How Covid-19 is drastically changing digital finance

Digital finance was already a fast-changing place before Covid-19. After the pandemic, expect more government intervention. A changing appreciation of data may have strong implications for finance as well.

The Covid-19 pandemic will eventually pass, but not before disrupting vast swathes of the global economy and making its mark on digital finance.

1. Bigger government role

The increased role of government in the economy and financial sector is likely to persist to some degree. Before Covid-19, the changing geopolitical landscape had already made policymakers aware of the strategic importance of vital domestic infrastructure, including communications and payments. Governments are now also looking into data, an area already identified as a strategic priority by the European Commission earlier. In finance, governments have quickly established huge guarantee schemes to see businesses through the crisis.

It will take years to wind down the increased public role in finance 

Even in a best case scenario, it will take years to wind down this increased public role in finance and the broader economy. A renewed debate on the division of labour between public and private sectors in finance will likely flare up, once the dust settles.

2. Reduced foreign dependence

Calls for autarky (e.g. in producing face masks) may fade quickly, but both businesses and authorities will look for less complex cross-border supply lines and smaller foreign dependencies, as Covid-19 demonstrates their fragility, but also on national security grounds. At the same time, governments have also been made acutely aware of the need for high quality communications infrastructure, e.g. to facilitate working from home. Countries with leading positions in the required technologies (think China and 5G) will be aware of their good negotiating position.

Authorities realise digital platforms are playing useful roles in locked down societies.

Finance  has grown into a business with complex cross-border linkages. This ranges from financial ties to IT outsourcing and supervision. These international, sometimes global linkages, were already critically scrutinised by authorities, a development that may intensify post-Covid-19. How bigtech’s endeavours in finance fit the revised picture, remains to be seen. National authorities e.g. in Europe were increasingly critical about bigtech before the pandemic struck, but also realise that major digital platforms have become an important part of daily life and are playing useful roles in locked down societies.

3. Cybersecurity

The switch to working from home has stretched across corporate and national network infrastructures. With resources reallocated to keeping the show on the road, this exposes businesses (and an already heavily burdened health care sector) to increased cybersecurity risks, such as ransomware attacks and data leaks, but also to things like fake news. We have to reckon with the possibility that bad actors use security gaps today to establish a presence, only to exploit this presence later on, when it suits them best. To counter this threat, cybersecurity may be expected to move up the policymakers’ agenda. Given that cybercrime knows no borders, it is best fought at the international level. In the EU, while there is an EU agency, there is no deep cooperation as in markets and finance, for example. That might change in the future.

4. Faster adoption of digital interactions in retail

On the retail end, we expect the adoption of digital finance technologies to accelerate post-Covid-19. Many people have had no other choice than to acquaint themselves with ways to do business digitally – ranging from video conferencing to exchanging documents securely by digital means, or paying contactless to minimise physical contact.

Identity verification via video call may become accepted practice rapidly

We expect identity verification via a video call to become accepted rapidly. In the medium term, this may provide a boost to digital-only financial intermediaries, and may accelerate the demise of brick-and-mortar financial shops.

5. Focus on inequality and financial inclusion

The pandemic has put new focus on inequality in society. Digital financial intermediaries may be asked to intensify their efforts towards financial inclusion, e.g. by improving access to financial products for groups such as the self-employed, temporary workers and small and medium-sized enterprises (SMEs). Access for these groups is hindered by the limited availability of financial data and the high costs of processing them. One way to go about this is to augment financial data with a diversity of non-financial data sources.

6. Changing attitudes vis-à-vis data

Until recently, data debates centred around things like privacy and the question of whether people are comfortable paying for platform services with their data. While people may not like the idea when they think about it, in practice they continue to use said services. Several European governments are currently considering tracking location, health and other personal data for Covid-19 control monitoring and personalised health advise (e.g. to self-quarantine). There are other examples where data sharing could be useful in a lockdown society. Acutely arising liquidity needs due to the lockdown have demonstrated the need for quick credit checks. In the absence of readily available financial data, alternative (platform) data may prove very valuable.

People may reconsider the potential gains of sharing data and the need to protect users and society at large from data abuse

While data protection and usage monitoring remain paramount, far-reaching data sharing may be temporarily acceptable to most given the challenge at hand. But after the pandemic too, people may reconsider the value of data, the potential gains of sharing this data and the need to protect users and society at large from data abuse. Such shifting views may in turn enable new business models such as data guardians (a function that prima facie banks might be in a good position to fulfil), and may accelerate the establishment of legal frameworks to govern data sharing and protection.

