Facebook's cryptocurrency ratchets up pressure on banks, but has big risks

Facebook's plans to launch its own cryptocurrency and digital wallet should be a clarion call to commercial banks: if you don't begin to explore blockchain technology, tech companies could eat your lunch.

Worldwide, blockchain-derived business value is forecast to grow from $9 billion this year to $50 billion in 2022, according to Gartner. The greatest growth between now and 2050 is expected to take place in 2020, when Facebook plans to launch its Libra coin and Calibra digital wallet; that year alone will see a 128% annual increase in business value.

Clifford Rossi, a finance professor at the University of Maryland's Robert H. Smith School of Business, said Facebook's entry into the banking marketplace puts added  pressure on commercial banks at a time when they are already scrambling to learn how to compete against nimbler, tech-savvy fintech companies.

"Given what their ambitions might be, I might start referring to them as Facebook Bank," Rossi said.

This isn't the first time Facebook has attempted to enter the financial services industry. Several years ago, it launched its own credit card; after a significant marketing campaign, the effort fizzled with little uptake, Rossi said. Libra coin, however, is a different animal. For one, Facebook has wrangled partner support from dozens of major corporations, including financial services providers such as Visa and Mastercard.

"This makes sense from the standpoint that our payments processing capabilities over the past 50 years are inefficient and they're also fairly costly when you think about the charges. If you look at Visa and Mastercard and even retailers who have to pay interchange fees [from banks], they'll tell you there has to be a better way," Rossi said. "So, I get what Facebook is trying to do.

A game-changer for the banking industry?

Blockchain represents a better way in many aspects. For example, blockchain financial networks disintermediate central banks and payment, clearing and settlement houses that charge fees and slow the processing of transactions.

Libra will likely impact banks and most financial services organizations, as well as retailers, as the planned cryptocurrency creates a payment system outside the central banking structure, Rossi said.

"Banks and their IT departments, many of which had a wait-and-see approach regarding digital currencies, will need to begin planning how they react or proactively address more widespread use of cryptocurrencies," Rossi said.

The securities marketplace may also be affected if Facebook's crypto catches on. In theory, public blockchains with fiat-backed cryptocurrencies can more efficiently buy stocks and bonds, sans clearing house.

"If that happens, it's a game-changer for banking because they currently have tight hold on all things capital markets transactions related," Rossi said. "But I'm also wary. It poses a lot of risk to many different parts of the financial and non-financial community."

For example, cryptocurrency exchanges have had a real history, albeit a short one, of hacks that have resulted in the loss of millions of dollars to investors. And if a global payment network such as SWIFT can be hacked, then no financial network is 100% secure, Rossi said.

And, while Libra may be based on low-volatility assets - the cash in your bank account - it is susceptible to foreign exchange fluctuation, meaning your crypto may not be worth tomorrow what it is today. Additionally, there's little to no regulation of cryptocurrencies; they're not insured by the FDIC, for example, or overseen by the Federal Reserve Bank, something Rossi believes needs to happen in the future.

Facebook may already be preparing for regulatory oversight. Jerome Powell, chairman of the U.S. Federal Reserve, said Wednesday that Facebook met with the central bank in the run-up to unveiling its Libra plans, according to a report by cryptocurrency exchange Coindesk.

"You know Facebook, I believe, has made quite broad rounds around the world with regulators, supervisors and lots of people to discuss their plans and that certainly includes us," Powell said during a news conference.

The initial launch of Libra is on a permissioned blockchain network governed by the Libra Association - Facebook's business parners - which effectively replace central banking authority with a consortium of corporate players, with Facebook playing a major role.

While Powell noted the potential benefits of Facebook's cryptocurrency for consumers and others, he also pointed out potential risks, a concern echoed by others.

"This is cause for regulatory concern, but regulators are not likely to move fast enough to do anything meaningful to stop it," said Avivah Litan, a vice president of research at Gartner.

EU regulators and U.S. legislators are pushing back against Facebook's new Libra project, Litan said, because they worry that Facebook, whom they already don't trust, will have too much control over a new global currency.

