So, the white paper on Libra has finally been released, and it’s capturing headlines all around the world. The introduction to the concept paper states that the document is an outline for a new decentralised blockchain, a low volatility cryptocurrency and a smart contract platform that all create a new opportunity for responsible financial services innovation. Well, that’s all right then, Regulators and Central Banks please get back in your boxes and relax – everything will be just fine. Or will it?
Before we start, the white paper is at pains to point out that there is a consortium of founding members behind the currency. These include Visa, Mastercard, PayPal, eBay, Lyft, Uber, Mercardo, Spotify, Vodafone and Coinbase. But let us be under no doubt – this is Facebook’s baby and they will be the biggest contributor and the one holding the reigns.
First of all, let us explore exactly what Libra is supposed to be. They are certainly aiming high, wanting to be a global currency as well as a financial infrastructure that will empower billions of people. No mean feat, but surely if anyone can do it, Facebook, with its purported two billion users, can? The vision is for Libra to become universally accepted as a means of payment, and in order for people to have confidence in it, and for its value to remain stable, it will be backed by a reserve of real assets. Such assets will consist of a basket of bank deposits and short-term government securities. Sounds awfully similar to the IMF’s global supplementary reserve currency, the Special Drawing Rights (SDR), which is based on a basket of five currencies (US Dollar; the Euro; the Chinese Renminbi; the Japanese Yen; and the British Pound Sterling). Is Facebook then preparing itself to become the new global central bank?
Before we get to this, we are presented with an initial problem in the white paper. Libra will be based on a permissioned blockchain. What exactly does this mean? A blockchain is a distributed ledger that allows data to be stored and transmitted in a peer-to-peer fashion. It is based on cryptographic protocols resistant to tampering, driven by network consensus and provides a very high degree of security, if set-up and run correctly. Now, a permisionless or public blockchain is what you typically envisage when thinking of blockchain. This allows every user to create their own address and hence interact freely with the network, adding entries to the ledger. Anyone can run a node on the system and undertake mining to help verify transactions. Most of the cryptocurrencies around today, including Bitcoin and Ethereum, are based on permisionless, public blockchains. They are decentralised, so no central authority can edit the ledger or shut down the network. They are also anonymous, albeit certain blockchains, for example that used by Bitcoin, ties a user identity to their private key.
There is also full transparency to all the information surrounding transactions on the ledger (apart from the private keys). These are the key factors that are driving the popularity and gradual adoption of such cryptocurrencies – their freedom from control of any one institution. Libra seems to be going directly against this by adopting a private or permissioned blockchain. This creates a closed system, where users cannot see the ledger history nor issue transactions of their own. The owner of such a blockchain can therefore choose how decentralised the system will be, as well as the level of transparency, anonymity and governance. The white paper does say that their blockchain will be open to everyone and also that within five years of launching Libra, the founders will start looking into making the blockchain a permisionless one. Even if it is actually possible to switch from a permissioned blockchain to a totally permisionless one, as I suspect a link will still have to be kept to the old system, there is of course no guarantee that this will be done.
Clearly Facebook and the rest of Libra’s founding members can very well decide to be as transparent as a public blockchain, but the key point is that this decision is up to them and can be altered as they see fit. They can change the rules whenever they wish, and at their whim they can freeze your coins, take your coins or issue new ones. Libra will therefore certainly not be attractive to the traditionalist Nakamoto supporters and libertarian die-hards. They see a cryptocurrency based on a public, decentralised peer-to-peer led transparent blockchain as one of the key enablers of returning all the trust that was lost from the monetary and financial system following the global financial crisis of 2007/8. Replacing the fiat money system, issued and controlled by central banks, with one issued and controlled by Facebook and a private consortium doesn’t seem much of an equitable swap. And, don’t forget, Libra would still be backed by fiat currencies issued by those same central banks. Indeed, given the data privacy issues that Facebook already suffers from, who knows what other problems, blunders and misdemeanours such further centralisation of power may lead to. In this case, many would probably opt for the lesser of two evils and stick to fiat (and / or digital coins) issued by central banks.
Getting back to the white paper, despite such a major lacunae, it seems that Facebook’s aim for Libra is nonetheless to create a “global, digitally native currency that brings together the attributes of the world’s best currencies: stability, low inflation, wide global acceptance, and fungibility.” Libra believes that the fiat currencies and interest earning securities that will back it form the major difference between it and other cryptocurrencies. Well, you can’t have it both ways. If the aim is to create a new currency with low inflation to replace existing fiat currencies, but you are still using those currencies as a reserve basis, then any inflation they suffer from will inevitably be transmitted through to Libra. And if they are purposely choosing stable fiat currencies with low inflation, as they say they are, then what is the benefit of replacing such currencies with Libra in the first place? Unless you trust Facebook more than any other central bank. The other supposed benefit of Libra is that it will fluctuate freely against all other currencies. In this case, those in countries with volatile domestic currencies may initially end up suffering the most if they have to purchase Libra in order to carry out day-to-day transactions and payments via Facebook platforms, as their currency will be continually weakening against Libra. So much for helping to empower the unbanked masses.
