In part 3 of this article about Libra (read what is it and how it works here), we will explore the third filter any new trend, product, or idea faces after passing through the test of technology availability and business sense (read about these here). The third filter is society which consists of government and customers. This is probably the hardest filter of all as we are dealing with regulations, trust and perception of Libra. It’s not an easy ride for Libra by any measure given recent data miss-use by Facebook and the lack of oversight and control on who accesses and shares the users’ data.
Government
The company’s crypto plans are already under fire from regulators in Washington and Europe who don’t like the idea of Facebook dipping its toe in yet another aspect of people’s personal lives. And gaining consumer trust after years of privacy mishaps may be harder than Facebook expects. A letter from US House Representatives Committee on Financial Services to Facebook sent on July 2, Facebook to officially put the project on hold.
Today, cryptocurrencies are backed solely by the willingness of users to accept them, not because they have any intrinsic value or are backed by any government. This makes such currencies unstable. Libra, however, will be backed by reserves: If a user buys a dollar of Libra, that dollar will presumably be held in reserve somewhere, ready to be honored when someone sells that Libra. Moreover, while most cryptocurrencies are hard to use, Libra promises to be user-friendly and embedded into Facebook and WhatsApp.
There are four core problems with Facebook’s new currency [3].
The first, and perhaps the simplest, is that organizing a payments system is a complicated and difficult task, one that requires enormous investment in compliance systems. Banks pay attention to details, complying with regulations to prevent money-laundering, terrorist financing, tax avoidance and counterfeiting. Recreating such a complex system is not a project that an institution with the level of privacy and technical problems like Facebook should be leading.
The second problem is that, since the Civil War, the United States has had a general prohibition on the intersection between banking and commerce. Such a barrier has been reinforced many times, such as in 1956 with the Bank Holding Company Act and in 1970 with an amendment to that law during the conglomerate craze. Both times, Congress blocked banks from going into nonbanking businesses through holding companies, because Americans historically didn’t want banks competing with their own customers. Banking and payments is a special business, where a bank gets access to intimate business secrets of its customers.
Imagine Facebook’s subsidiary Calibra knowing your account balance and your spending, and offering to sell a retailer an algorithm that will maximize the price for what you can afford to pay for a product. Imagine this cartel having this kind of financial visibility into not only many consumers, but into businesses across the economy. Such conflicts of interest are why payments and banking are separated from the rest of the economy in the United States.
It’s also possible that insiders belonging to the Libra cartel could exploit their access to information, business relationships or technology to give themselves advantages. There are many ways a new currency system could advantage large businesses over everyone else, especially when the large ones are sitting on the board of governors for the payments system. For instance, one of the incentives is to get people to use the currency is discounts on Uber rides; if this happens, Facebook would be giving an advantage to Uber instead of other ride-sharing businesses.
The third problem is that the Libra system introduces systemic risk into our economy. The Libra currency is backed, presumably, by bonds and financial assets held in reserve at the Libra Reserve. But what happens if there is a theft or penetration of the system? What happens if all users want to sell their Libra currency at once, causing the Libra Reserve to hold a fire sale of assets? If the Libra system becomes intertwined in our global economy in the way Facebook hopes, we would need to consider a public bailout of a privately managed system. We should not be setting up a private international payments network that would need to be backed by taxpayers because it’s too big to fail.
The fourth problem is that of national security and sovereignty. Enabling an open flow of money across all borders is a political choice best made by governments. And openness isn’t always good. For instance, most nations, especially the United States, use economic sanctions to bar individuals, countries or companies from using our financial system in ways that harm our interests. Sanctions enforcement flows through the banking system — if you can’t bank in dollars, you can’t use dollars. With the success of a private parallel currency, government sanctions could lose their bite. A permissionless currency system based on a consensus of large private actors across open protocols sounds nice, but it’s not democracy. Today, American bank regulators and central bankers are hired and fired by publicly elected leaders. Libra payments regulators would be hired and fired by a self-selected council of corporations. There are ways to characterize such a system, but democratic is not one of them.
Facebook is trying to convince U.S. regulators that it is ready to fight efforts by foreigners to interfere with the 2020 Presidential Election while at the same time promoting its Libra cryptocurrency that may make it easier to do just that. The social media giant says it will accept the cryptocurrency anywhere where it takes payments and at least for now won’t rule out allowing it to be used to buy political ads
Eight U.S. House candidates raised $550,000 in bitcoin contributions from 20 states between 2014 and 2018, according to the Center for Public Integrity.
States have varying views on cryptocurrency political contributions. Some such as Colorado, Kansas, and the District of Columbia permit it while others such as California outlaw the practice out of concerns over potential foreign meddling. [10]
The Libra Association, a not-for-profit organization based in Switzerland, will have several layers of governance, the most powerful of which is a council, on which each member organization will have a representative.
