Financial industry watchdogs are asking federal officials to attempt to stop the cryptocurrency pilot program launched by Facebook, noting that the U.S. government has the power to criminally prosecute executives for operating the venture.
The Open Markets Institute sent a letter on November 23 to numerous regulatory agencies and the U.S. Department of Justice (DOJ), saying the omnipresent tech conglomerate may be “in the illegal business of receiving deposits without a bank charter.”
“There are several legal and regulatory implications for Facebook’s pilot that warrant particular attention by the agencies,” the Open Markets Institute letter stated.
Other financial industry analysts share the Open Markets Institute’s opinion. Americans for Financial Reform and Demand Progress issued a joint statement in response to the pilot, urging “relevant regulators and lawmakers with jurisdiction over banking, consumer protection, and antitrust to intervene to put this project on hold.”
Facebook has not responded to a request from Truthout for comments on the claim that it might be illegally taking bank deposits.
Financial institutions in the United States that seek to operate as a bank by lending money and accepting deposits — the latter of which Facebook’s pilot appears to be doing — must first have a bank charter approved by the Office of the Comptroller of the Currency (OCC). The OCC is one of the country’s federal bank regulators and an agency within the Department of Treasury. Bank charters outline how firms will operate as a bank, and include plans to comply with safety and soundness regulations.
The Open Markets Institute letter also noted that regulators recently said so-called stablecoins, the type of cryptocurrency at the heart of the Facebook pilot, should be regulated like banks.
Cryptocurrencies consist of publicly available records that demonstrate an entity’s ownership of tokens by using public databases to cryptographically link the tokens to the digital wallet of their owner and past transactions. The exchange-value of many cryptocurrencies fluctuate wildly: In the past month alone, Bitcoin has lost some 20 percent of its value, but is still worth 35 percent more than it was six months ago. Stablecoins, on the other hand, are marketed as being pegged to the value of another asset, like the U.S. dollar.
The constant value of stablecoins has given them deposit-like qualities in the eyes of legal observers and some U.S. officials. Federal regulators made their determination that stablecoin ventures should be regulated like banks in a report on the tokens published on November 1 by the President’s Working Group on Financial Markets, a multi-agency executive branch panel that seeks to uphold market orderliness.
Treasury Secretary Janet Yellen convened the working group to investigate stablecoins because of concerns about the practices of Tether, a company behind one of the most widely used stablecoins, and because of Facebook’s interest in cryptocurrency, which long predates its recently launched pilot program, given that the website has billions of monthly users.
Facebook unveiled its cryptocurrency pilot program, Novi, on October 19, basing the initiative on remittances from the U.S. to Guatemala facilitated by a stablecoin called the Pax Dollar. The announcement came nine days before the company revealed that it was rebranding itself as “Meta” in a move designed to prepare consumers for the future release of virtual reality products for work and entertainment.
The Meta rebrand was rolled out after Facebook received intense scrutiny from federal policymakers. In September, a whistleblower had told The Wall Street Journal that the company was aware of the negative impact of one of its products, Instagram, on the mental health of teenage girls, while doing nothing to address the problem and simultaneously considering the launch of an Instagram for kids — the latest in a long history of scandals, which critics say demonstrate that Facebook has little regard for the well-being of its users. Instagram for kids has been put on hold in the wake of the revelations.
Problems with Tether were highlighted earlier this year by two regulatory enforcement actions, which revealed that the U.S. Dollar Tether frequently lacked the cash reserves that it needed to maintain its one-to-one peg, raising the fears that the global $3 trillion cryptocurrency market could crash if too many people attempted to redeem their U.S. Dollar Tethers for U.S. dollars at the same time. Stablecoins like the U.S. Dollar Tether are mostly used to speculate on the value of cryptocurrencies like Bitcoin and Ethereum.
