Facebook has finally revealed its cryptocurrency, Libra, which it will launch in 2020. Like other cryptocurrencies, users can access Libra through apps and use to pay for things or to send money to each other. But Libra shows a lot of more potentials with its careful design choices, which are disclosed in the Libra White Paper.
First of all, Libra explicitly targets people who are unbanked (or underbanked). And it promises a cheaper way (near zero fees) for people to transact and borrow money compared to traditional banking or payday loans. Nonconsumption is the best start point for disruptive innovations. In fact, nonconsumption is the fiercest competition to incumbents —and it’s winning in almost every battlefield. Clearly, Facebook is a believer of the theory of disruptive innovation and wisely chooses its beachhead. Both Google and Apple have tried to get into payment business but achieve only modest adoption because they chose the wrong market. iPhone users already have multiple credit cards in their wallet. Android users must have a phone with NFC to pay in stores with Google Pay. Those high end Android phone owners are not in desperate need of yet another payment approach. In contrast, Ali Pay and Wechat achieve huge success in mobile payment because China was a cash-based society. Not many people had credit cards and small businesses had no reliable and secure way for online payment. Ali Pay and Wechat filled in the void and provide a simple solution with QR code. Even a cheapest phone has a camera, right? Similarly, Facebook proudly talks about $40 mobile phone in the Libra White Paper. It is an open secret that Facebook wants to replicate Wechat’s success with its own messaging platform.
Libra is a currency, not an asset like Bitcoin. To avoid the gambling vibe of Bitcoin and other cryptocurrencies, Libra’s value is backed by a reserve of real assets. A basket of bank deposits and short-term government securities will be held in the Libra Reserve for every Libra that is created, building trust in its intrinsic value. This isn’t a coin that you buy because you think it will grow 100 times as valuable. It is more like exchanging a dollar for a Euro.
Facebook knows that it will face a hard fight and it cannot win by itself. Facebook needs allies, a lot of them. And it did a really good job of building the Libra Association. The Libra Association is an independent, not-for-profit membership organization headquartered in Geneva, Switzerland. It has an impressive list of initial participants, which cover a variety of industries and forms a solid foundation of the whole ecosystem. Although Facebook is expected to maintain a leadership role through 2019, final decision-making authority rests with the association. Facebook should be praised for good leadership and fair play.
Libra also makes good decisions on technical details. For example, it chooses permissioned blockchain (for now) to ensure the scalability to serve billions of users. It also adopts a Byzantine Fault Tolerant (BFT) consensus approach, which enables high transaction throughput, low latency, and a more energy-efficient approach to consensus than “proof of work” used in Bitcoin. Overall, Libra resolves many issues with Bitcoin, which we discussed in What’s Wrong with Bitcoin two year ago (when Bitcoin was reaching its peak). However, Libra is not flawless. The following challenges will have big impacts on how it fares.
“Don’t fight the Fed” is an old investing mantra in Wall Street. Although it refers to a investment policy, I would like to borrow it here literally. Libra is a currency and the Libra Association is essentially the central bank of Libra, which is the only party able to mint and burn Libra. In fact, the Libra Reserve acts as a “buyer of last resort”. Of course, central banks don’t like a new competitor, especially which will operate globally. French Finance Minister Bruno Le Maire said that Libra shouldn’t be allow to become a sovereign currency, while Markus Ferber, a German member of the European Parliament, warned Facebook could become a “shadow bank.” US lawmakers are not shy either. They called for Facebook to delay the launch of Libra.
Bank of England Governor Mark Carney appeared more open to the scheme, saying he’s keeping an open mind — although added the caveat that Libra would have to face regulation: “Anything that works in this world will become instantly systemic and will have to be subject to the highest standards of regulation.”
To be fair, central bankers and regulators are not paranoid. It is a reasonable requirement that the Libra Association needs to knows who its customers are (KYC) and that it has strong anti-money-laundering (AML) controls. But Libra, like other cryptocurrencies, are pseudonymous. It is challenging (if possible at all) to achieve KYC and AML goals under such settings. Besides, it is well known that complying with all the rules can be an onerous and expensive business for any money-transfer firms. All major banks spends well above $100MM annually on AML and still struggle to satisfy the regulators. Facebook seems ignorant on this topic. Even though the white paper says “We believe that collaborating and innovating with the financial sector, including regulators and experts across a variety of industries, is the only way to ensure that a sustainable, secure and trusted framework underpins this new system.”, there is no single word about KYC and AML.
Another issue with Libra is that to be a stable global currency, it is backed by a basket of fiat assets. It’s important to highlight that one Libra will not always be able to convert into the same amount of a given local currency (i.e., Libra is not a “peg” to a single currency). Rather, as the value of the underlying assets moves, the value of one Libra in any local currency may fluctuate. For most of us, we make only the domestic payments in everyday life. If so, why would I have to take risk of exchange rate?
A deeper question is “do we really need a global currency”? In 1990s, Motorola believed that a businessman would carry a satellite phone around the world and make calls anywhere. Unfortunately, the imagined demands didn’t exist and Iridium failure becomes a classic business case study. Facebook says many times in the white paper that a global currency should be designed but doesn’t provide any evidence to support the claim. If I were a $40 mobile phone owner, how likely do I need global transactions? Although I can start a presentation with the phrase “Imagining a world in which …” and list some use cases, any business venture needs to start with real demands and now.
In summary, Facebook develops a better cryptocurrency and avoids many issues with Bitcoin that are caused by anti-economics mindset. However, Facebook lacks of expertise and experience in regulations and financial service operations. Its ignorance of KYC, AML, FX risk, etc. may be relieved a little bit by other founding members of the Libra Association. But the Libra Association is skewed to tech companies and doesn’t have a heavy weight banking partner yet. I would not expect that Libra will enjoy an overnight success in OECD countries. On the other hand, it does provide values in high inflation areas and where people are unbanked or underbanked.