We are therefore left with the concept of a cryptocurrency that is not based on a public blockchain. What is then even the purpose of using the blockchain for it, one may quite legitimately wonder? A blockchain that is not decentralised and provides no rewards for mining is not a blockchain – it is just a database. So why then insist on using the blockchain, or at least the term “blockchain”? This could be Facebook’s greatest ace – perhaps the limited decentralisation that the blockchain would provide is what they think will allow them to escape regulatory oversight and de facto issue potential currency without being a regulated financial institution. So far, authorities have struggled to regulate cryptography, finding it impossible to define laws that are broad enough to be effective, yet sufficiently limited to capture only their intended targets. Even so, I still struggle to see the actual use of the blockchain here. The data structure of the Libra ledger’s history is a set of signed ledger states. Validators would be making commitments for each ledger state, and all of the historical ledger states are also committed to in Merkle trees. But there are no backlinked lists of data that form a chain—much less a chain of blocks. So where is the blockchain?
The regulatory response so far
Before we come to this, let’s first examine how Libra will be managed. Calibra will be the separate Facebook subsidiary that will build and operate services on the Libra network. Calibra will then apply for a money transmission licence. However, since they will be using deposits to invest in interest-bearing securities, a money transmission licence does not appear sufficient. Given that they would be taking deposits, earning interest, issuing tokens and investing in interest-bearing securities, they would basically be performing as a bank or an investment firm – without being regulated as such. What about the usual anti-money laundering and know your customer checks? Facebook may well be able to verify the identity of its users, but Libra will allow users to create multiple accounts that are not necessarily based on their real-life identities. The Calibra wallet states that all users will be verified via government-issued ID, but I suspect there may still be wide-ranging concerns around financial crime and the potential for money laundering. There is no way that Facebook will, or should, be allowed to by-pass such checks, regardless of how Libra is being defined. Albeit, to admit that such checks need to be carried out means we are also conceding that it can become a successful pseudo currency in its own right.
There’s also another question of data security. Calibra was set up to ensure a separation between social and financial data and to prevent any conflicts of interest. Calibra has promised not to exploit users’ financial data for cross-selling purposes, unless given permission to do so. Given the way Facebook operates and monetises user data in so many ways, it doesn’t seem very far-fetched to imagine that one of the key T&Cs for using Libra may very well mean giving permission to allow data to be used in this manner.
Let us then return to the regulatory response so far. The Bank for International Settlements, the central bankers’ bank, has just issued a report highlighting the risks that big tech’s foray into financial services could bring. Whilst they acknowledge that this may well result in efficiency gains and enhance financial inclusion, they believe that regulators need to ensure a level playing field between big techs and banks, taking into account big techs’ wide customer base, access to information and broad-ranging business models. The combination of these factors can result in significant challenges around ensuring fair competition, securing data privacy and maintaining financial stability.
Jerome Powell, the head of the Federal Reserve has said that he recognises potential benefits and risks to Libra and added that the central bank was not too concerned about no longer being able to implement monetary policy, given the infancy of the crypto digital asset class. The U.S is, however, certainly worried. Rep. Maxine Waters, chairwoman of the United States House of Representatives’ Financial Services Committee, is requesting that Facebook halt development on its cryptocurrency. She said, “given the company’s troubled past, I am requesting that Facebook agree to a moratorium on any movement forward on developing a cryptocurrency until Congress and regulators have the opportunity to examine these issues and take action.” What they will examine and the action they would take remains to be seen, but a hearing has been scheduled for 16 July 2019.
The chairman of the Russian State Duma Committee on Financial Market, Anatoly Aksakov, has said that Libra will not be legalised in Russia, and that it may well be banned in Russia. This may be because Russia is soon to formalise its own cryptocurrency bill, and perhaps also because Russia is thinking about issuing its own gold-backed digital coin in the future.
The French Minister of Economy and Finance, Bruno Le Maire, said that he intends to “ask for guarantees” from Facebook in regard to Libra, concerning fears that it may be used to finance illegal activities. The Governor of the Banque de France, Francois Villeroy de Galhau, has also stated that France will set up a task force representing all of the G7 countries, dedicated to examining the regulation of cryptocurrencies. France currently holds the rotating presidency of the G7, and the task force will examine how global central banks can regulate cryptocurrencies like Libra without the risk of them being used for money laundering and other illicit activities.The task force will be lead by Benoit Coeure, a board member of the European Central Bank.