Conclusion: Don’t stop thinking a step ahead

The coronavirus pandemic is such a fundamental and monumental shock that it will have a lasting influence on digital finance. In particular, and in no particular order, we see shifts in the relationship between the public and private sector in finance, changes to global interconnectedness, the need for increased cybersecurity cooperation, an acceleration of digitisation, an increased focus on financial inclusion and shifting attitudes towards data. For both financial intermediaries and policymakers, it is wise to start thinking about these tectonic shifts too.

 This article first appeared on ING THINK 

Will Covid-19 accelerate the arrival of digital currencies?

The Covid-19 pandemic took the world by surprise with an unprecedented political and economic shock. As a result, we’ve updated our outlook on digital currency attitudes and trajectories

CBDC – as we knew it

Two months ago, the factors that drove research and development into central bank digital currencies (CBDC) included:

  • Technology considerations: the possibilities unlocked by today’s tech to create e.g. programmable money and decentralised, even offline exchange infrastructures;
  • Efficiency and financial inclusion: the desire to develop payment systems and use them as a development tool for the rest of the economy (less of a driver in developed economies);
  • Geostrategic considerations: the dominance of the dollar in finance and trade, the emergence of China on the world stage and the role of US and Chinese big tech firms;
  • Monetary autonomy: the dystopian idea of a private sector global currency operator sharply reducing national central banks’ monetary degrees of freedom and efficacy;
  • The declining use of physical cash and the urge to develop public sector alternatives to private digital infrastructures;
  • The realisation that any CBDC is potentially highly disruptive and therefore has financial stability implications that need to be managed carefully.

Covid-19 will accelerate, not slow, CBDC developments

We don’t think that Covid-19 alone will be a good enough reason for central banks to suddenly adopt digital currencies. However, the pandemic is likely to accelerate the process.

Here are a few reasons:

  • The declining use of physical cash is likely to accelerate, as contactless payments are encouraged to reduce contagion risk. While this may not win over the staunchest physical cash fans, the forced introduction to contactless payments may convince a silent majority;
  • The role of government is likely to increase, as we discuss here. This may make it easier for central banks to obtain the necessary political mandate to introduce a digital currency;

The pandemic may clear the political way towards introduction of CBDC

  • The financial system will come under increased pressure from Covid-19. The financial stability concerns related to CBDC (mainly substitution from bank deposits into CBDC) will therefore be even more pressing. At the same time, so will be calls to insulate payment systems from pressures in the lending parts of the financial system;
  • The pandemic will reshuffle the cards on the geopolitical stage. Some countries may emerge with less economic damage, giving them a clear opportunity to flex their muscles;
  • This and de-globalisation may intensify attempts to establish “national champions” in digital payments, either private or public.

So what are central banks up to? Will Libra 2.0 host any CBDC?

The global Financial Stability Board launched a consultation on global stablecoins (such as Libra), however, that was already planned. The Dutch central bank stated this week it’s ready to test CBDC in the Netherlands, once CBDC is properly debated at the Eurozone level. Yet this statement too, like other communications about intensifying research and pilots starting, was already in the pipeline before Covid-19. In other words, it’s too soon to see a corona effect.

De-globalisation may intensify attempts to establish “national champions” in digital payments

Last week the Libra association updated their white paper and introduced “single-currency stablecoins” alongside the original multi-currency Libra coin. In this new version, they argue that if central banks were to create a digital dollar, euro or British Pound, the Libra association could host these on the Libra infrastructure.

This offer has put the ball firmly back in the central bankers’ court. It may sound like an offer central banks can’t refuse, but we doubt whether they will take it up. In principle, a central bank may like the idea of having its CBDC hosted on multiple private platforms, in addition to its own public infrastructure. Availability on widely used platforms is in fact necessary for broad CBDC acceptance. So from that perspective, hosting CBDC on the Libra platform may be fine. There are a few problems though.