“The council delegates many of its executive powers to the association’s management but retains authority to override delegated decisions and keep key decisions to itself, with the most important ones requiring a greater than two-thirds supermajority,” according to another supplementary document released by Facebook. As mentioned, to become a member, the initial investors must put in at least $10 million. In addition, a business must meet at least one of several elite criteria, such as being on a list like the Fortune 500.
For every $10 million invested, a member gets one vote, subject to a cap of 1 percent of total votes, in order to prevent the concentration of power in any single entity. However, the financial reward remains proportional to the amount invested no matter how much.
The council will be responsible for standard governance matters, such as appointing an executive team for the association, led by a managing director, and a board of directors to oversee them; setting the top executive’s compensation; and managing the currency’s underlying reserves.
But the body will also have final say over technical questions, such as activating new features to the protocol and resolving situations “where compromised validator nodes have resulted in many signed versions of the Libra Blockchain,” according to the document.
While Facebook’s newly created Calibra subsidiary will be a consortium member with a council seat, the social network stressed it won’t be in charge for long. “Once the Libra network launches, Facebook, and its affiliates, will have the same commitments, privileges, and financial obligations as any other Founding Member,” the company said. “As one member among many, Facebook’s role in governance of the association will be equal to that of its peers.”
The exact components of the basket of assets securing Libra are to be determined. But broadly, it will be “structured with capital preservation and liquidity in mind,” according to the social media giant. Importantly, while the coin has been described in early press coverage as a stablecoin, Facebook noted that “from the point of view of any specific currency, there will be fluctuations in the value of Libra.”
“The makeup of the reserve is designed to mitigate the likelihood and severity of these fluctuations, particularly in the negative direction (i.e., even in economic crises).” In this way, Libra will function more like a currency board such as Hong Kong’s rather than a central bank. The collateral will consist of “bank deposits and government securities in currencies from stable and reputable central banks,” according to Facebook. The latter will be limited to “debt from stable governments that are unlikely to experience high inflation.”
To make sure it can easily raise cash by selling this paper, it will all be “short-dated securities issued by these governments that are all traded in liquid markets.” While the composition of the basket may change over time, Facebook said, the currency will always be fully backed, discouraging “runs on the bank” that can happen with fractional reserve institutions. [12]
To comply with anti-money-laundering regulations that require traceability of funds, transactions on the Libra blockchain will be unencrypted, “like many other blockchains, so it is possible for third parties to do analysis to detect and penalize fraud,” Facebook said. In other words, it appears that there will be no use of cryptographic mechanisms such as zero-knowledge proofs, used to obscure transaction details in privacy-focused coins such as zcash.
If that raises privacy concerns (particularly given Facebook’s own reputation with user data), the company is offering similar assurances to those Satoshi Nakamoto gave in the 2008 bitcoin white paper. [12]
Customers
It’s important to realize that Facebook is actually launching two cryptocurrencies: the one everyone’s talking about (Libra) and the one available only to Facebook and its corporate partners (the Libra investment token).
The former will be backed by a basket of fiat currencies and cash equivalents, which means that for every dollar of Libra in existence, there will be (in theory) a “dollar” worth of real-world assets which that token may be exchanged for under certain conditions.
As a normal user, you’d get $100 worth of Libra by spending $100. Your Libra can (again, in theory) be used across a variety of platforms or sent to an approved friend.
The Libra Association (a Swiss not-for-profit) puts your $100 into a variety of low-risk, short-term investments like U.S. Treasury bills.
Those funds are controlled and spent by the Libra Association. According to the white paper, funds are used first to fund the operation of the network with the remainder being divided among the Libra Investment Token holders according to their holdings, with policies determined by the association.
The association itself is made up of holders of the Libra investment token who invested a minimum of $10 million, as well as “special impact groups” selected by the association to have a vote but who don’t have to buy the investment token.
From the white paper:
“How will the reserve be invested? Users of Libra do not receive a return from the reserve. The reserve will be invested in low-risk assets that will yield interest over time. The revenue from this interest will first go to support the operating expenses of the association — to fund investments in the growth and development of the ecosystem, grants to nonprofit and multilateral organizations, engineering research, etc. Once that is covered, part of the remaining returns will go to pay dividends to early investors in the Libra Investment Token for their initial contributions. Because the assets in the reserve are low risk and low yield, returns for early investors will only materialize if the network is successful and the reserve grows substantially in size.”
Early investors are primarily large technology and VC companies, for whom $10 million isn’t actually a huge investment. The big numbers come into play when you look at what success, big or small, would look like for the investors, at which point suddenly the project makes sense. [11]
Consumers, who will decide ultimately whether or not Libra is a flop, there was only a slightly underwhelming hint of what it might actually be used for: A picture of someone sending money to someone else via a smartphone.
Even setting aside the various risks thrown up by the Libra white paper (financial stability, user privacy, and whether it could cope with hundreds of millions of daily transactions), you have to ask why it might be a compelling product. The service described by Facebook, namely sending money “as you might send a text message,” is already offered by plenty of other companies such as Alphabet Inc.’s Google, Apple Cash, PayPal Holdings Inc.’s Venmo and Circle, a peer-to-peer payments provider that lets you transfer traditional fiat currencies.
