Facebook's Big Diem

Plus: Chinese Consumer Lending, Bank Cost of Capital, Policy Trade-Offs

Welcome to another issue of Net Interest, my newsletter on financial sector themes. If you’re new here, thanks for signing up. Every Friday I go deep on a topic of interest in the sector and highlight a few other trending themes below. If you have any feedback, reply to the email – I’d love to hear from you. And if you like what you’re reading, please spread the word.

Facebook's Big Diem

In case you didn’t hear, this week the price of Bitcoin went through $50,000.

It’s been on quite a journey since breaking out of a white paper in 2008. At the beginning it was touted as a currency, a new medium for facilitating commerce. “Electronic cash,” Satoshi said. People still talk about that time Laszlo Hanyecz bought two Papa John’s pizzas for 10,000 bitcoin – “like maybe two large ones so I have some left over for the next day.” (Ouch.)

In the early days, the goal of pioneers in the space was to get Bitcoin accepted by merchants as a medium of payment. Soon after its launch as a Bitcoin wallet, Coinbase began signing them up. By October 2014 it had ten $1 billion businesses plugged into its systems ready and willing to accept the new currency. 

Yet as a payment device, it didn’t really take off. Transactions were slow and the price of Bitcoin was too volatile. Bitcoin morphed from a cryptocurrency to a crypto asset, reinventing itself as an alternative to gold. 

Having survived its ups and downs and lived to tell the tale, its status as a commodity is likely secure. More fluid is the space it vacated in payments; that space remains a battleground. One contender there is Facebook. 


In mid 2019, Facebook picked up the baton Bitcoin dropped with a splashy announcement to launch a cryptocurrency called Libra. Libra was all about payments. “What we’re trying to do with Libra [is] rethink what a modern infrastructure for the financial system would be if you started it today rather than 50 years ago on a lot of outdated systems,” said Mark Zuckerberg. 

Libra was marketed as a scheme to provide access to financial services for people around the world, in particular those in underdeveloped countries where mobile phone penetration is higher than banking penetration (a billion people in the world have one but not the other). Libra aimed to squeeze down the cost of global money movement. “The idea behind Libra is that sending money should be as easy and secure as sending a message. Libra will be a global payment system.” 

Rather than pursue the “closed loop” model of payments, where Facebook controls the platform, the company chose to corral support for a new open network. It recruited 28 organisations from different industries to form the Libra Association. The association would be a not-for-profit in the mould that Dee Hock first envisioned when he set up Visa over sixty years ago. And just as Bank of America agreed to seed Visa in anticipation of capturing a small piece of a larger, open network, Facebook thought the same about Libra. It would sit on top of the network with its wallet Calibra, now called Novi, in the same way Bank of America cards sit on top of the Visa network. In a typical $100 card transaction today, Visa may take a $0.15 fee but the entity that has the attention of the consumer – the issuer – takes $2.00; that’s where the money is. 

Libra designed its technology to be faster than Bitcoin, promising 1,000 transactions per second compared with Bitcoin’s seven. Not as fast as Visa, but that’s the trade off: efficiency versus trust. Rather than have a single party maintain the transaction ledger, Libra would distribute it over its association members. By spreading trust out over multiple parties, Facebook was offering something traditional, centralised banking wasn’t; but by restricting maintenance to a consortium of ‘validators’, the process could be more efficient than Bitcoin, whose ledger is public. 

The instrument of payment that Libra would deploy across its rails was a new currency, the Libra, whose value would be linked to a basket of traditional currencies. One Libra would be worth some mix of dollars, euros and pounds. Not as volatile as Bitcoin then, so a user could be confident their purchasing power wouldn’t swing wildly between pizza nights.

But this is where policymakers started to get jumpy. They started to worry that if payments and financial transactions shift over to the Libra, they might lose control over their domestic monetary policy, all the more so if their currency isn’t represented in the basket. They worried too about the governance of the Libra Association and about its compliance framework. Perhaps if any other company had been behind it, they would have dismissed the threat, but they’d learned not to underestimate Facebook. 

Through Libra, Facebook was bringing to life policymakers’ fears, as forewarned by Dee Hock, the founder of Visa, when he envisioned the power of electronic value transfer many years earlier:

Any institution that could move, manipulate, and guarantee alphanumeric data in the form of arranged energy in a manner that individuals customarily used and relied upon as a measure of equivalent value and medium of exchange was a bank… Inherent in all this might be the genesis of a new form of global currency. If electronic technology continued to advance, and that seemed certain, two-hundred year old banking oligopolies controlling the custody, loan, and exchange of money would be irrecoverably shattered. Nation-state monopolies on the issuance and control of currency would erode.

