To protect consumers, not only will the Diem (formerly Libra) stablecoin have at least one-to-one reserve backing, but it won’t allow the digital currency to be fractionalized or leveraged elsewhere. Christian Catalini, Chief Economist at the Diem Association, explained how during an OMFIF webinar.
OMFIF is a central bank think tank, and given the audience, Catalini was positioning Diem as a highly regulated and conservative stablecoin compared to the others currently available.
“There’s a tremendous amount of innovation happening in spaces like DeFi decentralized finance, but when you think about payments, it’s especially important to think about what kind of risk does leverage in the system through all sorts of very complex smart contracts and financial assets introduce into a payments network,” said Catalini.
The Association will require any Value Added Service Provider (VASP) or wallet provider to ensure its liabilities are also backed one to one by stablecoins.
When you think about DeFi today and the free movement of tokens, it seems tricky to keep tabs on the assets. However, Catalini explained that there would be no unhosted wallets. Hence the control comes back to the VASPs. The wallet requirement is primarily to address potential financial crime, but the side effect is it will help prevent leverage.
Diem dollarization risk
One of the questions addressed to Catalini was about how Diem will deal with the potential impact on the sovereignty of national currencies, so-called dollarization. There is a two-pronged approach. If there is only a Diem dollar then some will use it out of convenience. So the first solution is to roll out digital versions of the local currency.
But the dollar might be attractive if viewed as more stable than the local currency. Here the hosted wallet restriction helps again. Because Diem will only work with locally regulated VASPs, currency controls can be imposed. For example, if someone receives a remittance from abroad, they may be required to convert it into local currency.
Keen for lift off
Catalini was certainly making a pitch for Diem to get a regulatory green light. He spoke about the opportunity costs to consumers of not having innovations, especially during times like COVID-19 when digital solutions are beneficial. And he was keen to encourage competition.
“Our view is that the public sector would probably be best served by essentially betting on multiple networks and encouraging multiple networks to emerge and compete with each other,” he said.
“In essence, that retains optionality in a phase that’s like the early days of the internet. There’s no such thing as a dominant design or a way to solve the problem of payments and financial services on digital assets.” Some would say that’s not entirely true. The primary ingredient of any successful payment system is a network effect. And there’s no bigger network than Facebook, which is precisely the issue that’s scared the living daylights out of central bankers.
Catalini continued, “And there’s a very big risk of picking winners or even trying to deploy a public sector solution that is one that’s going to be used for multiple decades.”