Indeed, Facebook itself lets you send cash through its Messaging app. The company even had its own virtual currency before, called Credits, for the purchasing of content from within apps. It didn’t take off.
Sweden, for example, is on the road to becoming cashless as soon as 2023. The local mobile payments service Swish was used by about 60 percent of Swedes in 2018, according to a Riksbank survey. It has more than 6.7 million users in the country.
Facebook plans to lead the Libra consortium for the rest of 2019, and it will be at least five years before the blockchain technology that supports the tokens is completely decentralized. The ultimate dream of any crypto project worth its salt is that the digital currency doesn’t rely on a single point of control. And what about Facebook’s targeting of the “unbanked,” or those in the developing world struggling with volatile currencies? Bitcoin and its ilk promised to address the same problems, and have failed completely to help anyone other than speculators and criminals.
Facebook’s own patchy record on international payments should give pause too. WhatsApp Pay has struggled to gain regulatory acceptance in India, the world’s top remittance market, because its data storage practices didn’t meet national standards. Libra will have to answer a lot of similar questions about its financial structure and treatment of customer information.
Facebook has been on a mission over the past year to recapture the trust of its users. Libra certainly demands a lot of faith.[4]
Another big question surrounding Libra is what kinds of consumer protections — if any — Facebook and its partners will build into the system. With bitcoin and other cryptocurrencies, there are often few protections.
Stories abound of people losing thousands or millions of dollars or more because they can’t remember the passcode to their cryptocurrency wallet, or a hacker broke into their wallet or into the cryptocurrency exchange where it was stored. And typically, any transactions conducted using such digital currency are final once they happen. They can’t be reversed because one party made a mistake or a customer didn’t get what he or she ordered. Customers using the traditional banking system have many more protections. In the US, federal banking insurance covers deposits. Consumers generally have the right to contest charges or have transactions reversed if they didn’t get what they’ve ordered or were defrauded. And they generally won’t be held responsible if someone steals their credit card and uses it to make a bunch of purchases.
It’s unclear what model Facebook and its partners will follow with Libra. But it’s likely that many customers and, perhaps, regulators are going to expect the company to offer similar protections that banks and credit card issuers offer. [6]
In Conclusion
Libra is still in the early stages of development with lots of things left to do, with a targeted launch in early 2020. However, Libra is perhaps the most ambitious and hyped cryptocurrency in existence, drawing on the stature of Facebook as a unicorn, as well as the partnerships that have been developed by the Libra association. With plans to create a fully-functioning blockchain that is open-source, and facilitates smart contract technology using a native programming language, Libra seems to be moving in fundamentally the right direction.
More importantly, the adoption of cryptocurrency and blockchain technology by a giant technology firm has set the tone for mainstream adoption of this nascent technology, and the fact that a prominent list of institutions, all of which were previously openly reluctant to embrace cryptocurrencies, serve as members of the Libra association, is a huge testament to the changing tides of acceptance towards distributed ledger technologies. Saying that this is a huge deal is perhaps an understatement, but it is definitely a well-deserved victory for the industry and technology. [2]
Ahmed Banafa, Author the Books:
Secure and Smart Internet of Things (IoT) Using Blockchain and AI
Blockchain Technology and Applications
References
[1] https://www.cnbc.com/2019/06/18/what-is-libra-facebooks-new-cryptocurrency.html?__source=facebook%7Cmakeit
[2] https://www.etorox.com/news/opinions/the-7-key-takeaways-about-libra/
[3] https://www.nytimes.com/2019/06/19/opinion/facebook-currency-libra.html?smid=tw-nytopinion&smtyp=cur
[5] https://www.wired.co.uk/article/facebook-cryptocurrency-libra-coin-globalcoin
[4] https://www.bloomberg.com/news/articles/2019-06-23/guardians-of-money-bristle-at-zuckerberg-s-new-financial-order?utm_medium=social&utm_content=business&cmpid=socialflow-facebook-business&utm_source=facebook&utm_campaign=socialflow-organic
[6] https://www.theatlantic.com/ideas/archive/2019/06/dont-trust-libra-facebooks-new-cryptocurrency/592450/
[7] https://www.bloomberg.com/news/articles/2019-06-25/facebook-s-libra-creates-new-path-to-printing-even-more-money-through-messaging-services?
[8]https://techcrunch.com/2019/06/18/facebook-libra/?tpcc=ECFB2019
[9] https://insurtechforum.net/compared-facebook-libra-and-calibra-vs-apple-pay/?
[10] https://www.forbes.com/sites/jonathanberr/2019/06/30/will-facebooks-new-cryptocurrency-enable-foreign-election-meddling/#19042b237949
[11] https://www.coindesk.com/billion-dollar-returns-the-upside-of-facebooks-libra-cryptocurrency
[12] https://www.coindesk.com/theres-a-second-token-a-breakdown-of-facebooks-blockchain-economy
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