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Private Digital Currencies and the Promise of Global Financial Inclusion

Graduate Research Trainee Aliénor Burghartz traces recent developments in private digital currencies and argues that it is vital to develop a comprehensive regulatory framework for stablecoins in view of the broader goal of modernizing payment systems and improving financial inclusion.

Although cryptocurrency is still far from fulfilling its promise of financial liberty and global financial inclusion, there is no end in sight to a continuing market presence if not proliferation of cryptocurrency. A substantial part of the more recent rise in the overall cryptocurrency market capitalization has been due to increasing investor interest in stablecoins, which are cryptocurrencies that attempt to peg their market value to some external reference.

Stablecoins and, more specifically, so-called “global stablecoins” face – especially since Facebook's June 2019 announcement to launch "a simple global currency" – increasing regulatory scrutiny by both national and international financial regulatory bodies. While it is in general good news that they take an increasingly active interest in stablecoins given their significant systemic risks, it is vital to develop a comprehensive regulatory framework for stablecoins in view of the broader goal of modernizing payment systems and improving financial inclusion.

Cryptocurrency’s Promise of Global Financial Inclusion

Cryptocurrency has been praised for its potential to lead to a new era of global financial inclusion by giving people access to banking that were hitherto prevented from opening and benefitting from a bank account. It is believed by many to simplify the financial services infrastructure worldwide by offering an alternative financial and technological infrastructure that is global, open source, and accessible to everyone who has access to the internet. The term cryptocurrency refers to digital or virtual currency in which transactions are verified and records maintained by a decentralized system using cryptography. While traditional fiat currencies are legal tender that are backed by a government (instead of any commodity) and controlled by a central bank, cryptocurrency refers to a “distributed” global currency that is backed neither by reserves nor by the reputation of a well-established institution. Lower transaction fees, speedier processing, easier cross-border transfers, and the possibility to conduct transactions for un- and under-banked people are regularly named as main advantages of cryptocurrency.

According to the World Bank, providing access to useful financial products and services that meet the needs of individuals and businesses can serve as a key enabler of poverty reduction and boost prosperity, given that close to one third of adults (1.7 billion people) are still unbanked, according to the 2017 Global Findex Database. As reported by a 2016 McKinsey Global Institute study, the widespread use of digital finance (financial services delivered over digital infrastructure, including cryptocurrency) could boost the annual GDP of all emerging economies by $3.7 trillion. Pursuant to the World Economic Forum’s Global Future Council on Cryptocurrencies, “blockchain technology and the cryptocurrencies that use it are creating open, democratic financial systems”, hence we should, according to the Council, all participate, and technology leaders should foster their experience with these innovations as “cryptocurrencies transform how we trade, transact, and interact online”.

Is Cryptocurrency Money?

To this day, however, cryptocurrency’s speculative and risky nature, its uses in cybercrime and the dark web, as well as its environmental impacts rather than its alleged quality as a broadly accessible general-purpose medium of exchange and – alleged – enabler of financial inclusion led to its high profile. More than a decade after the introduction of bitcoin in 2009 as the world’s first and today largest cryptocurrency, cryptocurrencies used as a means of payment – as opposed to speculative trading – play only a marginal role in normal (not illegal) economic activity. Whether cryptocurrency should thus be seen as money at all (or rather just as an asset in which people are speculating) is currently controversial. Especially given cryptocurrencies’ extraordinary, but unsurprising price volatility, leading economists argue that they are actually not well designed to fulfil any of the three functions that are traditionally attributed to money – a unit of account, store of value, or means of payment.

Whether a particular cryptocurrency could be accommodated as money under a specific national law, is in general subject to that cryptocurrency’s features and to whether these features meet the requirements set out by the relevant currency legislation and case law. Canadian currency legislation does neither define “money” nor “legal tender” (cf. s. 8(1) of the Currency Act). While specific statues may focus on national sovereign currency (cf. s. 8(1) and 13 of the Currency Act; s. 1(1) of the Ontario Personal Property Security Act), there is also a solid line of case law which, by reference to the above-mentioned classic functions of money, holds that money may be privately issued. While cryptocurrency is thus still far from being generally recognized as money (not to mention legal tender) under Canadian law, the legal situation in El Salvador – the world’s first country to adopt bitcoin as legal tender – has recently changed dramatically. By using his control of the country’s legislative assembly and courts, president Nayib Bukele imposed bitcoin, against almost universal opposition from the country’s population, to become the second official currency, next to the US dollar, in September 2021. This move triggered the country’s biggest street demonstration in years and was widely seen to have prompted the International Monetary Fund, in its October 2021 Global Financial Stability Report, to warn against the significant macro-financial risks that the Fund sees associated with the current “cryptoization” in emerging market and development economies.

The Uncertain Fate of Global Stablecoins

Although cryptocurrency is still far from fulfilling its promise of financial liberty and global financial inclusion, there is no end in sight to a continuing market presence if not proliferation of cryptocurrency. The overall cryptocurrency market capitalization nearly tripled in 2021 to $2.55 trillion by early May 2021. This spectacular ascent was soon followed by a 40 percent fall later the same month primarily due to a Chinese government crackdown on banks’ use of cryptocurrencies and tweets from Tesla’s Elon Musk to no longer accept bitcoin as payment out of a concern over “rapidly increasing use of fossil fuels for bitcoin mining”. Nevertheless, at the beginning of this month, the overall cryptocurrency market capitalization reached an all-time high of $2.86 trillion.

