase if the company also monopolised payment information. It would not only have insight into users’ preferences and political leanings, it would also know about their purchasing decisions and financial habits. Such information could be resold at a very high price, which is interesting for Facebook as it earns 98% of its income from publicity revenue. Regulators all over the world are alarmed by the company’s lack of clarity over the way it expects to use the personal data and have asked for guarantees.

The arrival of Libra has shaken the financial sector and many questions remain about regulations and the technical difficulties of indexing it to a basket of currencies. It is likely that the project will continue to evolve in the coming months, before a launch that promises to be historic.

This article first appeared in ING Expat Time

Written by Charlotte de Montpellier, economist, ING Belgium