Diem could not Seize the Day

Netta Korin
Netta Korin

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3 months ago

blog

In January of 2022 it was reported that the Diem Association was negotiating the sale of its IP assets, most likely, as a way to repay capital to its investors. The deal was ultimately signed on January 27, 2022, with Diem reportedly agreeing to sell its assets to Silvergate Bank for $200 million.

A quick recap, Diem was launched as the Libra Association in 2019. The leading force behind it was Meta (then, Facebook), who gathered additional 20 giants from the payment, telecom, technology, blockchain, non-profit and venture capital industries as founding members. The goal of this project was to revolutionize global financial services by launching a new stablecoin backed by a basket of currencies and securities, and powered by a newly Facebook-created blockchain protocol. The announcement created quite the buzz. Not surprisingly, it did not take long for financial regulators around the world to realize what was going on and fight it.

Within a few months of the launch announcement, Zuckerberg was subpoenaed to testify at the US Congress, and ended up admitting that Facebook would be "forced to leave" the project's governance organization, unless US policymakers approved the new currency. Later on, as some partners left the project it was rebranded as Diem, however, more importantly it readjusted its goals - instead of launching a brand new global stablecoin, launching multiple stablecoins (e.g., Libra-USD and Libra-EUR). In addition, it rebranded the Calibra (a Libra/Diem founding member) digital wallet to Novi, as the project's core product. Last October plans changed once again, as Novi was planned to launch only in the US and Guatemala, supporting Paxos' USD-backed stablecoin (USDP) with Coinbase as the custodian.

The recent joint report on stablecoins, by a working group that included all of the major US financial regulators, may have been the last nail in Diem's coffin. In a nutshell, the report recommends that all stablecoin issuers should be required to register as financial institutions and comply with US regulations accordingly, meaning - must maintain adequate deposits and adhere to risk management standards. Anyone who doesn't meet these requirements will be barred from stablecoin issuance.

One can only imagine what would have been the global effects had this ambitious project initiative materialized according to its original plan. Let us examine a few:

Even though Facebook/Meta was only a founding member of Diem, it was undoubtedly the driving force behind the project. Its global reach could have potentially made it one of the world's largest financial institutions. Integrating a digital wallet into Facebook, whether desktop or mobile, would have meant that on Day 1 this wallet would have billions of users who already have it installed and ready for use on their devices. Furthermore, it would have been available in a closed technological environment users trust and spend hours a day in. Moreover, as practically every place of business, big or small, is on Facebook, the perfect marketplace for the new integrated currency is there. I dare guess that it would not have taken long before the new currency was used in real life as well, starting with the small coffee shop around the corner and later accepted by all large retailers. In that case, Meta (sorry, Diem) would have turned into a large global non-governmental central bank.

The direct result of the above might have been a severe user privacy concern. As the new payment platform would have gained more and more traction, attracting more service providers in a virtuous (or perhaps vicious?) cycle, Facebook would have gained even a deeper level of insights on users actions, preferences and even intents. Not surprisingly, Meta had obviously been aware of this concern, and in its Novi pilot version announcement last October addressed it, stating that: "We know privacy is top of mind for Novi customers, so it will always be top of mind for us. We prioritize the security and privacy of people's information by encrypting sensitive financial information". Try not to laugh when you read that, I know.

In addition, there would have been an interesting macroeconomic effect on global foreign exchange markets. The Diem was supposed to be backed by a basket of currencies and securities, hence there would probably have been an immediate effect on many of both, depending on whether they were included in this basket or not. Assuming the token had become more and more popular, so would the demand for those currencies and securities have grown. Of course, the opposite goes for those that would not have been included.

It is rare that I advocate for government involvement in private business initiatives. However, perhaps in this particular case which instigated the failure of Diem, our privacy became a bit more secure.

It is also possible that the failure of Diem actually opens up the possibility that we can get a more nuanced and appropriate form of regulation for stablecoins down the road. The proposal by the Joint Working Group suffers from a lack of creativity - the only approach considered in detail is to expand the current standard approaches of banking regulation to apply to stablecoin issuers and related entities as well. The report does not consider whether new regulatory approaches might be possible that achieve the same goals, but with different methods that leverage the blockchain technology on which stablecoins are built.

Luckily, as the report fully admits, the proposal cannot be implemented without new legislation by the Congress. This means that the agencies in charge cannot simply dictate that the approach laid out in the report must be followed. Instead, there will be a legislative process in which the blockchain community can have a voice. If lawmakers are willing to listen, the end result could be something better for everyone involved than what was proposed in the November report.

Diem and Meta being out of the picture can only help with this process. Fairly or unfairly, Facebook/Meta is not politically popular on either side of the aisle. The left blames this company for allegedly facilitating misinformation which they claim led to the loss of Hillary Clinton during the presidential election. Conservatives claim that it favors the left and censors them. Having Diem, driven by Facebook/Meta, as the face of stablecoins was not a good recipe for an open-minded hearing from the US Congress. Maybe Diem's failure will end up removing this political baggage and ultimately allow us all to seize a better day.

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