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Facebook promises to make cross-border transactions “as easy as sending a message” with Libra. If this means that such transactions are literally as cheap as sending a message, this would indeed be a big advance over other international transfers, which typically flow through the banking system, with its outrageous foreign exchange transaction margins.
If Libra’s frictionless transactions hold up benefits for consumers, Libra might seem to promise nirvana for financial markets. Easy transactions between all players ought to lead to equilibrating arbitrage and full price discovery. In textbook jargon, financial markets should become perfectly efficient.
However, with a huge user base of 2.4 billions, Facebook’s project of launching a cryptocurrency has been greeted with skepticism, criticism and alarm. The social media giant has a reputation for pursuing its own commercial advantage and fold when it comes to ignoring privacy issues.
In Europe, Libra has not exactly been welcomed with open arms. According to an article on Bloomberg, the EU’s antitrust chief, Margrethe Vestager, said in an interview recently with Denmark’s finance industry union, Finansforbundet, that governments need to take things slow. The European Union’s antitrust chief says she’s taken the unusual step of scrutinizing Facebook’s planned cryptocurrency, because of the risk that Libra will lead to the creation of a new, entirely separate economy.
Libra and a separate economy
It should be noted that the EU commissioner opened an investigation into Facebook’s Libra project before, and has claimed that it may lead to anti-competitive behavior. Additionally, beincrypto points out that there are also concerns that Libra could create a separate economy online altogether. This economy could prove to be near impossible to regulate and might facilitate illicit transactions on a social network that currently supports billions of people. The potential for this to spiral out of control is, for regulators, a major concern.
Recall Facebook’s original motto: move fast and break things. As critics have rushed to point out, putting Facebook’s dominating ambition and erratic track record in policing its users together with the crucial infrastructure of global financial payments is a big risk. Red flags have been raised over everything from privacy and regulation to the vulnerability of such a big new financial network.
But one danger in particular needs to be highlighted that is at the core of the problem with the proposed Libra cryptocurrency, which would affect developing countries, especially mid-sized open economies in Asia with easily traded currencies.
For Facebook, and its partner companies, the logic is compelling. Smartphones are ubiquitous, even in poor countries. However, bank accounts are not. Typically less than half the population of emerging countries have a bank account. Therefore, if payments are made between two smartphones, life is made easier and new commercial opportunities open up, buying goods online or making international remittances is not an expensive challenge anymore.
It is important to note that Facebook is not the first to see this opportunity. Kenya’s M-Pesa pioneered the idea more than a decade ago, using the Vodafone mobile infrastructure, or the case of PayPal that used email to transfer money similar to how Blockbasis does for cryptocurrency. Moreover, cutting-edge innovators like Apple jumped at the opportunity, with Apple Pay or in China, with the congenial environment of a huge population with few bank accounts but many smartphones, was a fertile breeding ground for WeChat and Alipay. But if Facebook’s Libra currency entered the market it would have a huge competitive advantages, because they have the network externalities with a lot of connected customers.
So, what could possibly go wrong? Quite a lot, actually. As well as the general issues already raised by other commentators, Libra might lead to major financial instability for emerging economies, especially in the Asian region which is mostly more open to global financial flows than Africa or Latin America. The issue can occur when people can switch from their fiat money to a basket of stable currencies with a simple touch of their smartphones. Whenever there is a shiver of nervousness about the exchange rate, the public can move, collectively and cheaply, into Libra. In the perfect case, such flows would be self-correcting. As the public abandons its fiat currency holdings, the currency depreciates, creating the opportunity for arbitrageurs to support the now-undervalued currency. Such a trajectory could spiral out of control, making Libra the go-to currency for people around the world without proper access to bank accounts.
Libra and a global bank run
The effects of Libra could heavily affect people who generally have access to banks also. People in emerging countries predominantly hold cash and bank deposits because these are needed for everyday transactions. But if a depreciation seems imminent, shifting out of their fiat currencies into stable foreign currency would be best. What is rational for an individual resident, if mimicked by many others, would be a disaster for the country.
At present, this sort of widespread shift between currencies does not often occur on a massive scale, because there is substantial friction in international currency transactions. The spread between the buying and selling exchange rates for the general public is substantial. On top of this there are heavy transfer fees.
Fortuitously, so far we have been saved from the disastrous consequences of frictionless international currency flows by the prevailing inefficiencies and overcharging of the financial companies, augmented by the red-tape regulations covering Anti Money Laundering (AML) and Know Your Customer (KYC).
If Facebook offers frictionless international transactions to everyone, with the opportunity to put funds into a stable Libra, then the capital flow reverses which could easily turn into a full-blown economic crisis.
Exchange rates in emerging economies are not firmly anchored by farsighted analysis, well-founded expectations and stabilizing speculators. Instead, they are driven by waves of fluctuating sentiment. The disastrous 1997 Asian crisis is still remembered, with these memories refreshed by the 2013 taper tantrum. Middle-sized countries with floating exchange rates, such as Indonesia, Thailand and South Korea, are potentially particularly susceptible.
Libra poses multiple global challenges: to financial stability, the safety of the payments system, competition, data, and privacy. For emerging economies, a sensible response might be to “throw some sand in the wheels of international capital flows,” as economist James Tobin suggested almost half a century ago. One thing seems sure: in its venture into finance, Facebook cannot be given the sort unregulated free-for-all it has enjoyed so far.