Millions of Low-Income People Are Locked Out of The Financial System. More Big Tech Monopoly Power Is Not The Answer.

Saule T. Omarova

Introduction

Whether Facebook fashions itself as a neutral social platform, or as the solution to global poverty, might depend on the day’s headline news. Caught in the bind of simultaneously saving the world and staying out of it, Big Tech companies like Facebook have resorted to ever more creative ways to expand a monopolistic and extractive business model under the guise of corporate activism. 

In June 2019, Facebook took this business strategy to the next level by announcing plans to create its own private cryptocurrency, originally dubbed Libra, and later renamed Diem. Diem is designed as a special kind of digital currency, a “stablecoin” that holds its value and promises rapid movement of money around the globe.[1]On December 1, 2020, the Libra Association, the consortium of companies that planned to issue Libra, was renamed the Diem Association, and the coin itself was renamed Diem. For the sake of … Continue reading From the start, Facebook marketed its new stablecoin as an answer to the challenge of financial exclusion and the means of providing everyone in the world the ability to store and move money cheaply and conveniently.

No doubt, accessing the financial system is a real problem for millions of low-income people in the United States. Because many traditional banks have effectively stopped providing affordable deposit accounts to the poor, viewing them as unprofitable and high-risk customers, switching to digital currencies could potentially allow many disadvantaged people to participate in the financial system. For the broader population, digital technology could also cut the cost of banking services and increase the speed of money transfers, especially across national borders. In Treasury Secretary Janet Yellen’s words, it “could result in faster, safer and cheaper payments.”

But Facebook’s proposed remedy—a financial system controlled by private tech giants—is not the answer. Congress must act to ensure that the power of digital currency is used not to cement Big Tech’s already outsize influence, but to make the financial system truly inclusive and responsive to the needs of everyday people. As a starting point, Congress should pass legislation, such as the Stablecoin Tethering and Bank Licensing Enforcement (STABLE) Act, under which all stablecoin issuers would be regulated as banks. Moreover, Congress should use more assertive policy tools—such as introducing a public option for digital currency and payments —to address the legitimate need for safe, stable, and reliable banking services for those locked out of the traditional financial system. 

Stablecoins and the Promise of Digitization 

Digitization of money and payments is rapidly transforming financial markets. Since the emergence of Bitcoin in 2009, digital currencies have exploded onto the scene, with some estimating that there were nearly 5,000 cryptocurrencies (a term often used interchangeably with “digital currencies”) on the market by early 2021.

As the name implies, digital currencies are intended as an alternative form of money, sometimes competing with sovereign money like the U.S. dollar, the Euro, or the British pound. They offer their users the benefit of instantaneous payments around the clock, across borders, anonymously, and potentially at low cost. 

But despite their promise of superior speed and cost savings, digital currencies have not become an adequate replacement for sovereign money that is spent for everyday transactions. Today, most people use Bitcoin and other cryptocurrencies as investments rather than actual money. Because private cryptocurrencies are not backed by a sovereign government, the value of any privately issued cryptocurrency depends on people’s willingness to transact in it. That makes cryptocurrencies inherently volatile. And volatile assets are not good money substitutes.

Stablecoins emerged as the crypto-market’s solution to this volatility problem. A stablecoin is a type of digital asset whose value is tied directly to the value of some other financial asset—most commonly, a sovereign currency like the U.S. dollar or Euro. Stablecoins—such as Tether, USD Coin, or Paxos standard—are designed to mirror the value and reliability of traditional money while also being free to move separately from it. 

Typically, the issuer of a stablecoin achieves this pegging to traditional money by setting up a “reserve” to hold the “reference asset” backing it. For example, the reserve might be a traditional bank account in which the issuer deposits the equivalent value in U.S. dollars as collateral for the stablecoins it distributes. Theoretically, in this arrangement, every single unit of the stablecoin could be easily exchanged for the corresponding amount of U.S. dollars.

