Over the past few years the rise of "Fintech" (financial technology) has had a profound impact across the globe.
The exponential growth of the Fintech sector has largely been fuelled by the rapid rate at which new technology is evolving but also by the strong consumer appetite for innovation in all aspects of financial services
Some of the most advanced examples of Fintech innovation can be found within the payments and money remittance space. The development and use of cryptocurrencies and blockchain is often the segment of Fintech that attracts the most headlines. This is particularly so after some of the largest tech giants have recently sought to enter the scene.
Here we address the potential for digital currencies, such as Facebook's newly proposed Libra coin, to facilitate cheaper and faster cross-border money transfers. We also address the challenges that Libra and other digital currencies are likely to face before they begin to make a more widespread impact.
The Libra coin
Facebook's plan to launch Libra, a new global digital currency built on an open-source blockchain, with a payment system embedded into its messaging services, poses the significant and immediate question of how deeply Libra and other digital currencies like it might transform the traditional financial services and payments industry.
If realised, Facebook's vision could mean the disintermediation of banks and other payment providers by Libra, through enabling instant, near-free international money transfers for Facebook's 2.4bn users from their mobile phones. Aside from cross-border payments, the widespread use of e-money like Libra could have broader implications for online commerce. The creation of Calibra, the payment service which Facebook aims to integrate into its messaging service, could be used for micropayments between customers, potentially bringing a new way for users to interact with digital content and make digital purchases.
When Facebook first announced its plans to launch Libra earlier this summer it was reportedly being backed by over 27 partners, including payments companies, e-commerce groups and venture capital companies, such as Visa, MasterCard, PayPal, eBay, Lyft and Spotify.
It was intended that these companies would together form the independent consortium, the Libra Association, which would govern the network and also provide the financial capital to kick-start the project.
It was proposed that Libra would be backed by a pool of currencies and assets around the world, with a view to providing a stable and safe store of value, effectively setting it apart from other cryptocurrencies like Bitcoin, Ripple or Ethereum, known for their price volatility
Whether Facebook will achieve its audacious plans to launch its own digital currency remains to be seen. Over the past month the mission has gone awry. At least seven high profile partners have dramatically withdrawn from the project, including PayPal, eBay, Visa and MasterCard, citing regulatory uncertainty.
The departure of these high-profile financial firms and mainstream companies may cause damage to the project's credibility or, at the very least, delay the launch.
The main challenges for Facebook and any other companies entering into this space are seen as two-fold: regulation and adoption. Libra continues to cause a storm of inquiries and warnings from regulators in the U.S., as well as in the UK and Europe.
Aside from the regulatory and procedural issues faced by Facebook in setting up a network to move money around the world, including anti-money laundering checks, Libra may have wide-reaching implications for the structure of the financial services system.
Regulators and bankers alike are worried about the harmful potential of the Libra coin:
- Will Libra be used as a vehicle for money laundering?
- Is Libra a threat to global financial stability?
- Is Libra open to data privacy abuse?
- Will Libra strip nations of control of their monetary policy?
These concerns, amongst others, led to regulators in the G7 nations creating a working group to examine the risks of such currencies to the financial system.
Consequently, earlier this month, the G7 group warned that digital currencies, such as Libra, "pose challenges for competition and anti-trust policies" and should not be allowed to launch until all of the legal, regulatory and oversight challenges and risks are adequately addressed.
In the U.S., there have also been hearings by the Senate Banking Committee to understand how the currency works. Mark Zuckerberg appeared before the U.S. House of Representatives recently and faced some tough questions over many things, including data privacy.
What is eminently clear is that Facebook and the Libra Association will need to work closely with regulators across the globe if they wish to overcome the many regulatory concerns.
In addition, Libra faces the perpetual challenge that other cryptocurrencies face: namely, the adoption of blockchain and cryptocurrencies at scale to make a practical business case for their mainstream use. In particular, there is the difficulty of convincing merchants to agree to accept payment in the form of a digital coin whose value would fluctuate against the local currency of the assets used to back it.
That said, overcoming this hurdle could potentially signal a new era in which digital currencies become the predominant medium of exchange.
Cross-border payments and remittances
Decentralisation in financial services through technologyenabled innovation is not a new phenomenon, nor is the idea that distributed ledger technology is capable of transforming many facets of finance, such as retail and wholesale payments, trade finance, capital markets, lending and insurance.
The impact on financial services is likely to be particularly hard-felt in the payments industry, given the potential application of blockchain technology to the settlement of interbank payments and remittances.
This is particularly so given the inefficiencies, slow speed and high cost of the current banking system.
If counterparties were to exchange digital currencies rather than fiat currencies, that is, without having to go through a central regulating body like a bank, payments could be made and settled in a matter of minutes, if not seconds, via blockchain. Moreover, the distributed nature of blockchain would mean that a digital record of payments would exist that is both transparent and immutable.
Some initiatives that leverage distributed ledger technology, of course, already exist. Ripple, for instance, connects financial institutions and payment providers via their own global payments network and enable transactions using fiat currency or Ripple's own XRP cryptocurrency.
Similarly, central banks and other financial institutions that have previously lagged behind the curve are showing signs of increasing blockchain adoption and a readiness to engage with the new era of digital currencies. For example, thirteen of the world's biggest banks are preparing to launch digital versions of major global currencies in 2020
Despite the upsurge of blockchain-based payments solutions, there remain significant barriers to adoption at scale. One issue is that the transparent nature of blockchain means there are limitations to anonymity in scenarios where sensitive or private data is involved. In response, several companies are exploring the "tokenization" of sensitive data to preserve anonymity
Another challenge is the inevitable friction caused by the conversion of crypto assets and fiat currencies, particularly given the inherent volatility of cryptocurrencies.
This is, however, where Libra is perhaps different and could (if successfully launched) raise the credibility of cryptocurrencies. The proposal is to create a digital currency that is fully backed by a reserve of real-world assets which would effectively minimise volatility, although would not entirely eliminate it, given that the value of Libra would inevitably fluctuate as the value of the underlying assets moved.
The future of cryptocurrencies
Despite Facebook's recent set-back, Libra still draws support for its potential to revolutionise finance ―if it can satisfy the regulatory and other concerns being raised.
It has been widely acknowledged that Libra represents a significant step forward in the process of extending financial inclusion and reducing payments' friction, which have been the aim of many entrepreneurial minds for decades.
We must wait to see whether Libra becomes the global currency and de facto money transfer standard that it aspires to be and, importantly, what final form it takes when it is ultimately launched next year, if it is launched at all.
Notwithstanding this, Libra has already succeeded in focussing the minds of policymakers and regulators around the globe and boosting awareness and the adoption and development of cryptocurrencies and security tokens more broadly. This may still serve as a watershed moment for digital currencies.
Insurers should carefully watch this space to see whether Libra does become the digital currency that brings cryptocurrencies to the masses.
As we discussed in our previous article ( Cryptocurrencies - to insure or not to insure?), insurance demands are only likely to increase as the crypto and blockchain markets continue to mature. It will be interesting to see whether insurers' appetites to write crypto-related risks expand as and when the industry and regulation become more stable.
1. The substance of the article was first discussed in the Jusletter IT Journal and has been updated accordingly (https://jusletter-it.weblaw.ch/en/issues/2019/26-September-2019/ facebook-s-libra--wa_1ce3575e35.html__ONCE&login=false).