The U.S. Dollar Tether redemption problem is reminiscent of a classic bank run, bolstering the argument that stablecoins resemble traditional banking deposits. Bank runs occur when a critical mass of depositors simultaneously attempt to withdraw their money, in a phenomenon that typically leads to the collapse of the bank itself, and losses by customers and other businesses that have partnerships with the bank.
Though the President’s Working Group report said Congress should pass legislation in order to regulate stablecoins like banks, much to the delight of the cryptocurrency industry, it also noted that existing authorities could be used by officials to regulate the market. The working group concluded, as the Open Markets Institute remarked, that “the Department of Justice, may consider whether or how section 21(a)(2) of the Glass-Steagall Act may apply to certain stablecoin arrangements.”
The Glass-Steagall Act was passed in 1933 during the Great Depression, and is best known for having erected a firewall between investment banking and retail banking. Though it was largely repealed by banking deregulation legislation passed during the final months of the Clinton administration, parts of Glass-Steagall remain on the books, including section 21(a)(2), which says that any entity “in the business of receiving deposits subject to check or to repayment…upon request of the depositor” must be licensed by the federal government or state governments. Stablecoins are subject to repayment upon request of those who purchase them.
Punishments for violating the law include a maximum of five years’ imprisonment. Facebook’s pilot, which is called Novi, is only licensed on the federal level as a “Money Services Business” with the arm of the Treasury Department tasked with detecting money laundering and other financial crimes. It is licensed as a money transmitter in 38 states, the District of Columbia and Puerto Rico.
Five Democratic senators blasted Facebook’s decision to move ahead with its Novi pilot under the money transmission framework, though they stopped short of accusing Facebook of violating criminal law. They noted that in 2019, Facebook CEO Mark Zuckerberg promised Congress that the company would wait for regulatory approval before moving forward with plans to launch its own cryptocurrency payment system.
“To be clear, your ability to secure state-issued money transmitter licenses is not equivalent to obtaining the blessing of ‘all U.S. regulators,’ as you said in your testimony two years ago,” the lawmakers said in an October 19 letter to the company, written in response to the launch of Novi. They urged the firm to “immediately discontinue your Novi pilot.”
Arthur Wilmarth, a law professor at George Washington University who has helped pioneer the theory that the Justice Department could prosecute stablecoin issuers, said that the agency “should probably send a letter of warning to Novi: either cease and desist or you can anticipate that we will bring a criminal indictment.”
“Anyone who knowingly partakes is liable,” he told Truthout, adding that the DOJ could send a message to the cryptocurrency industry by going after Facebook executives or those involved with “one of the other stablecoin issuers like Tether.”
Still, Wilmarth and other supporters of this theory aren’t confident that federal prosecutors will exercise their power.
“Is DOJ prepared to do anything? At least the President’s Working Group mentioned the possibility,” Wilmarth said. He noted that the legal theory isn’t as “ironclad” as it used to be because it allows companies to take deposits if they are licensed under state law. In recent years, two states, Wyoming and Nebraska, have allowed special bank charters without deposit insurance requirements as a means of attracting cryptocurrency ventures. (Novi doesn’t have any Wyoming license, and the company is only licensed in Nebraska as a money transmitter.)
Renita Marcellin, a senior policy analyst for Americans for Financial Reform, which has also pointed to the Justice Department’s powers when urging the Biden administration to take a tougher stance on cryptocurrencies, said that she doesn’t “expect DOJ to say much here.”
“For market participants and industry people, I am assuming that they feel so empowered to do this because DOJ has been really lacking in this space,” Marcellin said. “Unfortunately, that’s not Mark Zuckerberg’s problem, that’s DOJ’s problem. They need to be very clear about what this law means.”
Assuming Novi does comply with federal law, there are many other criticisms of the project, including worries about its environmental impact, fears that the company could prod Guatemala toward passing laws favoring the cryptocurrency industry, concerns about the viability of Novi itself and the probability of Facebook using the venture to engage in predatory behavior.