In practice, however, stablecoins are not always tied to traditional, government-backed currency, which means that they vary widely in their features, function, and reliability. An individual coin’s price stability depends on the type of reference asset and the reserving method. For example, some stablecoins are backed by other privately issued, volatile digital assets, including other stablecoins, rather than sovereign money. These arrangements can sometimes become complex, with elaborate and opaque formulas dictating the relationship between the stablecoin’s value and that of its reference asset. Furthermore, without regulatory guardrails, some stablecoin issuers might miscalculate riskiness, or even knowingly misrepresent the composition or value of the assets backing their coins. 

The Diem Project: A Recipe for Financial Inclusion?

Facebook went public with the plan to issue its own stablecoin in June 2019. Technically, the new currency would be issued by the Diem Association, a consortium of corporations brought together by Facebook and based in Switzerland. From the outset, Diem was promoted as a service that would benefit the billions of people locked out of the financial system. As David Marcus, the Head of F2 (Facebook Financial), said at the time, “there’s 1.7 billion people around the world that are unbanked, the same number are underserved by financial services. Now, anyone with a cheap smartphone has access to all the info they want in the world for free with a basic data plan. Why doesn’t money work the same way?”

Marcus was pointing out a real problem. In 2019, nearly a quarter of adults in America were unbanked or underbanked—effectively priced out of the basic bank deposit and payments services. Without access to bank accounts, people often resort to alternatives like prepaid cards, which may carry excessive fees and  lack the credit-building benefits of traditional credit cards. Underbanked people cannot receive direct deposits from employers, which forces them to pay exorbitant fees to predatory check-cashing businesses and at remote ATM machines. Even with access to basic bank accounts, Americans pay high fees for wiring money, especially to foreign countries, as well as overdraft fees that can quickly add up to ruin many consumers’ credit. As always, these multiple fees and charges disproportionately hurt the most vulnerable members of our communities. In short, for poor and low-income people, the financial system is more often a source of exploitative extraction rather than convenience.  

Facebook’s Diem promised to remedy all of these problems. With just a smartphone—and, crucially, a Facebook-owned application—any user, banked or unbanked, could easily and instantly move money to other individuals, or make purchases using a digital wallet hosted by Facebook or another provider. 

This decentralized structure, however, drew immediate criticism from a wide array of U.S. lawmakers and regulators, wary of Diem’s potential to undermine consumer privacy, financial stability, and the nation’s monetary sovereignty. Diem’s critics questioned Facebook’s use of its tremendous market power, its methods of managing Diem’s value, and its ability to prevent money laundering and other illicit uses of the Diem network. The strong backlash caused many corporate partners to exit the Diem Association, threatening the project’s viability and forcing Facebook to rethink its original plans. 

Facebook unveiled a revised version of the plan in April 2020. This iteration was designed to show that Facebook was not really seeking to issue its own global currency but is, much more modestly, trying to build a better cross-border payments network. In other words, Facebook claimed Diem would compete with PayPal, not the Federal Reserve.[2]Diem is designed as a double-layered stablecoin system. The first layer comprises several single-currency Diem Coins, fully backed on a 1 to 1 basis by individual sovereign currencies (starting with … Continue reading 

The new plan has several key features. The Diem blockchain will be developed and operated by Diem Networks, the Diem Association’s subsidiary. Members of the Association—Facebook and its corporate partners—will validate all transactions on this blockchain. A select number of Designated Dealers will buy Diem Coin directly from Diem Networks, for further distribution to various retail payment service providers—Virtual Asset Service Providers (VASPs)—and digital wallets. These customer-facing payment service providers—including Facebook’s own digital wallet, Novi—will be responsible for compliance with anti-money-laundering regulations, even though not all of these providers will be regulated financial institutions. 

In emphasizing the accessibility of Diem, the revamped Diem Association doubled down on its potential to serve underbanked people: “Today, people with less money pay more for financial services. Hard-earned income is eroded by fees, from remittances and wire costs to overdraft and ATM charges. Blockchains have a number of unique properties that can potentially address some of the problems of accessibility and trustworthiness.” 

There are, however, several important reasons to doubt that Diem would deliver on these promises.

The Dark Side of Diem: Why Should We Worry?

In Facebook’s narrative, the Diem project is an inclusive, accessible, and efficient payment system—a true public good. But benevolence is not Facebook’s business model. In reality, Diem is a combination of private global cryptocurrency and a cross-border payments network, effectively controlled by a profit-seeking Big Tech company and integrated into its suite of global social-media and data-management business lines. This unprecedented structural alignment raises significant questions about the Diem project’s actual, as opposed to publicly proclaimed, purposes and potential implications. 

Financial Risk to Users

Diem is not a full equivalent of the sovereign money backing it. The ability of Diem users to redeem their Diem Coins for the underlying sovereign currency on a strict 1-to-1 basis depends fundamentally on the business practices of Diem Networks (the issuer and manager of the Diem Reserve), Designated Dealers (the wholesale distributors), and VASPs (the retail distributors). What these practices will look like in real life remains an open question.

The Diem Association’s White Paper does not specify exactly how Designated Dealers will mark up the price of Diem Coins they sell to VASPs, who then sell them to the end users. These middlemen can unilaterally and non-transparently vary the premium that retail customers will have to pay for the convenience of using Diem Coins. Multi-currency LBR, the layer of Diem that is constructed out of single-currency Diem Coins and facilitates cross-border payments, is particularly susceptible to this type of hidden overpricing. The result is both ironic and troubling. Without clear legal and regulatory constraints on the behavior of Diem distributors, the same underserved people whose woes Facebook used as a marketing tool could end up paying high hidden fees for access to Diem. This is an especially disturbing prospect if Diem becomes a widely used currency.

It is also not clear how safely the Diem Reserve will be managed. According to the White Paper, the sovereign money raised from ongoing sales of Diem will be invested in cash and cash equivalents, including short-term government bonds and “safe” money market instruments. But this mixed reserve composition means that the value of Diem Coins may actually fluctuate in response to changes in the market value of these securities. And because the interest generated by these reserve assets will presumably benefit the Diem Association members, there is a built-in incentive for raising the overall riskiness and potential volatility of the Diem Reserve portfolio.

Furthermore, VASPs and digital wallets do not simply move money but also store customer balances, effectively functioning as uninsured deposits (in contrast to traditional bank accounts that are insured by the FDIC). This exposes Diem users to serious risk of loss in the event of a major financial or operational failure, cybersecurity attack, fraud, or bankruptcy of individual VASPs or wallet providers. Any such disruption may trigger a run on the Diem Reserve, with everyone rushing to convert their Diem coins back into the underlying currencies. Although the White Paper points to the creation of a “loss-absorbing capital buffer” and emergency “redemption stays,” it is unclear how this protection against runs would work in practice.

Data Privacy

Diem is not simply another payments platform, it is a complex ecosystem of multiple platforms linked to Facebook’s social media empire. This takes the already well-known problems of widespread data privacy violations by Facebook and other Big Tech companies to a qualitatively new level. Facebook and its corporate partners in the Diem Association will have constant direct access to the financial and transactional data generated by all Diem users. These private companies will be able to monitor individual users’ spending, earning, and investing patterns in real time. There is little doubt that this trove of financial data will be harvested and commercialized in ways that could be both deeply invasive and impossible to opt out of. In effect, acting through Novi and Diem Networks, Facebook will be able to conduct seamlessly integrated commercial surveillance of billions of people. 

Abuse of Market Power

Privacy issues are closely related to concerns about the excessive accumulation and abuse of market power by Facebook and its partners. It is hardly surprising that Facebook deliberately downplays its dominant role in the Diem Association. However, Facebook is likely to have outsize influence within the Diem club. In fact, Diem’s success as a global stablecoin is directly tied to its ability to reach—that is, be actively marketed to—Facebook’s 2.8 billion active social media users.

Control of a widely used digital currency will, in turn, give Facebook a crucial advantage in expanding its business operations across many commercial and financial market lines. In addition to offering Novi wallets, Facebook’s numerous subsidiaries and affiliates will be well situated to roll out Diem-denominated loans, insurance and investment products, payroll management services, credit reporting and rating services, and so forth. In effect, Facebook may become the one-stop shop for billions of people interacting with one another in multiple economic and social contexts.

This unprecedented level of corporate power invites abuse. Put simply, Facebook will be able to suppress competition and coerce people into economic transactions that benefit Facebook and its partners. For example, individuals’ access to the Diem payments system may be implicitly or explicitly conditioned on their purchasing of other commercial or financial goods or services offered by Facebook, its affiliates, and partners. Availability and pricing of financial products and services within the Diem ecosystem can also depend on some form of social scoring maintained by Facebook or its partners, which could become a tremendous lever of power over people’s lives and livelihoods.

The Diem plan also raises the distinct specter of predatory pricing and predatory inclusion, whereby “financial institutions offer needed services to specific classes of users, but on exploitative terms that limit or eliminate their long-term benefits,” according to Americans for Financial Reform. These are only a few potential examples of such abusive conduct.

Systemic Risk

If Diem grows as large as Facebook plans for it to be (and as its current user base suggests it would), it could also come to threaten systemic financial stability. The issuance of Diem will enable the rise of a complex institutional ecosystem with a wide variety of Diem-denominated financial products and services offered by unregulated or lightly regulated entities. Built on top of one of the world’s biggest tech platforms, this “shadow” financial system could easily reach the scale and scope that requires a public backstop. If the majority of Americans come to depend on Diem for their daily financial needs, or if their 401(k) funds are heavily exposed to Diem-denominated assets, then any significant turbulence in the Diem ecosystem could trigger a federal bailout, potentially on an unprecedented scale. This would effectively make Facebook an entirely new breed of financial institution that is “too big to fail.” 

Even in the absence of a major crisis, the Diem network could well replicate the dysfunctional dynamics of the existing shadow banking sector. Although the 1-to-1 backing of Diem Coin is said to prevent new money creation, the Diem Reserve is functionally similar to money market mutual funds (MMMFs) that issue securities with guaranteed stable value and invest in short-term debt instruments. As financial regulators continue to assess how to contain the well-known systemically destabilizing impact of MMMFs, the Diem network could elevate this problem to new heights.

Looking Forward: How Should Policymakers Respond to the Rise of Stablecoins?

The Diem strategy illustrates not only potential risks associated with the growth of stablecoins, but also the difficulty of regulating them effectively. To begin with, Diem’s global reach raises thorny jurisdictional issues. Organized in Switzerland, the Diem Association aims to be licensed and regulated by the Swiss Financial Market Supervisory Authority. Yet, its operations will also have to be subject to direct oversight by the national authorities in jurisdictions where Diem circulates. 

In the U.S. context, defining the precise contours of such oversight is a complex exercise. Because of the many facets and uses of Diem, it could theoretically be characterized as foreign currency, mutual fund shares, deposits, commodities, derivatives, and so on. Accordingly, the Diem Association can potentially be regulated as a money service business, a mutual fund, a bank, or a financial market utility, just to name a few possible designations. Depending on the applicable regime, participants in the Diem ecosystem may thus be regulated at the state level or at the federal level by the U.S. Treasury’s FinCEN unit, the Securities and Exchange Commission, the Commodity Futures Trading Commission, or the multiple federal banking agencies. In addition to these specialized regulatory schemes, the Diem network will also be subject to generally applicable laws and regulations, including antitrust and consumer protection laws administered and enforced by the Federal Trade Commission and the Consumer Financial Protection Bureau, respectively. 

It remains unclear which, if any, of these regulatory regimes will govern various segments of the vast and complex Diem ecosystem.

Facebook’s high profile and controversial history make this a highly politically salient issue. Launching Diem would clear the path for other Big Tech companies to enter, and potentially overtake, the U.S. financial services markets. Not surprisingly, Facebook’s Diem project catalyzed legislative attempts to prevent that from happening. 