"Libra's network will be regulated in terms of onboarding customers, currency reserves (backing Libra), and for money laundering. In addition, regulators likely will come up with regulatory reporting requirements," Litan said in a blog. "In some sense, Libra is very similar to PayPal, but it's built on a blockchain and is therefore called a cryptocurrency."

Rossi agreed there are significant risks.

"While Facebook looks to tap a new reservoir of customer data, their spotty track record of late in protecting sensitive personal information provides further proof that the tech giants should face tighter regulatory scrutiny. Linkages between cryptocurrencies and cyber-risk are not well understood at this point," Rossi said.

"The cryptocurrency revolution is here, and so are its risks. Beware."

A trust problem

While some would  argue cryptocurrency is about trust in that it takes a village of users to verify any transaction and every transaction is unchangeable, Facebook is anything but trustworthy in the eyes of consumers. The revelation last year that data analysis firm Cambridge Analytica acquired personal information on tens of millions of Facebook users without permission saw trust in the social network plunge drastically, according to polls.

To address potential issues, Facebook said its Libra cryptocurrency platform will be governed by a non-profit consortium of dozens of third-party businesses, including potential competitors such as PayPal, Mastercard and Visa. Facebook also created Libra Networks, a Geneva-based subsidiary, to run the cryptocurrency platform's operations. Facebook said it will also not mix user social media information and their financial data and it will not have access to the latter.

That may not be enough.

"Unfortunately, [the] Facebook brand is already at the center of a long history of mistrust events that have to be taken into account when estimating its potential to succeed as the first large-scale used cryptocurrency," Jean-Marc Seigneur, director of the Certificate of Advanced Studies (CAS) on Blockchain, DLT and dApps Development at the University of Geneva, said in a blog post.

To estimate the trust people have in Facebook, Seigneur conducted an online poll of 2100 Americans and 2100 French citizens. Seigneur's poll was not focused solely on  Facebook; it included the world's largest internet technology companies such as  Google, Amazon, Facebook, Apple and Microsoft (GAFAM).

Amazon came out of the survey with the highest level of trust among Americans: 45% of respondents completely trusted it and only 9% didn't. Thirty-five percent neither trusted nor distrusted Amazon. The remaining 11% didn't understand the question.

Facebook fared far worse. Only 11% of those surveyed said they trusted Facebook while 35% indicated they didn't trust it at all. Forty-five percent indicated they neither trusted nor distrusted the social network and the remaining 9% said they didn't understand the question. Among French respondents, Facebook didn't far any better: 13% indicated they trusted it and 43% said they distrusted it. Twenty-nine percent neither trusted nor distrusted Facebook and 15% said they didn't understand the question.

"Only Bitcoin is less trusted than Facebook. It is worth noting that between 2017 and 2019, trust in Bitcoin has decreased noticeably from 8% to 6%," Seigneur said, referring to earlier online surveys he conducted on bitcoin trust. Facebook has still the main advantage of being the only [among] GAFAM who is releasing its coin."

"People have no other GAFAM coin choice," Seigneur continued. "Amazon coin would undoubtedly win the social trust aspect, but it doesn't exist. When people have no choice, they choose what is available. The other GAFAM should try to release their crypto-currency at the same time as Facebook, especially Amazon, which is in a leading position."

Facebook targets developing nations

Facebook has made it clear it intends to target developing nations where people have little or no access to banking services, according to Gartner. In fact, 40% of the world's overall population has no active bank accounts, though they do have easy access to a mobile phone, according Gartner's Litan.

Libra coin is expected to achieve significant adoption by consumers in those nations as it is backed by fiat-currency similar to the World Bank/IMF SDR currency, which proved very useful as a stable currency for making loans to developing poorer economies, Litan said.

"Libra is the first digital global currency that will potentially be used by billions of users around the world. If successful, it will likely take significant amounts of money out of the bank depository systems into the Libra network, and may also be used for large fund movements that banks have no visibility into," Litan said via email. "This means banks will earn much less revenue on bank and payment fees, interest income, and more."