This article was originally posted on Medium

The Social Media Giant Is Set to Introduce Its Own Cryptocurrency That Could Change the Way the World Transacts

If the widely accepted and stable US dollar, and the revolutionary but volatile Bitcoin gave birth to a new currency, it would most likely be the one Facebook plans to introduce later this year.

The details on this secret cryptocurrency project are still scarce but here’s what we know: the digital currency will be a stablecoin and will be first made available for foreign remittances on WhatsApp. We do not yet know how much control Facebook is going to have over this currency and how does it plan on overcoming the regulatory and technological hurdles. We also do not have an official name, so I will refer to it as “Coin” for simplicity.

How is Coin different from Bitcoin and other cryptocurrencies?

Let’s start with reach. Bitcoin currently has 23 million distinct wallet addresses and Ether has 60 million, but a single user usually has multiple addresses. With Facebook’s plan to integrate its three messaging services — Messenger, WhatsApp and Instagram Direct — the potential reach of 2.7 billion users dwarfs the competitors. Even if Facebook manages to get 5 percent (135 million) of its users on-board, it will be far greater than all cryptocurrencies’ combined.

The next difference, the biggest one, is that Facebook’s product will be a stablecoin pegged to the US dollar or a basket of foreign currencies. This solves one of the main problems of Bitcoin and other major cryptocurrencies — the volatility.

In 2012, when Bitcoin first gained traction, the BTC/USD price fluctuated between $5.27 and $13.30. Then in 2013, the price hit an astonishing $770, but by the end of 2014, it fell to $314. It rose back to $434 in 2015 and closed at $998 at the end of 2016. In 2017, Bitcoin jumped over 1000 percent to hit an all-time high of $20,000! But by the end of 2018, it lost 81 percent of this value and settled at $3,747. The price is currently hovering below the $4,000 mark. Because Bitcoin was highly erratic, it was rational for people to hold it as a speculative asset rather than buy their groceries with. Thus it failed to fully satisfy some important criteria of money: medium of exchange, store of value and unit of account.

Here is a chart showing the volatility of Bitcoin (blue), Litecoin (purple) and Ethereum (green) compared to that of traditional currencies like USD/EUR (yellow) and USD/GBP (orange).

Facebook’s Coin avoids the issue of volatility because it will be pegged to traditional currency. How does that help?

Let’s assume Facebook decides to peg Coin to the USD at a 1:1 ratio (other pegs are also possible). So 1 Coin will always be equal to 1 USD. If I want to transfer $10,000 from the US to India, I will first convert my dollars for 10,000 Coins and send it to my recipient through WhatsApp, who can keep the money in his Coin account and spend it wherever Coin is accepted or withdraw it as Indian Rupees (INR). Until Coin becomes a widely accepted currency, the latter would be more popular. Since Coin is pegged to USD, if 1 USD equals 70 INR, then 1 Coin will also equal 70 INR. The recipient will get 700,000 INR minus any transfer fees. The loss from exchange rate fluctuations will be the same as that of a traditional dollar wire transfer. The reason people will choose Coin over a traditional wire is for the convenience of doing it instantly on WhatsApp, and more importantly, the cheaper fees — assuming Facebook charges lesser than the exorbitant fees charged by banks.

Pegging a currency is not a novel concept. It is commonplace in a fixed exchange-rate regime where the value of the domestic currency is fixed to a more stable foreign currency. Economies as large as Saudi, UAE, China, and Hong Kong currently peg their currencies. In order to maintain the peg, the domestic country (in this case Facebook) has to maintain large reserves to buy and sell excess amounts of their currency.

Looking at the graph below, the initial equilibrium will be at the point where the supply of Coin (S Coin) meets the demand of Coin (D Coin) at the fixed-exchange-rate Ē (USD/Coin) set by Facebook. But if for some reason the demand for Coin increases to D’ Coin, the quantity demanded is now Q2 but supply is only Q1. In order to maintain the fixed-exchange-rate, Facebook has to supply additional Coin and buy dollars, pushing the supply curve to S’ Coin.

Similarly, if for some reason the demand for Coin reduces, then Facebook has to satisfy the excess supply in the market by selling dollars from its reserves and increasing the demand for Coin.

Other major cryptocurrencies that are pegged such as Tether and TrueUSD are also stable to an extent, but Facebook has deeper coffers to maintain the peg and will be held more accountable to audits because of its larger reach.

Since Coin will be a pegged, it has to be based on a centralised blockchain. This means the participants (nodes) in the distributed-ledger network will be under Facebook’s control, unlike in Bitcoin, which is a decentralised blockchain and anyone is free to participate.

