Libra

By now you’ve probably heard of Libra, Facebook’s new cryptocurrency that has changed the way the tech world thinks about cryptocurrency. We’ve seen several big name companies experiment with crypto over the past year or so, with JPMorgan and Amazon among the biggest. JP Morgan, Amazon, and Facebook provide legitimacy to the whole movement, guiding digital tokens from fringe tech nerd concept into the mainstream. No longer is the world of crypto dominated by niche smart-contract startups that your Uber driver invested in (Really, though, the number of Uber drivers I’ve met who have struck it rich in crypto is unbelievable). These are real players, ready to spend their bottomless pits of cash on high-risk, high-reward projects.

We hear a lot about world-changing new technology, especially around here in San Francisco. Libra’s white paper is another level of aspirational, promoting a new currency that will “empower billions of people”, “innovate on compliance and regulatory fronts”, ultimately creating a “more connected global financial system”. They’re setting big goals to make a splash and to show their commitment to the idea.

Of course, