Nigel Walton discusses the potential disruption to the global financial system a cryptocurrency like Libra Coin could cause.Henry Ford democratized the automobile and transportation and more recently Google and other leading technology platforms have democratized information. The only area of our lives that has remained largely untouched for centuries is the way in which we undertake financial transactions. That is until Facebook and the Libra Association announced its intention to launch a `stablecoin` that would allow its 2.6bn users to transfer money and undertake a range of financial services.
The cryptocurrency, Bitcoin (created by Satoshi Nakamoto) was first mined in January, 2009 and was a response to the financial crash a year earlier in 2008. The purpose of Bitcoin was to create a decentralised currency that was outside the control of the traditional banking system by using an electronic ledger called Blockchain.
Over the last ten years the number of cryptocurrencies has proliferated but Bitcoin has remained the key benchmark. However, Bitcoin`s attempts to become a challenger to established fiat currencies has been hampered by its volatility (being primarily a used for speculative purposes). It is important to remember that money fulfils three key functions. Money acts as a store of value, a medium of exchange and a unit of account. A highly volatile currency is not attractive as a store of value because any deposits made using a cryptocurrency could become worthless very quickly. The same problem applies when using a cryptocurrency as a medium of exchange. Although digital money can be transferred much faster than conventional methods, the value of the cryptocurrency could also go up or down by a significant amount during the exchange transaction.
In order to overcome the volatility of cryptocurrencies, Facebook has decided to launch Libra as a `stablecoin`. Stablecoins can also be pegged to gold, oil, minerals or to another cryptocurrency or they can be allowed to float within a pre-determined range algorithmically based on various levels of programmatic intervention. Facebook is therefore removing two important barriers to the use of cryptocurrencies as a substitute for fiat currencies.
Instead of “moving fast and breaking things”, Facebook`s approach to the launch of the Libra coin has been to gain regulatory approval first. However, the regulatory backlash has been hostile to say the least. The US Congress has been very vocal in questioning Facebook`s credentials as a trustworthy guardian of people’s money following the Cambridge Analytica scandal. Issues such as money laundering, the financing of crime and terrorism and consumer protection have been highlighted as reasons to ban the launch of the Libra Coin. However, the main form of money laundering today is still transacted using US dollars whilst proportionately, credit card fraud and shop lifting still exceed cryptocurrency fraud in terms of financial losses to consumers.
The real reason for the strong resistance from the financial sector is the disruption it will cause to the global financial system. Facebook`s Libra coin will potentially disintermediate banks by providing a new medium of exchange and store of value and the unit of account, previously set by central banks, will pass into the hands of a private company.
If Facebook was a country it would the biggest in the world and only marginally smaller than China and India combined with 2.6bn users.
When analyzing industries that are ripe for disruption, platform Internet companies look for three key weaknesses. These include:
- Relatively high transaction costs and `gatekeepers`
- Asymmetry of information and
- Regulatory protection
It would therefore be a tragedy if governments and regulatory bodies were to ban Facebook`s Libra project for a number of reasons. It would be a set-back to private sector innovation. It would be a blow to greater financial inclusion - since the project is also aimed at helping the unbanked. Finally, if the US and Europe were to take a unilateral stance in banning Libra coin, then this would open the door to Chinese Internet firms such as Alibaba and Tencent. The Chinese Internet firms already have far more sophisticated online banking services which, if converted to a `stablecoin` business model, could give China the opportunity to control global monetary policy as they expand their payments platforms overseas.