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January 3, 2021

Diem and the economy

Opinion

January 3, 2021

The Facebook Diem is a cryptocurrency that Facebook announced on June 18, 2019. The project was announced by CEO Mark Zuckerberg, but its creators are actually Morgan Beller (staff at Facebook blockchain division), David Marcus and Kevin Weil (Novi’s Vice President of product).

The original plan for the proposed cryptocurrency was to create a stable coin that would be backed by a basket of assets (currencies like the Euro, Singapore dollar, US dollar, Pound sterling), but in November 2020, according to a report by The Financial Times, Facebook announced that it would be launching the project with a slimmed-down plan that includes the currency being backed one-for-one by the US dollar as opposed to its original plan to back it up against major currencies.

After losing a few of its founding members, the Facebook Diem Association currently has 27 members after being joined by a few others. Facebook also announced that each of its members would inject an initial deposit of $10 million so that the cryptocurrency has ‘full asset backing’ on its launch. On December 1, 2020, the originally titled Facebook Libra currency adopted a new name in a bid to reinforce its ‘organizational independence’ as the project seeks approval from the regulators. The proposed token, as well as its Association will now be known as Diem, according to a media release.

Since Facebook announced its cryptocurrency in mid-2019, it has met with criticism and opposition from central banks and world financial regulators. The employment of a private cryptocurrency as a legal tender has been questioned. Much of this criticism has come from the European Union regulatory response and US regulators. A few minutes after the announcement of the project, French Finance Minister Bruno Le Maire, who was on an interview on a French radio station, gave his response to the introduction of the Diem cryptocurrency (then known as Libra). He said he believed that the cryptocurrency could not be allowed to become a sovereign currency. He also spoke on matters regarding money laundering, privacy and terrorism finance.

The new cryptocurrency proposed by Facebook could affect the global economy in many ways. Since the cryptocurrency hasn’t been officially launched yet, only speculations by financial analysts and regulators have been made. It’s more possible for Diem to inflict a currency crisis on a country rather than go through one itself. The introduction and use of Diem could cause a downward surge in the currency of countries experiencing a currency fall already. In third world countries where local currencies are not stable, it is normal for them to run to more stable currencies and short their local currency. As confidence falls and the economy faces headwinds, the citizens of these countries will most likely use Diem to save money and make transactions. This will further worse the downward spiral and lead to an eventual economic collapse.

The accessibility and stability of Diem makes it appealing, but also makes it a threat to sovereignty globally. Another area of concern is that interest rates might be lowered as the interest rates are normally pulled by the major currencies, which means Diem would most likely affect interest rates if it becomes a widely preferred option for transactions.

Diem is meant to be a medium of exchange and transactions, as proposed by the Facebook Diem Association. Although Bitcoin had initially made an attempt to become a platform for making transactions, it has become more of an investment platform. While Bitcoin has no backing which makes it volatile, Diem has been speculated to be backed against the USD, which will make it more stable than other cryptocurrencies.

Currently, Facebook Diem is not in use as it is still in development, trying to meet the standards of global regulators. However, with its powerful backing, it is certain to be employed all over the world for transaction through Facebook and WhatsApp messengers, as well as a proposed standalone app. The Facebook Diem currency will be used to make transactions as easily as sending a message on Facebook social media apps. It will employ almost zero fees and will be faster and well available to people who don't have bank accounts. Facebook has also mentioned that the user address will not be linked to his/her Facebook Data, making it very secure and convenient.

Being cheap remains one of its biggest advantages as it charges zero fees on transactions. It’s also good for developing countries where quite many people don’t have access to bank accounts, as they could easily make transactions through Diem. Also, it would be useful for making cross-border payments.

There is currently no known effect of Diem on developing economies. However, there have been speculations regarding its effects – by studying the general economic structure of developing countries. Since Diem is not managed by the government nor restricted to a specific geographic area, it could provide low-cost money transfers and business transactions. However, the adverse effect is that it could also make it easier to transfer money from illegal activities and to fund terrorism activities without government interception.

Studies have also proven that financial inclusion is paramount for a developing country like Pakistan, Argentina and others. Because most people in developing countries do not have easy access to financial services, they are excluded from worldwide trade. Introducing Diem to the economy of developing countries could enable financial inclusion and help citizens gain access to financial services without having to go to the bank to make transactions.

The main benefit to the developing economies is protection from unstable currencies. Developing countries have a volatile domestic currency so citizens will look to store their savings in a currency other than their local currency. However, even with these benefits, there might be a macroeconomic impact on the economies of many developing countries. For example, it could lead to an increase in interest rates and also depreciate the exchange rate.

The writer is director of the Centre for Information and Communication Technology at IBA.

Email: [email protected]

Twitter: @imranbatada.