“Facebook’s pilot is likely another attempt by the firm to further grow its dominance in digital advertising, and monetize its users’ private data,” said Alexis Goldstein, financial policy director at the Open Markets Institute.
In its letter to regulators, the organization enumerated its concerns with the operation’s safety and soundness. Paxos, the company that issues the Pax Dollar, claims that its stablecoin is backed up by banked cash and “cash equivalents,” which are short-term, highly liquid investments. But the federal government typically only insures up to $250,000 in customer deposits per bank, and it’s unclear how Paxos cash deposits are distributed. And while the firm is overseen by New York state regulators as a limited purpose trust company, a special classification of financial firm established by New York in 2015 to impose some oversight on cryptocurrency ventures, Facebook has not publicly outlined its contingency plans in the event of a run on the Pax Dollar, or if the token loses its peg. Moreover, it’s not clear what would happen if Coinbase, the cryptocurrency exchange that has been hired by Facebook to provide custody services for Pax Dollars, is hacked.
“They mentioned that Coinbase has an insurance program, but they don’t really say what type of losses the insurance covers,” Marcellin said. “How are you taking deposits when you don’t have any backstops for people’s money?”
As for the environmental impact, the Pax Dollar is based on an energy-intensive security feature to validate transactions: algorithmic problem-solving called “proof of work” crypto mining. The Open Markets Institute said this “creates a number of extensive climate harms, which include annual energy consumption akin to that of entire nations, 30,700 tons of electronic waste (computer hardware is notoriously difficult to recycle) annually, [and] higher electricity bills for residents of states with crypto mining.”
There’s also the issue of Facebook claiming that Novi offers poor people access to financial services “with no fees” because the Pax Dollar operates on the Ethereum network which requires users to pay validation transaction fees, which tend to spike when there’s an uptick in transactional activity. For now, Facebook isn’t passing these costs onto Novi users. But the company could put the burden on its customers after capturing market share — a common “predatory pricing” practice employed by numerous tech firms such as Uber, Lyft and Amazon, as the Open Markets Institute remarked. The lack of Novi transaction fees also obscures the fact that users in Guatemala would still need to exchange their Pax Dollars with the Quetzal, Guatemala’s national currency.
“They’re free-riding off the banking system. If people want to transfer it to physical cash, they have to use a bank, so then they have to be subject to transfer fees,” Marcellin said. “This completely undermines the whole idea that this is [offering] services to underbanked. If you don’t have a bank account, you can’t use it.”
There is a potential workaround for this conversion problem, albeit one with troubling implications, if the experience of another Central American country is any indication. The government of El Salvador, Guatemala’s neighbor to the southeast, made Bitcoin legal tender in September much to the chagrin of Salvadorans who protested the move, lamenting the wild swings in the price of Bitcoin, among other aspects of the law. Results of a poll published in August showed that 65 percent of Salvadorans were in opposition to the law that made Bitcoin legal tender.
“The only alternative to leveraging the existing banking system is if Facebook is planning to work with the government of Guatemala to change the laws of that sovereign nation to mandate the acceptance of Pax Dollars as legal tender,” the Open Markets Institute warned.
Finally, there’s the nontrivial matter of how Facebook has treated its users. In addition to the recent Instagram scandal, the company has conducted psychological tests on unwitting users; allowed the data of 87 million users to be exploited in 2016 by Cambridge Analytica, the hardline right-wing political consulting firm that used the information to push fearmongering ads to benefit Donald Trump and the Brexit campaign; enabled incitement to genocide in Myanmar; and allowed disinformation and fake accounts to manipulate political processes in countries around the world.
Considering “Facebook’s track record of violating user privacy, and Facebook’s ongoing need to find new profit centers,” the Open Markets Institute warned, “there is absolutely no reason to believe its promises today that it will not find a way to monetize its digital assets pilot project.”
“If anything, an effort to monetize the data of users who take part in this project seems not merely plausible, but likely,” the organization said. That is, unless the federal government defies expectations and exercises its power to stop the godlike tech giant.