The Reserve Bank of Australia is also sceptical. Their Payments Policy department has said that there is “little likelihood of a material take-up of cryptocurrencies for retail payments in Australia in the foreseeable future.” The department argued that cryptos will never be able to fulfill all three conditions required for a currency: decentralisation; scalability; and security. An additional issue they have highlighted is around volatility, and whilst they accept that Libra is expected to solve the volatility issue, they see this being achieved at the cost of sacrificing decentralisation, given Libra’s reliance on a central body to buy and manage the assets that back it. The Governor of the Reserve Bank, Philip Lowe, has also said that he does not think Libra will attain mainstream usage in the near future.
Probably the most welcoming response has come from Mark Carney, the Bank of England’s Governor.
Carney said that Libra may have genuine use cases, if it can conform to regulatory demands, and sees it gaining traction in countries such as the U.S., where the informal movement of smaller amounts of cash are slow and costly. Carney therefore sees Libra being able to increase financial inclusion, whilst lowering transaction costs. This was accompanied by the news that non-banks are also going to be allowed access to the Bank of England’s balance sheet. The payments network in the UK had previously been opened up to non-bank players a couple of years ago, giving direct access to the RTGS system for FinTech payment providers like Transferwise (which, by the way, can already process cross-border payments at much cheaper rates than traditional banks). This new announcement from the Bank will mean that non-bank firms can hold interest-bearing deposits at the Bank of England. In particular, it would potentially mean that Libra would be able to hold its Pound Sterling reserves risk free at the Bank of England directly, whilst still earning interest. This would by-pass the need for Libra to have accounts with commercial banks, along with the associated risks. So, why is Carney so overwhelmingly positive about Libra, something that may end up greatly weakening the power of the central banks to set and influence monetary policy? Certainly, he, and the Bank of England, have been welcoming of new FinTech players and technologies, and this response is certainly in line with that standpoint. It may also be a clever ruse in welcoming Libra in public, but then weakening or killing it behind the scenes with a variety of regulatory demands and burdens.
Conclusion?
So, it does not appear that Libra is an actual cryptocurrency and there is therefore little chance it will become the next Bitcoin anytime soon. But does that actually matter? In a telling post some months back, Zuckerberg admitted he regretted not taking note of Tencent’s WeChat app much sooner. WeChat has a billion unique users and its digital wallet app WeChat Pay is also incredibly popular amongst users in China, being used to pay for everything from shopping to hailing taxis, ordering food and paying utility bills. It is now focused on expanding outside China and has recently entered the Malaysian market. This may be the vision Facebook has for Libra, which together with WhatsApp, would create a similar all-encompassing digital wallet. Indeed, the white paper does acknowledge this clearly by stating that “just as people can use their phones to message friends anywhere in the world today, with Libra, the same can be done with money — instantly, securely, and at low cost.” WhatsApp has 300 million users in India alone. Getting them to start sending payments through it would be huge. People would still initially need to purchase Libra with fiat currency, but once they were locked into the ecosystem, they would continue to send and spend using the Libra digital wallet and would then be much less likely to leave to use other payment systems, shopping apps and websites. This in itself would create a very significant marketplace for Facebook, with the vision being that there would eventually be much less need to swap Libra back into fiat. Add in the monetary value of all the additional user data, and the future for Facebook seems dazzling. So, rather than a currency per se, Libra would be more of a token to facilitate payments, and to capture the wallet and spend of people onto Facebook’s platforms. Don’t get me wrong, this in itself is an extremely powerful concept, and given the two billion users Facebook has, I would not bet against the concept anytime soon.
But why should Facebook and WeChat Pay be the only ones exploiting this new market opportunity? Perhaps one major impact of the Libra white paper is to encourage all the other global corporations to start issuing their own cryptocurrency coin, and this may be what really brings blockchain and cryptos into the mass market. Amazon, eBay, Google and Apple (who are not part of the Libra consortium) could all be tempted to throw their coins into the ring and being issuing their own versions of Libra to use on their platforms. Amazon has announced that they have no immediate plans to issue their own coin, but they added that they would be happy to start having this conversation in two-or-three years time. Indeed, Libra’s white paper may also end up persuading some central banks to begin issuing their own digital currencies sooner rather than later. They could then provide all the same transaction benefits that Libra, and others, may offer and hence do away with the necessity for people to turn to Libra in the first place.
So, if nothing else, Facebook’s move has highlighted the importance of crypto currencies, bringing them further into mainstream adoption. And when you come down to it, looking at all the pros and cons of a Facebook issued Libra vs. central bank issued fiat, perhaps the fully decentralised Bitcoin is not such a bad compromise after all. Could that be partly why the Bitcoin price is happily testing the $10k mark and potentially setting its sights on $11k?
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