On Dec. 2, 2020, a group of House Democrats led by Rep. Rashida Tlaib introduced the STABLE Act. The Act would require every issuer of a stablecoin to obtain a bank charter and be fully subject to the U.S. bank regulation and supervision regime. To protect end users from financial risk and predatory inclusion, the proposal would mandate that all stablecoin issuers fully guarantee the stability and full on-demand convertibility of their coins into U.S. dollars, by either obtaining FDIC insurance or maintaining reserves at the Federal Reserve. By imposing these requirements, the STABLE Act could deter Facebook and other Big Tech companies from issuing their own stablecoins. That’s because, under U.S. banking laws, any company that owns or controls a U.S. bank is required to register with the Federal Reserve as a “bank holding company” (BHC) and is generally prohibited from conducting any commercial, or nonfinancial, activities. No Big Tech conglomerate would risk becoming a regulated BHC and, as a result, having to divest its core businesses. 

However, restricting stablecoin issuance to regulated banks may not be enough to keep Big Tech in check. For instance, a Big Tech giant could partner with banks authorized to issue stablecoins for use in the Big Tech firm-dominated financial ecosystem. Big Tech conglomerates’ enormous market power will ultimately assure de facto dominance over any such business arrangement. More broadly, the STABLE Act would not address significant risks to financial stability and market integrity posed by stablecoins issued by the U.S. mega-banks, such as JPM Coin issued by JPMorgan. Although JPM Coin has not attracted nearly as much publicity as Diem, JPMorgan’s plans to expand its proprietary stablecoin network to retail payments implicate many of the same concerns. 

Ultimately, any large-scale private stablecoin platform backed by the U.S. dollar could threaten the federal government’s control of the nation’s monetary and financial health. The most direct and effective response to the rise of private stablecoins is simply to pre-empt the field by eliminating the need for an extra, private layer on top of existing public money. To achieve this, the Federal Reserve can and should either speed up the implementation of the fully operational and comprehensive real-time payments system, or start issuing the U.S. dollar in digital form—or both. 

To address the problem of financial exclusion and to ensure equal access to core banking services, Congress should consider several options. For example, Congress could authorize the Federal Reserve to offer free digital-dollar deposit accounts to all Americans. Creating this type of a fully public option for digital currency and payments should render private stablecoins, including Diem, largely superfluous. It would also create the basis for the Federal Reserve to work with other central banks on setting up a cross-border “fast payments” system. That would solve the problem of slow and inefficient cross-border payments, which private stablecoins promise to optimize. Many central banks across the world are already actively exploring, researching, or piloting their own “central bank digital currencies” (CBDC), and Congress should encourage and facilitate these efforts in the United States. 

 Conclusion

The rise of stablecoins—including Facebook’s Diem—underscores both the need to ensure universal access to affordable and fast payments services, and the failure of existing institutions to meet that need. It is crucial, however, that the American public understands the risks that large-scale private stablecoin networks like Diem pose to consumers and, more broadly, to the integrity and stability of the nation’s financial system. 

Financial exclusion is not a problem born of inadequate technology; it is a public policy problem ultimately rooted in the unequal distribution of wealth and power in our society. Commercial banks, while subsidized and regulated by the federal government, are driven by profit considerations and have little incentive to provide services to low-income individuals. It would be naive to expect that Big Tech, another profit-driven enterprise with even less oversight, would solve this problem. In fact, as with many fringe financial services, there are many reasons to think that it might make things worse for all of us.

Creating an inclusive, fast, safe, and affordable financial system—including a payments infrastructure—is a vital public policy goal that will require the attention and dedication of Congress and multiple federal agencies. That goal, rather than false narratives perpetuated by savvy Big Tech behemoths, should guide our collective search for a more accessible, equitable, and efficient financial system.

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Millions of Low-Income People Are Locked Out of The Financial System. More Big Tech Monopoly Power Is Not The Answer.