A substantial part of the more recent rise in market capitalization has been due to increasing investor interest in so-called stablecoins, which have emerged since 2014 in order to bring more confidence into the cryptocurrency marketplace. A stablecoin is a cryptocurrency that aims at maintaining a stable value relative to a specified asset (or pool of assets). Stablecoins are normally backed by either commodity, fiat, or other cryptocurrencies. As such, stablecoins are expected to offer both the security, anonymity, and decentralized features of cryptocurrency and the low volatility of traditional fiat currency. So-called “global stablecoins” – stablecoins with a potential reach and adoption across multiple jurisdictions as they can build on existing large, cross-border user bases to scale rapidly and achieve substantial (global) volume – have attracted a great deal of attention.

In particular, Facebook’s June 2019 announcement to launch “a simple global currency” within a year, a stablecoin called Libra (now Diem), attracted wide attention, given its potential to shake up the world’s banking system. Facebook is today a digital platform with close to 3 billion monthly active users worldwide. The company, which recently renamed itself to Meta, explained in a public statement that it hoped to use its comparative advantage to take digital currency mainstream. The declared goal was to improve cross-border transactions and provide a payment network for billions of unbanked people. The Libra, as a strictly digital token, was to be backed by a basket of currencies issued by countries with a reputation for stability and reliable central bank backstopping (US dollar, Euro, Singapore dollar, and Japanese yen). In an effort, however, to attain independence from sovereign monetary powers, the Libra itself would be issued by an association incorporated in Switzerland, hence by an entity outside any of those countries’ jurisdictions.

Unsurprisingly, the regulatory backlash was immediate: National authorities quickly united against the Libra project. The G7’s working group on global stablecoins concluded that, in particular, global stablecoins carry systemic risks. And the Financial Stability Board, which in 2009 succeeded the Financial Stability Forum and functions as an international negotiation and policy platform for financial regulatory matters and counts the G20 among its members, launched a review of existing regulatory frameworks and began to coordinate the response to Libra and other aspiring global stablecoin arrangements. In light of this backlash, Facebook had to back out: The Libra Association (now Diem Association) lost important members (Mastercard, Visa, and PayPal). Facebook had to give up its own engagement with the association to mitigate market and political concerns, and its rebranding of Libra to Diem may be facing a copyright infringement lawsuit. In May 2021, Diem dropped plans to secure a payment license from the Swiss Financial Market Supervisory Authority (FINMA) and announced its relocation from Switzerland to the United States as well as a partnership with the crypto-friendly Silvergate Capital Corporation to issue the Diem US-dollar backed stablecoin. As Columbia Law School professor, Katharina Pistor, observed, Facebook’s failure to launch a global digital currency and payment system bears analogies to the Holy Roman emperor Henry IVs infamous trek 1077 to Pope Gregory VII in Canossa, illustrating that both emperors and Zuckerbergs have discovered that it was risky business to reach for monetary sovereignty, “the crown jewel of sovereignty”.

Regulating Stablecoins is Part of a Changing Global Banking Landscape

Given the rapid growth in market capitalization of stablecoins and their potential impact on financial systems, stablecoins face continuing regulatory scrutiny. Among other leading central banks, the U.S. Federal Reserve recently called for a comprehensive regulatory framework for stablecoins, and the Fed Chair Jerome Powell said during a congressional hearing in July 2021 that “you wouldn’t need stablecoins, you wouldn’t need cryptocurrencies if you had a digital U.S. currency”. In September 2021, China’s top regulators announced comprehensive measures against cryptocurrencies (not least because China is gradually rolling-out its state-backed digital yuan): nine institutions, including the Ministry of State Security, the Supreme People’s Court, and the People’s Bank of China (which publicly announced that the new rules are necessary to maintain national security and social stability), jointly declared that all business activities related to cryptocurrencies are illegal; even foreign crypto exchanges are no longer allowed to offer services to residents in China. In October 2021, the International Organization of Securities Commissions (IOSCO) held that (systemically important) stablecoins should be regulated as financial market infrastructure alongside payment systems and clearing houses.

While it is in general good news that financial regulators take an increasingly active interest in stablecoins with view to their significant systemic risks, it is important to stress that regulating stablecoins is not just about avoiding destabilizing runs that could erode financial stability. Regulators must simultaneously address operational resilience standards, standards on disclosure and protection of customer information as well as digital currencies’ environmental impact while trying to articulate the larger goal of modernizing payment systems and improving financial inclusion. Providing access to digital money, also for low-income people which are particularly burdened by slow and expensive payments, is key here. Since private innovation is – despite increasing efforts on central bank digital currencies – likely to play a crucial role in providing such access, it is vital to establish a comprehensive regulatory framework for stablecoins through collaboration among and beyond financial regulatory bodies, both nationally and internationally. All this is, of course, very challenging. But after all, it might be precisely these new forms of digital “money” that get us, lawyers, to include in our work a perspective which recognizes money as an institution that links politics and the economy, state and civil society.

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