It sounds like a gift from the stars. Imagine one single global currency with no FX risk, round-the-clock liquidity management, one bank account (or perhaps none), virtually no costs and significantly less regulation – a treasurer’s dream. Too good to be true? Perhaps not. On 18 June, Facebook announced such a digital currency with the potential to deliver on such a dream.
Facebook has transformed many areas of our lives, changing the way we interact and communicate. After acquiring Instagram and WhatsApp, the social media giant is attempting to shake up another part of our lives: financial services.
With the unfulfilled promise of bitcoin and its own failed foray into payments in 2015, just why would Facebook decide to launch its own cryptocurrency, and why would consumers want to use it?
Like many treasurers I suspect, I have paid little attention to cryptocurrencies, dismissing them as simply a fad.[1] When bitcoin crashed in 2018 after a period of unsustainable growth, my initial thoughts regarding cryptocurrencies appeared justified.
According to some parts of the media, bitcoin has indeed been a total disaster. It does not fulfil one of the most important criteria required of a global currency: to maintain a relatively stable value. Having lost 73% of its value in 2018, rebounding significantly in 2019, bitcoin appeals mainly to speculators rather than showing the potential to become a stable global currency. Its administration is decentralised, with no one individual or company holding overall control. New money continues to be generated. These features make bitcoin almost impossible to govern.
While, like many, I was initially sceptical, Libra already has important differences. Lessons have clearly been learned from the bitcoin story. Unlike traditional currencies, Libra is digital, designed to cross borders almost instantaneously (much like a text message) and 15 times faster than a bitcoin transaction. Blockchain technology will underpin its security, as it does for other cryptocurrencies. Levels of take-up could be high if all of Facebook’s 2.4 billion users decide to adopt it.
What is more, Facebook has a huge funding base, massive resources and the determination to ensure the currency’s success. It also has significant support from other high-profile and powerful global companies including Visa, Spotify, Uber and Vodafone, ensuring its liquidity and reach.
Additionally, Libra will be a so-called ‘stable coin’; its value will be pegged to other stable currencies, such as the dollar and the euro, as well as relatively safe assets such as government bonds, which provide protection from inflation. Bitcoin and other cryptocurrencies are not backed by cash or government bonds. Libra, however, will be backed up by a reserve fund, the majority of which will consist of stable government bonds, thus limiting the currency’s volatility. Consumers and businesses will be able to cash-in their local currency into the Libra Reserve and get out a freshly minted Libra of equivalent value. This limits the growth of Libra by the value of the subscriptions by Libra’s partners.
Given these strengths compared to bitcoin and differences to other cryptocurrencies, treasurers will need to be aware of Libra and the potential benefits and risks of using the digital currency as part of their operations.
Decisions regarding Libra’s administration will be made by the Libra Association, a private company resident in Switzerland formed by Facebook and its partners. Facebook has stated it will be independent of the Association, holding just 1% of the voting power, a response to the recent misuse of customer data and other misdemeanours Facebook has been accused of in recent times, as well as general concerns around data privacy.
There are benefits to using Libra as a global digital currency… but also significant risks. Digital currencies, despite a shaky start, have the potential to make a positive change to the world. One of the biggest potential benefits from Libra will be for people residing in unstable emerging markets.
Libra has the potential to give people and businesses in emerging markets access to a basket of stable currencies and assets, moving away from local and often volatile currencies. It may offer protection for wages and assets from snowballing inflation and allow many more people, currently locked out, to enter the financial system.
Corporates could also benefit: moving liquidity across borders should be easier with invested assets held in emerging countries valued in a stable currency; transaction costs and other fees for moving money could be done away with and transaction delays almost eradicated; and FX management could eventually become obsolete, significantly reducing transaction costs and uncertainty.
Despite these benefits, there are significant risks and genuine concerns, a threat to the stability of the financial system being the main risk or systemic risk. If enough people and corporates use the new currency then governments and central banks will lose some of their ability to control monetary policy and to impose capital controls, effectively decentralising power over their monetary policy to a private company in Switzerland.
This would signal a huge shift of power from public, accountable institutions such as the US Federal Reserve and European Central Bank to private sector organisations.
In times of economic stress, these institutions will have reduced power to act decisively and significantly either to stimulate or cool the local economy if there is a significant amount of currency in the financial system they have little or no control over.
Also, commercial banks may become vulnerable to solvency risk if a significant amount of deposits were swapped for Libra. Bank balance sheets could also be hit by the purchase of safe assets, such as government bonds, by the Libra Association reserve fund. They would then have to shrink their lending, potentially negatively impacting the credit markets and the general health of the local and global economy.
Finally, bank revenues would shrink if lucrative revenues from cross-border payments, domestic clearing and multinational bank accounts were severely reduced along with FX margins. Facebook has stated that cross-border payments will cost virtually nothing, but the new currency will not yield interest. In that respect, at least, it will not be dissimilar to many bank deposits!
Governments and treasurers should not underestimate the benefits of a stable global currency, which Libra is vying to be. As stated, the free flow of liquidity across borders at little or no cost, stable asset prices and ease of use are just some of the many benefits of using a stable cryptocurrency.
However, to ensure the risk to the financial system is minimised, central banks, regulators and institutions, such as the UK’s Financial Conduct Authority and the International Monetary Fund, will need to address the following:
If governments and regulators fail to watch closely, significant harm could be done to the financial system. Indeed, only days following the announcement, we saw significant resistance from politicians, activists and bankers – testifying to both the potential Facebook has to make a success of Libra and the known and unknown risks posed by the new digital currency.
If Libra is a success, with proper controls and regulation, Facebook could develop a host of other banking services, which treasurers may want to take advantage of given the global reach of the social media giant. Transaction costs could be significantly reduced and liquidity management streamlined. Imagine the benefits of using just one currency for global operations. I think we are some way off that, currently.
Treasurers will need to stay informed on the potential impact of Libra on their liquidity, FX and risk-management processes, both the risks and the benefits. If Libra is a success, we could witness a major change in the financial landscape not seen since the rise of the internet and smartphones.
Treasurers may then experience one small snag from such success: what would we actually do?
Joe Scattergood is a fellow of the ACT and a chartered accountant
[1] Other cryptocurrencies in the digital currency market include Ethereum (Ether) and Ripple (XRP). Created for different purposes and each appealing to different markets and industries, they do share some of the main characteristics of bitcoin. They are underpinned by blockchain and they have so far appealed mainly to speculators.