In the decentralised Bitcoin blockchain, every node gets a copy of the ledger (currently a massive 210GB!) to verify transactions. This process called ‘mining’ is energy and time intensive and is carried out by a large number of nodes across the globe. In Facebook’s centralised blockchain, the ledger will only have to be distributed to the limited nodes chosen by the company. Also, because outside participants have no way of influencing the ledger, the verification process can be made simpler. This helps Facebook solve lots of technical problems and inefficiencies that Bitcoin faces, but it also makes Coin less secure because attackers will have to target only a few nodes to alter transactions.

Another Bitcoin concern addressed by Coin is the use of cryptocurrencies in illegal trades. The centralisation will make it easier for Facebook to monitor and control the use of Coin for such purposes. But this is a double-edged sword because Facebook maintaining excessive control over this currency might not bode well with regulators given its recent history. To avoid some of these concerns, Facebook is in talks with third-party cryptocurrency exchanges about holding Coins and handling customers.

Why does Facebook want to go through all the trouble of creating a currency, maintaining large reserves, enabling foreign remittances at low fees and securing a whole new currency system? After all, Facebook still has to bear the cost of converting traditional currency to Coin and vice versa. In fact, Facebook tried something similar with Facebook Credits in 2011 but it failed for various reasons, including high conversion cost.

The one motivation for Facebook to be doing this is to diversify its revenue, 98 percent of which is currently from ads. The company is hoping to make money by charging fees for transfers, however low they may be. The large scale adoption of Coin will offset the small margins and is expected to add as much as $19 billion in additional revenue by 2021.

Beyond the WeChat model

But this revenue boost alone is not enough incentive to introduce Coin. Facebook wants to be a payment method in its own right. To go beyond a transfer service, it has to get customers to keep their Coins within Facebook and spend it through Facebook, and it has a model to follow.

WeChat, a household name in China, is less known in other parts of the world. In a country where many Western tech giants are banned, this app is a Facebook-Instagram-WhatsApp-Snapchat-Venmo-ApplePay-Visa-Mastercard mashup. WeChat allows its users to not only to send money to friends and family, but to pay online, in stores, and even in street-side food carts. It is a replacement for cash, check, and credit card in China.

While WeChat enables all its services in the local Chinese currency, Facebook will try to emulate the model for a much larger audience with an entirely new currency of its own. To do this, it has to make Coin a widely accepted and reliable medium of exchange across borders. People should be able to use Coin as a payment method online and in stores for anything and everything: bills, gas, groceries, meals, Amazon purchases, movie tickets, Uber rides etc. This could take years to implement but Facebook can leverage its biggest asset — the large user base — to convince buyers and sellers to adopt Coin.

Why doesn’t Facebook just use dollars instead? After all, if Coin is pegged to the dollar, what makes it much different from a digital dollar.

How is Coin different from the dollar?

Apart from being a completely digital currency for which Facebook need not worry about designing, printing, storing, and circulating notes, the other obvious difference is that Coin is a cryptocurrency which can enjoy the benefits of blockchain technology. But some of these, including transparency, anonymity and security are specific to a decentralised blockchain. Nevertheless, the centralised blockchain based Coin will still be able to enjoy the other benefits: reduced transaction costs, faster settlements, efficiency and reliability. The other reason for creating a new currency is to allow seamless cross-border transfers by eliminating conversion fees.

The End Game

If Facebook plays its cards right, it can satisfy the three important criteria of money. By creating a stable currency, Coin becomes a good store of value. With wide-scale adoption among buyers and sellers, Coin will be a reliable medium of exchange. And if Facebook manages to successfully tackle regulatory challenges, Coin can also become a commonly used unit of account.

Upon becoming successful enough, this offspring of dollar and Bitcoin could become independent. Just like how the US government decoupled the value of the dollar from gold in 1971 and ushered in the era of free-floating monies, Facebook can ultimately unpeg Coin and welcome a new era of digital money.

A few years ago, the thought of a private company issuing a currency that has the potential to replace all existing currencies and become the primary means of transactions across the world would have been unimaginable. If Facebook succeeds in making Coin a global currency, the idea of a world in which you earn income in Coins, pay taxes in Coins, save in Coins and spend in Coins is no longer science fiction. Of course, all of this hypotheses can be dismissed in one fell swoop if the governments around to world decide to impose regulations from the get-go. But, the slight idea that it is now possible, is entertaining and I, for one, cannot wait to see how this plays out and how far Coin goes.