Although Facebook’s Diem stablecoin is risky, it is also part of the future financial system

According to reports, Facebook will launch its long-awaited digital currency as early as January 2021: a stable currency anchored to the US dollar. Since Facebook first announced its intentions in a white paper published in 2019, central banks and regulators have begun to take action. Their concerns are correct, because stablecoins, especially those that may produce large-scale network effects, such as Diem, have brought new risks to consumers and savers and the global financial system.

But they can also bring huge benefits in terms of speed, efficiency and financial inclusion. In countries with unstable domestic currencies, they can be used as a store of value for savers, similar to the dollarization of many emerging market countries today. Well-structured stablecoins with appropriate legal, regulatory and governance controls can play a valuable role in the world economy and can bring the benefits of encryption technology to a new generation of users.

Diem, formerly known as Libra, is the most watched stable currency. Since Facebook announced its intentions in 2019, it has been under discussion. In fact, it is widely believed that Diem has promoted the so far tepid central bank digital currency research. Diem has also received great warnings from the global regulatory community. Since Facebook’s statement, they have been enacting strict regulations for stablecoins.

Why are regulators and central banks so worried about stablecoins? What are their functions?

A stablecoin is a cryptocurrency designed to stabilize its value relative to another asset, whether it is a legal tender, a basket of legal tender or a commodity. The idea is that by stabilizing its value, stablecoins can be used as a means of payment.

This is unattainable in earlier generations of crypto assets, such as Bitcoin (BTC). Bitcoin’s price movement last month shows that its volatility is still high.

Stablecoins are another matter entirely. In its essence, stablecoins are designed as a “value store”, which is the most important feature of currency, so stablecoins can be used as a means of payment.

Diem may also produce large-scale network effects. Facebook has 2.7 billion monthly active users, which means that Diem has the potential to become an instant “transaction medium” in most parts of the world.

Stable coins have risks. Secure wallet storage, good corporate governance and control, anti-money laundering, data protection, tax compliance, and network security are all well-known risks that must be managed. Stablecoins bring additional risks, especially to ensure that they are properly supported by the assets they are linked to, and that all necessary controls to manage these assets are in place.

Those stablecoins that have become global success stories have brought more challenges. If consumers and savers seek to hold stablecoins instead of their national currencies, this could have a profound impact on the existing financial system. Stable coins may even have an impact on a country’s monetary policy and ultimately affect its economic growth. This is why global regulators are so worried about stablecoins.

In October 2019, the Group of Seven nations issued a work report on stablecoins. While acknowledging the benefits of stablecoins in the form of “faster, cheaper and more inclusive” global payments, the report focuses on the legal, regulatory, and supervisory challenges brought about by this new innovation. The report emphasized the risks of “monetary policy”, “financial stability”, “international monetary system” and “fair competition”.

Regulators are currently working to resolve these issues. This fall, the European Commission launched a comprehensive legislation proposal for the regulation of crypto assets. Although the proposal covers all encrypted assets, it imposes particularly strict requirements on the issuers of “asset reference tokens” (stable coins), and even puts forward an issue of “important asset reference tokens” (global stablecoins) Stricter requirements. The UK Ministry of Finance plans to issue draft regulations on stablecoins and CBDC soon.

These regulations are welcome. Stable coins have the potential to improve the efficiency of the existing financial system by providing faster and cheaper payment methods, especially in cross-border remittances. They can also promote financial inclusion and provide a store of value for depositors in countries with unstable domestic currencies. As long as the structure is reasonable and the supervision is proper, stable currencies have the potential to bring cryptocurrencies to a new generation of users.

The upcoming approval of the Swiss regulator is the last link in Facebook’s launch of Diem as a payment method. The question now is when it will be launched, not whether it will be launched. For regional or national regulatory agencies that have not established a similar digital asset framework, time is pressing, and they risk their respective financial industries being left behind. This is the power of Diem’s ​​network effect.