Policymakers didn’t hang around. They warned off many of Libra’s founding members and co-ordinated their response at the highest level: “The G7 continues to maintain that no global stablecoin project should begin operation until it adequately addresses relevant legal, regulatory, and oversight requirements through appropriate design and by adhering to applicable standards.”


Facebook was forced back to the drawing board. Last December it renamed Libra the Diem Association and removed itself to the wings. Diem differs from Libra in a number of key respects. First, it will issue single currency coins rather than just a basket. So there’ll be a Diem Dollar and a Diem Euro and a Diem Pound and so on; Diem will sit on top of existing currencies rather than seek to replace them. (Although it will still offer a Diem composite which will behave like a kind of ETF of the underlying single currency coins.)

Second, Diem has dropped its original ideal of one day going ‘permissionless’ – of allowing anyone to access the network, as they can with Blockchain. Regulators were concerned that free access would compromise the integrity of the financial system. Instead, validation of the ledger will be restricted to members of the association, although Diem anticipates creating a competitive market for membership. Many years earlier at Visa, Dee Hock had retained the same ideal, which he too had to drop. 

Wrack my brain and twist Old Monkey’s tail as I might, I could devise no way to include cardholders and merchants as owner/members of the system. They should have been, for they are certainly relevant and affected parties… Thoughts of including merchants and cardholders as equitable owners of the system had to be set aside, since everyone was already pushed to the limits of their ability to accept change…

Third, Diem is seeking robust regulatory oversight. In order to guarantee the value of a Diem Dollar, the association needs to back it with an actual Dollar. Diem has indicated that the actual Dollar reserves it accumulates will be invested in cash and short term government securities. This shouldn’t pose credit risk, but it does create market risk and liquidity risk of the kind that a money market fund faces. 

It’s a risk policymakers are keen to contain. History is littered with examples of entities seduced by the attraction of earning just that little more on the funds they maintain. A conflict arises between coin holders, who want to retain the value of their coin, and intermediaries, who want to maximise returns. 

The Bank of Amsterdam, active in the 17th and 18th centuries, provides a cautionary case study as one of the earliest issuers of Diem-like ‘stablecoins’. It was feted by Adam Smith in his Wealth of Nations of 1776: “For every guilder, circulated as bank money, there is a correspondent guilder in gold or silver to be found in the treasure of the bank.”

Rather than wallets, the Bank of Amsterdam used cashiers to provide retail clients with services; and rather than validators, it used a central ledger, copies of which were made twice per year. A set of four reigning burgomasters on annual terms, “visits the treasure, compares it with the books, receives it upon oath, and delivers it over, with the same awful solemnity, to the set which succeeds; and in that sober and religious country oaths are not yet disregarded.”

In 1776, the Bank of Amsterdam’s assets consisted almost entirely of gold and silver coins. But over subsequent years, as war waged between the Dutch Republic and Great Britain, the bank began making loans at scale, in particular to the Dutch East India Company. Confidence in the bank eroded, a series of runs followed and by the beginning of the 19th century the Bank of Amsterdam was insolvent.

Various protections are available today to keep bank treasurers in check. The Swiss financial regulator, from whom Diem is seeking authorisation, will require Diem to retain capital on par with levels it requires of banks. Diem also promises complete transparency around the composition of its reserves. 


Diem had been expected to launch in January but it still awaits regulatory approval. Questions persist around its governance – the association’s membership lost a lot of quality when initial members fled – and how compliance will be managed. A particular challenge is how to preserve the integrity of the reserve downstream – at the wallet level – where payment providers may be tempted to diverge from 1:1 backing even if that’s not endorsed at the network level. 

Facebook’s continued involvement may also be an issue. German finance minister Olaf Scholz said recently, “a wolf in sheep’s clothing is still a wolf.” And that was before the Australia row and the associated backlash from policymakers elsewhere in the world.

One thing Libra, and now Diem, has done is prompt central banks around the world to explore development of their own digital payment platforms. We talked about ‘central bank digital currencies’ in The Politics of Money a few months ago. Like Diem, they represent both a means of payment (the digital currency) and a set of associated electronic rails. China is currently piloting a digital yuan which it hopes to showcase at the Beijing Winter Olympics next February; Sweden is not far behind and the Bahamas is already live.

Diem recognises this and is positioning its Diem coins as an intermediate technology that could be displaced by central bank digital currencies, as long as they work on its rails. Regardless, the market for electronic payments systems is likely to grow significantly over the coming years. There’s already Visa and Mastercard of course, and then there’s Diem and existing regional networks and the central bank digital currencies that countries around the world are rolling out. 