The dreaded multi-currency original Libra is not off the table yet. Authorities will continue to regard this global stablecoin with suspicion

The biggest one is that, even though Libra added single-currency Libra’s and potentially CBDC to the mix, the dreaded multi-currency original is not off the table yet. Authorities will continue to look at this global stablecoin with suspicion, and will probably demand guarantees in some form that it does not threaten monetary autonomy. We doubt whether Libra is able and willing to give such guarantees. The best one, from the authorities’ perspective, is to have no multi-currency Libra at all. But even in this long-awaited version 2.0, Libra refused to bite that bullet.

Moreover, Libra 2.0, which still has the potential to quickly become a dominant payment platform, will not make the previously mentioned questions on financial stability any easier. The Libra association may feel it has addressed all authorities’ objections to its v1.0 proposal, yet it may face more stiff conversations with central bankers.

A new dynamic?

In the end, whether CBDC arrives or not, was never, and never will be, a purely technological question. It was and will primarily be about political acceptance and alignment with other political strategic goals, both domestic and international.

De-globalisation, bigger role of governments and close cooperation with the financial sector will guide CBDC discussions

In that respect, our initial assessment is that CBDC will be a more likely option post-Covid-19. The bigger role of governments and the close cooperation between them and the financial sector in combating the economic fallout will guide discussions about CBDC in the context of the role the financial sector has in serving society.

That said, CBDC will not be introduced overnight. Right now, authorities and the rest of society are in crisis-fighting mode. However, previous crisis episodes have shown us that the foundations for the post-crisis institutional framework are laid in crisis times. We expect the debate to start soon.

This article first appeared on ING THINK

Facebook’s Libra updates its plans, now back in business?

It’s been a few months since we heard from Libra. As it turns out, the consortium has been working hard on version 2.0 of its white paper. This time, its proposed digital currency has a serious chance of being acceptable to authorities

It turns out that Libra had a lot of homework to do. When the initial white paper was published in June, a storm of criticism followed. Authorities all over the world were afraid a global stablecoin with the userbase of Facebook would create a de facto global private central bank, reducing the monetary autonomy of existing central banks. Concerns were also raised about Libra’s governance and its compliance framework. It quickly became clear that Libra would not fly in its initially proposed form, simply because many authorities would outlaw it.

But the Libra Association paid attention, and their 2.0 plan contains a number of fundamental changes that should to a very large extent address the fundamental concerns raised. To name the most important ones:

  • Libra has introduced “single-currency stablecoins” alongside the “global stablecoin”. In other words: the original Libra will get company from EUR-Libra, USD-Libra etc. These local currency versions blend in much easier in domestic monetary, financial and regulatory framework, and do not pose direct threats to monetary autonomy. That said, a successful Libra network could still influence financial stability. While an important concern, this should not be a complete showstopper. We do see potential issues around the fact that the “global” stablecoin, the original Libra, continues to exist. Authorities will continue to regard this global stablecoin with suspicion, and demand guarantees in some form that it does not threaten monetary autonomy. In what was probably a well-timed coincidence, the Financial Stability Board issued a consultation about global stablecoins earlier this week..
  • Libra is attempting to bring its business participants clearly within existing regulatory parameters. For example, exchanges and wallet providers are to register as Virtual Asset Service Providers (VASPs), meaning they have to comply with global standards to counter money laundering and terrorist financing. This too is important, as it will provide regulators with the tools needed to monitor and enforce compliance.
  • The third important change is that Libra is giving up on a fully decentralised future. Doubts about the feasibility arose immediately on publication of the initial white paper. There was great uncertainty about how a decentralised Libra network would look, and how authorities and supervisors would interact with it. Libra has apparently not been able to provide authorities with a satisfactory sketch of a decentralised network that nonetheless can be supervised and controlled effectively, and has instead opted to let go of the decentralised idea altogether. This is a very important signal with wider implications. Various crypto-projects are still working on fully decentralised approaches. But they now have a hard question to ask: will a decentralised setup ever be acceptable to authorities, or will it cause the coin/asset to languish on the fringes of the financial system forever?

Libra has shown that those who gave up on the project, did so too quickly. Libra 2.0 is very different from the initial version and now has a serious chance of being acceptable to authorities, and actually come into existence. The biggest issue in our view remains that the global currency basket-version of Libra is not off the table enitrely. Moreover, even in its watered down local-currency form, Libra, in combination with Facebook’s vast userbase, would remain a strong disruptive power to existing payment systems and the financial system at large. Let’s see how Libra’s proposals are received this time round.

This article first appeared on ING THINK