The title of the post is a mouthful, I know. I went down this path after Assad Liaqat’s tweet
What is Novi?
I followed up to see what Novi does. It turned out to be Facebook’s previously announced project comprising of Libra currency and Calibra digital wallet. The latter has been renamed Novi and enhanced as an app. The currency and unit of accounting will remain Facebook’s Libra currency.
Instantaneous fund transfers
Trope on Novi’s twitter account seems to be instantaneous remittances targeted towards diaspora/immigrants and low-income groups who do not have access to cheap or any financial services. Asad’s tweet hinted as much with ‘financial inclusion’ – another trope of usurious microfinance institutions. Though I don’t mean to imply that Novi will be usurious or an MFI though that always seems to be the next evolution with fintech entities whether through clichéd peer-to-peer lending trope and/or algorithmic decision making for approving credit to such groups. But I digress.
The free instantaneous transfer isn’t a big deal in Canada where I live. All you need is an email address of the beneficiary (provided the beneficiary has registered the address with his/her bank) and using Interac email transfer, money is deposited in beneficiary’s account in a few seconds and free of any costs. There is no need for Novi for making payments within a country. I presume such instantaneous transfers are available within many other countries. Not having lived in US, I don’t know about the US but I believe Venmo/Paypal can do the same thing. Thus, it appears Novi does not have a strong case for within-country transfers, at least in the developed countries provided people have access to bank account and/or debit/credit card for Interac or Paypal.
What about developing countries? I don’t know about other countries but I presume it must be similar but let’s take Pakistan, my native country. Transfer by Easypaisa (similar to Kenya’s MPesa) to an individual not on easypaise network of Rs.10,000 rupees incurred charges of Rs.500 i.e. 5%. This is what is usually described as disruptive fintech. The within-country remittance charges are exorbitant if you are not on the same network. In addition, this just transfers the money to the mobile wallet of the beneficiary. The beneficiary can now make payment for groceries or other items using NFC which is free as per the schedule of charges on easypaisa site but there aren’t many POS terminals in Pakistan. Else he can transfer money to the grocer using Easypaisa which will lead to more charges or he can withdraw money in cash at various retailers which will also cost him. Though dealing in cash can be cumbersome, yet there aren’t any costs associated with dealing in it. That is the convenience of cash.
International Money Transfer – Official Channels
Let’s deal with international money transfer. Whereas earlier it used to take days for transferring money internationally, now the money can make into the beneficiary’s account in a few hours or in a few minutes depending on which money remitting agent one is using and where is the beneficiary’s bank account located. My experience is limited to transferring money to urban center branches. I presume it will take at least a couple of days for the money to make it to remote branches in Pakistan though in recent years with the increased focused of the Government of Pakistan to increase remittances through banking channels (as opposed to hawala/hundi) one may presume that remittances would be making their way to remote branches quickly as well. In order to increase remittances, the government of Pakistan doesn’t allow local banks to charge any fees on incoming money rather government enhances the payment. Instead, the government pays a fixed fee to local banks to compensate them. Recently, the government has increased the compensation for money coming from Saudi Arabia. In addition, the government is providing incentives to domestic banks and remitting companies for bringing in remittances. Similarly, Bangladesh offers a 2% cash incentive to the beneficiary who receives the money through banking channels. The central bank can only direct the banks in its jurisdiction. The financial institution used by remitter may be charging money. To summarize, the transfer in case of international remittances may not be instantaneous but there are benefits to receiving the money through the official channel. Despite the government incentives, WesternUnion or MoneyGram, which charge not an insignificant amount to transfer money, are also thriving. This is where Novi could have an impact i.e., disrupt WesternUnion and MoneyGram’s business but I am getting ahead. Even when banks aren’t charging fees for the bank to bank transfers, they are making money on the spread i.e., the rate at which currency is exchanged. The bid-ask spread for consumers is significantly higher than for businesses. In international remittances, there are four points where a fintech can disrupt incumbents:
- Bid-ask spread,
- Charges by the remitters bank
- Charges by the beneficiary bank and
- Transaction time. Steps taken by the government of Pakistan and Bangladesh show that governments can neutralize these charges by supplement remittances with bonus payments, asking domestic banks to limit or charge no fees for incoming remittances and to finally get their act together in upgrading their banking infrastructure. But not every country is Pakistan or Bangladesh and in those countries, Novi may have an advantage.
