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July 11, 2019

Facebook's Libra Will Fizzle As Banks Hit Back

Facebook recently announced its ambitions for Libra, the company’s new global cryptocurrency. Given Facebook’s community of over 2.4 billion users, any foray into financial services could be a game changer.

As a result, governments and regulators wasted no time in warning that they would rigorously scrutinize the new offering. In a speech yesterday, Fed chair Jerome Powell said Libra raises “many serious concerns.”

Unlike Bitcoin, Libra is backed by a basket of global currencies, which should in turn provide the digital currency with greater price stability. Facebook also intends to comply with money laundering and counter terrorism requirements, while Bitcoin has no such checks.  

However, despite this, Facebook still faces an uphill battle in getting its digital currency past regulators of the financial industry. Meanwhile, banks are already developing blockchain technology that will speed up international transfers. The latter will probably win out. 

In reality, Libra may have less to do with disrupting the payments industry, and more to do with Facebook’s intent to set the standard for digital identity.  

Libra Faces Skepticism From Regulators

Facebook’s history of being cavalier with user data will embolden regulators to be aggressive in their probe. The U.S. House Financial Services Committee has signaled that they want to explore the potential risk to global financial stability that could result from an organization of Facebook’s size providing financial products on its platform. 

Since Libra will extend across borders, it will attract a legion of international regulators, most of whom are skeptical about Facebook’s reliability in protecting sensitive information.  Notably, in addition to user privacy, the Federal Reserve has concerns about potential money laundering and financial stability issues with Libra, according to Federal Reserve Chair Jerome Powell’s testimony to lawmakers. The central bank has a working group established to monitor the digital asset and is coordinating with the U.S. government and central banks around the world.

Facebook is not going it alone. It has pulled together a consortium of 27 launch partners, including payment processors like Visa, Mastercard and PayPal and new economy titans like Uber and Spotify. In total, Libra Association, the currency’s governing body, expects to attract 100 member organizations, but no banks have joined the lineup.

Investor reaction to the news was modest. Facebook’s stock jumped a little, but nothing consequential.  

Don’t Fight Central Banks

Beyond regulations, Facebook’s Libra — indeed, any cryptocurrency — faces one significant obstacle: Central banks can constrain their growth anytime they want.  

Central banks control the currency supply, which has knock-on effects for economic growth and monetary policy. If that landscape gets jilted from competing currencies that expand money in circulation, then it makes fine-tuning the economy harder. And, should anything misfire, central banks are left with the cleanup.  

An immediate tactic for central banks to constrain the growth of alternative currencies is to refuse to accept them for any government payments, such as taxes, fines or fees. If they further demand that commercial banks refuse to accept cryptocurrency deposits, it will quickly reduce the digital currency’s benefits as a financial asset. 

Central banks aren’t blind to the transformation that societies are turning cashless. In response, most are exploring their own digital currencies, which would function the same as today’s paper bills except reside in your digital wallet. The Facebook threat will certainly help accelerate that introduction.  

Commercial Banks Are Innovators Too!

Banks, meanwhile, are quietly toiling away in their own research labs. A consortium of banks, led by UBS and Santander, are working with technology partners on a “utility settlement coin” that would expedite the processing of international inter-bank transactions. The coin would leverage a blockchain processing unit but will be fully backed by central bank assets of the currencies involved. 

The consortium’s intent is to simplify the process of transferring funds between banks from a complex series of handoffs that can take up to a day, to one that is streamlined and close to instantaneous. So far, the banks have been tight lipped about progress, but many expect a rollout of the technology within a year. 

Meanwhile J.P. Morgan has developed its own blockchain technology and a companion digital currency, JPM Coin, designed to speed up institutional payment processing. The Coin is a processing convenience. It is pegged to the U.S. dollar and fully convertible at any time. 

One application they are investigating is bond trade settlement. Using JPM Coins, the bank is exploring the possibility of instantaneously settling bond buys and sells, a process that currently takes several days. Right now, JP Morgan is waiting on regulatory approval to start testing. 

So Big Banks are not falling behind Big Tech. They are battling hard to retain their customers and know how the user experience needs to be improved.

Does Facebook Have a Bigger Agenda?

Facebook appears to have made two miscalculations. They have underestimated the regulatory complexity of rolling out a global, digital asset and assumed the banking sector wouldn’t respond. 

But perhaps Facebook’s vision is broader than a digital currency that may help users loiter more on its site, or bringing banking to those who have never set foot in one. 

In its white paper, Facebook stressed that it had an additional goal: developing a digital identity standard. Digital identity is the Holy Grail of online validation and has long evaded easy solutions. Passwords can be stolen or hacked, but a digital identity is based on behavioral history that makes it harder to bluff or steal. 

That means knowing a lot about the user. Facebook’s leadership and involvement through Libra, assisted by a financial services consortium, could provide a rich lab to help it determine what works. Innovating an identity standard would give them a significant edge in extending their global leadership. 

So, Libra may simply be a research project to help Facebook reach the ultimate goal of defining the standard of how we unequivocally know it is really you online.

This material contains opinions of the author, but not necessarily those of Sun Life or its subsidiaries and/or affiliates.