Facebook’s coin is a bad idea, whose time has come

Mark Carney, then as governor of the Bank of England, put this well in 2019, stating that the Facebook project “would instantly become systemic and will have to be subject to the highest standards of regulation”.

Further detail was provided by Reserve Bank governor Philip Lowe in December. He confirmed ”the initiative has raised concerns from governments and regulators in many jurisdictions regarding a wide range of issues, including consumer protection, financial stability, money laundering and privacy”.

He added the RBA was participating in a regulatory college established by Swiss authorities, on behalf of Australia’s Council of Financial Regulators.

Facebook has had its hands full recently as well.

More significant than Australia being “defriended” on February 18 are the anti-trust suits that were filed by the US Federal Trade Commission and 48 attorneys-general, on behalf of the states, on December 10.

These allege the use of monopoly power, particularly concerning the acquisitions of WhatsApp and Instagram, “with the aim of suppressing, neutralising and deterring serious competitive threats”.

True to form, Facebook filed a motion to dismiss the complaint last week.

Move slow, break things

Even if Facebook is not moving with customary speed, it remains fully committed to Diem.

This was evident in the rollout of Novi as a digital wallet last May, the ongoing addition of new backers (the Diem Association has 27 members) and various high-profile executive appointments.

The scope of the project has also become clearer. Novi confirmed that peer-to-peer payments would support business, and “additional merchant services” would be added online, in-app, and in-store over time.

There have been technical refinements as well, mostly announced last April. These include the introduction of single currency stablecoins, (Diem is most likely to launch in its US dollar form), and enhanced compliance with anti-money laundering and counter-terrorism financing regulations.

In contrast to cryptocurrencies, Diem is also now to remain a permissioned system. This means the blockchain will be updated by trusted nodes within the network, as distinct from a public blockchain such as bitcoin.

The 2020 changes provided more detail on how the reserves underpinning Diem would be managed, including during periods of market stress.

It further committed to the development of a regulatory capital framework with “an appropriately sized, loss-absorbing capital buffer”.

In sum, these steps have kept the project on track while creating some optical distance between Facebook and the Diem Association (Facebook, via its subsidiary Novi, holds one of six board seats).

Full circle

Here is the kicker. When Libra was first announced in mid-2019, it had a profound catalytic impact on central banks, in terms of their willingness to develop digital currencies.

In the West, this culminated in the Bank of International Settlements publishing a report on foundational principles and core features for central bank digital currencies in October.

But the People’s Bank of China has a multi-year headstart in rolling out a digital currency electronic payment project in China.

China has been field-testing its digital yuan via a series of lotteries, which have been heavily oversubscribed and will only continue to accelerate.

This project has immense systemic significance, both domestically and internationally.

In October, it attracted the attention of the Australian Strategic Policy Institute, a pre-eminent right-leaning think tank, with close ties to the US Department of Defence.

Its report detailed the profound domestic implications, in terms of payment technologies and surveillance, and concluded that a successful national digital currency could “greatly expand the party-state’s ability to monitor and shape economic behaviour well beyond the borders of the People’s Republic of China”.

Without diminishing the scholarship involved, it is no coincidence, in our view, that this report was funded by a grant from Facebook.

With Western central banks still many years away from being able to deploy a central bank digital currency, and with Facebook’s active global user base in the region of 2.7 billion, a strategic policy case can be made for Diem as a credible and preferred alternative to China’s national digital currency.

We have come full circle.

Different risks, different rules

Still, this does not make Diem a good idea in and of itself.

Indeed, the following criticism that defence analysts made of China’s digital currency could be said to apply to Diem via the Novi wallet: “It has the potential to create the world’s largest centralised repository of financial transactions data and ... would also create unprecedented opportunities for surveillance.“

This would be amplified in the event that Novi shares transaction history with Facebook, allowing digital and financial identities to be merged.

Facebook has said this would not occur without authorisation. But users may opt-in, and functions such as friend-finder may be used to constitute permission.

While Facebook is not the Communist Party of China, legitimate questions can and should be asked about whether a listed US company should have this power and influence.

For their part, the Swiss say the guiding principle is “same risks, same rules” – that is, if Diem poses bank-like risks, it will be subject to bank-like regulatory requirements.

That is necessary, but not sufficient.

If Diem gains widespread adoption, it will pose different risks than banks do, both in terms of vertical integration and the ongoing encroachment of big tech on the private domain of citizens.

Different rules, and new thinking, will be required to cope with this new era of digital currencies.