International Money Transfers – Financial Plumbing
We will consider a simplistic example of how international transfers work. Suppose I want to transfer $100 from my bank account maintained in Wells Fargo Bank, US (WF) to the beneficiary’s account maintained at Habib Bank Limited, Pakistan (HBL). The actual money will not travel from the US to Pakistan. Both WF and HBL may be maintaining an account at say JP Morgan (JPM) New York (remember this is a simplified example) usually called NOSTRO account. JPM will debit $100 in the WF account and credit $100 in the HBL account. The dollar balance in the HBL Nostro account will increase by $100. Against this, HBL Pakistan will credit the account of beneficiary in Pakistan by equivalent Pak Rupees. Similarly, when funds are transferred from the UK to Pakistan, GBP balances shift between the Nostro accounts maintained by banks in the UK and equivalent Pak Rupees are credited in the beneficiary’s account in Pakistan. HBL reports the balances in its Nostro accounts to the central bank of Pakistan and the central bank of Pakistan reports these as foreign exchange reserves of the country. These reserves are then used to pay for the imports or service foreign currency loans of Pakistan. Sometimes the remitter’s bank and beneficiary’s bank may not have Nostro’s in the same bank and the transaction may be routed through various banks before it makes it to the beneficiary. This increases the time as well as costs of remittance. Thus there is an invisible infrastructure that ensures these bank-to-bank transfers happen quickly and smoothly. This infrastructure not only incurs technology costs but being regulated entities, they have licensing and compliance costs as well. The fintechs and banks using this infrastructure recover these costs through fees on remittances or from the bid-ask spread.
International Money Transfers – Unofficial Channel
Finally there is the hawala/hundi business which is the bane of governments, and those agencies that fight money laundering and terrorism. The governments dislike it because the money does not come into the formal economy thus they do not get the foreign exchange to add to their reserves. Also as the transfer doesn’t leave a banking trail, it is hard to monitor by law enforcement and tax entities. Hawala/Hundi system works on trust, is very quick even where there is no banking infrastructure and depending on the competition, it can provide a currency conversion rate that is better than the banking channel. Since there is no Nostro or banking system involved, how are the dollar funds that are deposited with remitting Hawala/hundi agent used? For undocumented transactions mainly (but not necessarily) to evade taxes or to finance smuggling of goods.
Now that we have covered the landscape, let’s see how Novi will work.
How does Novi fit in?
The website describes it as standing on three pillars 1. Secure and scalable based on blockchain 2. Libra digital currencies backed by reserves in those currencies mainly USD, EUR, and GBP 3. Governance by Libra Association. Ignoring 1 and 3 for now as 1 I think is vaporware (but I can be wrong) and 3 doesn’t affect our discussion. Let’s take a hypothetical scenario where money needs to be remitted to Pakistan from the US. Since the value of Libra$ = 1USD, the remitter converts her money to Libra$ and transfers it to beneficiary’s wallet. To utilize the Libra$, the beneficiary can only use it with retailers who are part of Libra network and quote their prices in Libra$ or the beneficiary will need to go to an agent who will provide her an equivalent Pak Rupee amount for beneficiary transferring the Libra$ to the agent’s Novi wallet. The agent may not provide the best conversion rate. In addition, the agent will be incurring costs or forfeiting interest on savings for maintaining liquid cash balances to provide to all beneficiaries. This opportunity cost will either be built in the exchange rate the agent provides or would be explicitly charged as withdrawal fee.
There is a way to avoid all these fees and conversion charges. If everyone becomes part of the Libra network and quotes their prices in Libra$. To wit, say the beneficiary needs to buy her weekly groceries. She can either buy the grocery in Pak Rupees or the grocer maintains the Novi wallet. She can buy the groceries by transferring Libra$ to the grocer’s wallet and buy the groceries. Now the grocer needs to pay his kid’s school fees. If the school accepts payments in Libra$, then the grocer can transfer the money to school. Otherwise he will have to withdraw or convert it to rupees at a Libra agent. Similarly, the school has to pay the salaries of teachers, utility bills and taxes and unless all of them accept Libra$ or are on Libra network, eventually, the chain will break. This is similar to the problem of wholesaler that a scrip money or a local currency faces.
Back at Novi Financial, as long as the money is being kept in Libra$ in Nov wallets, Novi Financial can keep the dollars in its account. However, as soon as the beneficiary withdraws the money in Pak rupees, the Novi Financial needs to transfer the USD to the Libra agent’s account. The Libra agent may maintain a Nostro account with Novi Financial. This will present an insurmountable challenge i.e. how an agent or merchant based in Pakistan can have an account with a banking company Novi Financial in US.