Adoption of new payments networks is typically thwarted by the chicken-and-egg problem endemic to two-sided markets. But if Facebook can aggregate demand through its wallet, Novi, and if governments can incentivise demand by pushing their own solution on to consumers, then competition will grow. It’s what Dee Hock, founder of Visa, always wanted:

Having come from a relatively poor family, I knew that the economic power of ordinary people arises from freedom of choice and sufficient resources to pursue them. It led me to strong belief that they would be best served if there were many competing card systems, and many competing card issuers within each system. I was deeply convinced that there could and should be many card systems within the consumer banking industry, and that there was ample opportunity for others to emerge in the retail, travel, and communications industries.

There is so much change happening in payments currently and this is one more element to be aware of.

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Chinese Consumer Lending

A year ago it looked like China fintech was on a divergent path from fintech in the US and Europe. But then Covid happened and, as PayPal CEO said at his investor day last week, “today… we're seeing a collapsing of financial services, shopping tools, payments” – just like in China. Clear differences remain, linked to the starting point of the respective systems; China moved from a cash economy to an app economy without lingering on the card phase. But PayPal, with its new super-app strategy, and Square, with its third horizon of growth, are converging on the model of China fintech more rapidly than anticipated.

In her Big Ideas presentation for 2021, Cathy Wood, founder of ARK Invest, estimates that the model is worth ~$20,000 per end-user to the fintech provider, through the cross-selling of multiple products. A chunk of this is commerce ($9,400) which, by the way, regulated banks aren’t able to access because of the historic legal separation of commerce and banking. But the rest breaks down into lending, insurance, payments, retail brokerage and savings. 

Some of the opportunities – or dangers of the model, depending on how you look at it – are evident in China today. Protocol points out that app-based lending is taking off. “Of the 20 most commonly used apps in China – ranging from photo editing to file sharing, from maps to streaming platforms – all have some kind of in-app loan services, according to Chinese tech site iFanr.” The FT reports that a lot of this exploded after Ant pulled its IPO. “Six online lending platforms told the Financial Times they had experienced an uptick in business in the wake of the pulling of Ant’s IPO.”

Everything happens in overdrive in China, like the boom-bust in peer-to-peer lending in 2015-16 (see More Net Interest: More China “Fintech” here). Both Protocol and FT articles highlight the pent-up risk the growth in consumer lending is creating. Ultimately, either regulation will cap the earnings from app-based lending, or losses will. 

Bank Cost of Capital

Bank annual reports can be pretty unfathomable. For example, here’s a random quote from Credit Suisse’s latest annual report:

“In addition, the CRR II introduced a requirement, as of June 27, 2019, for material subsidiaries of non-EU G-SIBs, which are not resolution entities, to maintain internal MREL scaled at 90% of the external MREL requirement that would apply if the material subsidiary were a resolution entity.”

To be fair, a lot of that comes straight from the regulatory rule book which is famously complex (see More Net Interest: Regulatory Complexity here). Nevertheless, banks rarely make an effort to translate. And it may cost them. A recent finance paper concludes that “complex textual reporting deters investors’ ability to process and interpret annual reports, leading to higher information risk, and thus higher cost of equity financing.” 

If complex textual reporting is indeed a contributing factor to banks’ very high cost of capital, then not to worry – another finance paper provides an antidote. It shows that hiring financial analysts as investor relations officers improves the company’s standing by “lowering the effort expended by the investment community to process corporate disclosures.” 

Credit Suisse does have a former bank analyst heading up its investor relations team. But the real winners are those banks in that quadrant of the 2x2 matrix which write their reports with low density and whose investor relations managers have years of experience as banks analysts. Any contenders, please let me know.

Policy Trade-Offs

Last week we introduced the concept of the Policy Triangle to reflect the three trade-offs financial regulators currently face between financial stability/integrity, consumer privacy and competition. Ben Evans reflects on one of these trade-offs in the context of technology: “What the competition regulator gives (or tries to), the privacy regulator takes away.”

One thing we failed to consider, however, is just how robust the triangle is. In a new paper, legal scholar Dan Awrey questions whether the triangle stems from the bundled nature of banking, money and payments. He suggests that these theoretically distinct systems are only bundled through an accident of history, reinforced by powerful economic and political forces, path dependence and technological capacity. Treated separately, many of the traditional trade-offs disappear; he proposes a blueprint for how the three elements of banking, money and payments can safely be unbundled, thereby enhancing competition, promoting greater financial innovation and inclusion, and ameliorating the too-big-to-fail problem.

Probably because of path dependence, it doesn’t feel like we are going to untangle the financial system any time soon. And Awrey’s proposals are neither especially positive for the banks nor for payments companies such as PayPal, so they won’t be clamouring for the reforms either. But it is useful to question the premise on which regulation is baked, and the paper offers fascinating insights on the structure of financial services.