Libra vs. Governments: The race towards an inclusive global payment infrastructure
Franz v. Weizsäcker, Uta Meier-Hahn, Lars Wannemacher
Disclaimer: You will find exploratory thoughts in this blog. This is not a place to look for governmental positions. The Blockchain Lab is an experimental outfit within Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH at the intersection of research, start-ups, and development practitioners.
The race is on: The Libra consortium is developing a global payment infrastructure based on an asset-backed stablecoin, the Libra. The People’s Bank of China rushed to announce its digital version of the yuan, intending to defend sovereignty in response to Libra. Similarly, the German government — as outlined in its German Blockchain Strategy — would like to prevent stablecoins like Libra to compete with national currencies, yet it speaks in favour of an electronic version of the euro.
This article argues that financial inclusion can greatly benefit from openness and competition in global payment infrastructures. Libra may not be the solution, but it acts as a catalyst towards interoperable payment architectures. While reducing rent extraction, this may ultimately result in the international streamlining of regulatory approaches towards deposit insurance, know your customer (KYC), anti-money laundering (AML) rules.
At first glance, Libra looks like a boon for financial inclusion
Today the financial sector continues to disadvantage the world’s poorest populations in multiple ways. To highlight just a few: Globally, 1.7 billion people remain unbanked, leaving them devoid of access to essential services such as receiving wage deposits or a credit. Migrant workers spend about $30 billion annually in remittance fees, i.e. a rough 6% of the $529 billion they send to family members overseas. Even saving money can be difficult. From Argentina to Zimbabwe, wealthy savers are managing to store their assets abroad or in foreign currencies, while the middle class suffers from an implicit tax on their savings through high inflation rates. Saving money can be hard, but acquiring loans may be much harder. As many developing countries lack reliable credit information systems, loans end up being unavailable or too costly with interest rates of up to 55% per year. In 2019, we still have a long way to go to reach a decent level of financial inclusion in the world.
Here the announcement and promises of Facebook’s Libra come in: a cryptocoin to be issued by a Swiss-based consortium, and collateralised by a low-risk investment portfolio. Readily available to Facebook’s 2.7 billion users, Libra could reduce the unbanked population overnight — with a mere App update disseminated by Google and Apple’s app stores. It promises to reduce remittance fees to near zero and, for savers, a stable Libra coin would pose a convenient alternative to inflation-prone national currencies. Even for loans, Libra’s digital payment system holds a promise. Data collected across mobile phones could serve as a basis for credit scoring, possibly shrinking interest rates, and making loans affordable to the many. With such amazing opportunities within reach, who could possibly argue against Libra?
What makes people so sceptical?
As expected, the incumbents of the financial industry feel threatened by Libra. As a global payment infrastructure, it would provide fertile grounds for competition. A plethora of services could be built as plug-in services within the open application programming interface (API) of Libra’s ecosystem. This lowers market entry barriers. We can imagine new fintech startups offering services to its retail customers within days, because they can easily plug together several white-label banking services such as payment, KYC, insurance and loans that come as part of the Libra ecosystem. Beyond retail banking, the open Libra ecosystem may result in strong competition for the incumbent oligopoly for international clearing and settlement — a market currently dominated by the likes of Swift, Visa, and Clearstream. By unbundling banking services within an open-ecosystem approach, Libra would lower switching cost of retail and wholesale banking services, and thereby squeeze the rent-extraction potentials of well-guarded intermediary roles, resulting, among others, in lower remittance fees.
The criticism by privacy and human rights advocates was similarly unsurprising. Libra could set a precedent in a global convergence of money and speech, where censorship on the social network could lead to people simultaneously being locked out of a global payment system. What’s more, who would entrust sensitive financial data to companies like scandal-ridden Facebook that built their business model on selling personal data for advertising purposes? The ongoing debate provides plenty more detail on what could go wrong. To not reiterate what has sufficiently been said, here we focus on the drivers for financial inclusion. In the provision of digital financial services, personal data fulfils two important functions: the scheme called “know your customer” (KYC) and credit scoring. KYC describes the regulative demand for retail financial services to prove the identities of their customers, e.g. to fight money laundering. For the 1 billion people worldwide who are lacking official proof of identity, financial inclusion would become more achievable if regulators accepted a phone number, selfie or social media profile like Facebook. We could imagine KYC-services and credit-scoring services on top of Libra’s architecture. Given the wealth of data Facebook holds on its users, this is where Facebook’s Calibra wallet would have its competitive edge.
Governmental sovereignty concerns go far beyond KYC and AML regimes. Looking at the lessons of the 2008 financial crisis, regulators’ goal is to avoid a potential taxpayer-financed bail out of private risk taking. Libra would be exactly that, a systemic risk, with an implicit responsibility of governments to provide bail out in case the Libra consortium’s investment portfolio turns sour — a run on the Libra starts, and millions of people’s savings, plus their ability to use Libra’s payment infrastructure would be at stake. From the perspective of Libra’s retail user, that risk could be mitigated if any Libra wallet came with a deposit insurance, or alternatively, if Libra would constitute an exchange-traded fund (ETF) of the underlying assets. Both options are currently not part of Libra’s concept, and therefore regulators remain sceptical for good reason.
Governments are racing to issue CBDCs — and that’s a good thing
China and Sweden might have been working on it for several years, but since Libra’s announcement, the US and Eurozone also started calling for a central bank digital currency (CBDC). This includes Germany’s Blockchain Strategy that speaks against Libra, and in favour of the e-euro. Such digital forms of existing fiat currencies may, if properly implemented, deliver upon many of Libra’s promises, while avoiding the systemic risks that come along with the current concept of Libra. The CBDC infrastructure established by central banks would avoid transaction costs. Ideally, it would provide an open interoperability framework enabling the competition of modular services and thus reduce fees like those for remittances. We could imagine a standardised interface (API) to comply with KYC and AML regulations. With the backing of a major player like the European Central Bank or the People’s Bank of China, this API could set a standard on how wholesale banking services, retail services and regulatory functions interact with each other.
Even if Libra may not succeed in seeing the light of day, the idea of a global open ecosystem around payment services may survive. This could bring the much-needed competition to reduce remittance fees, as well as getting more people banked thanks to widely recognised identification services.
Overall, we welcome that Libra sparked this long-overdue debate. To develop a solution that works for the benefit of the people, however, we will need to include the perspective of various stakeholders. From financial regulators, banks and fintechs, from privacy advocates, consumer protection and competition policy experts — a proper solution for central bank digital currencies may turn out to be a multi-stakeholder process. This process should include technical standard setting, the defining of a regulatory technology solution to interface with national regulators, an interface for retail payment-service providers, and an interface for identity or KYC providers. While monetary policy works best in a centralised, expert-driven and mostly independent body such as the European Central Bank, the success of a global payment architecture of a CBDC may benefit from a more inclusive multi-stakeholder governance.