In-game fiat currency
But all hope is not lost. Libra will work best like an in-game currency. In-game currencies can seamlessly be used to buy in-game goods from people all over the world without worrying about conversion rates or remittance delays or Nostro accounts. Say everyone becomes part of the Facebook marketplace and quotes the prices of goods and services in Libra$. As the transactions are happening in Facebook marketplace in Libra$ and between everybody’s Novi wallets, payment for purchases can be quick, efficient, and transparent without any worries about Nostros, remittance delays, or bid-ask spreads. This will be similar to how Paypal grew out of Ebay. Initially, Novi Financial may require Libra$ to be backed by USD reserves but as the Facebook economy takes off, Novi Financial can start acting like a central bank and issuing Libra$ without having a USD reserve. This will be akin to USD moving from gold-backed currency to fiat currency in the Nixon era. This is not unrealistic or unthinkable at all. Bitcoin is a currency that is backed by nothing except trust in its algorithm, scarcity of Bitcoins and transcends international borders.
Potential and Pitfalls
If Libra$ takes off, this will weaken the control of countries and central banks over their own currencies. Similar to how weak countries go through dollarization economies, a successful Libra$ and Novi wallet system may lead to liberalization (pun intended) of their economies. The remitters’ USD will be in Nova Financial accounts and countries will not be able to see their foreign exchange reserves increase. In addition, this will also help people evade taxation from local authorities (similar to how Bitcoin helps keep transactions anonymous) as the transactions though are occurring online aren’t being done through the financial infrastructure of that country. The potential for Nova is huge. By integrating Novi with Facebook, WhatsApp, and Instagram, Novi can become a super app. Whereas the other peer-to-peer lender boast about data analytics in their lending decisions, they cannot compete with Novi when it comes to lending based on data analytics. Novi through Facebook will have insight into the transactions they undertake on the Facebook marketplace, through the wallet will know the money that goes in and out of their accounts, will know the social score of the user (based on the friends and connections they interact and socialize on Facebook/Instagram and Whatsapp – controversial I know but the world is anyway moving in that direction). Novi can offer working capital loans to Facebook marketplace merchants as well as financing to expand their businesses. The power that Facebook will wield over consumers and merchants internationally cannot be overstated. This is why when Facebook introduced Libra there was such a flurry of activity amongst governments and central banks. They could foresee that if this takes off, their control over currency would weaken. The money they make from seigniorage will disappear. Moreover, Novi Financial could become a global central bank and can also affect the consumption and saving behaviors of consumers similar to the effect Bank of Nook had on 12 million global players of Animal Crossing Virtual rate cut forces Nintendo gamers into riskier assets .
The other two pillars – a distraction
This is why I believed in an earlier paragraph that the other two pillars i.e “blockchain” and Libra Foundation are a distraction. Blockchain is there to hint to users that they can use Libra$ in the same way as blockchain based Bitcoin works i.e. international borders do not exist. Novi doesn’t need blockchain to secure the data. Data is already secure on the servers that are securing our photos, conversations, and likes on Facebook, Whatsapp and Instagram. Libra foundation may be there to give regulators comfort that Facebook will not act as a malicious central bank but central banks can foresee the writing on the wall. That is why Libra announcement sped up work on Central Bank Digital Currencies (CBDC) with China at the forefront, followed by Bank of Canada studying CBDCs and economists working at other central banks churning out working papers on CBDCs.
Novi and Libra have the potential to disrupt the global monetary architecture, with Novi to become a super app and Libra to achieve a status of global fiat currency. Unlike Bitcoin which is mainly used for HODLing or undocumented transactions, Libra can be a true transactional currency. Fearing this, Libra may invite clampdown from regulators and countries so it has to tread carefully. This is where bitcoin has an advantage. Not being backed by any entity and existing on a distributed ledger, Bitcoin has an advantage of avoiding national regulators. Needless to mention, with increasing digitalization, in-game currencies and internationally popular games as Fortnite, soon there will come a time when we will see a digital currency or multiple digital currencies. Novi with a pre-existing network of Facebook, Instagram, and Whatsapp has the potential to be the first and formidable one. However, remittance may be a way to test the waters but I believe remittances, blockchain, and Libra foundation are just a distraction. The real deal for Libra is to be a global digital fiat currency. It remains to be seen if Novi and Libra are successful in achieving that status. A path that needs to be tread carefully considering that Big Tech is under intense scrutiny at Capitol Hill due to the power it already wields over the society and economy.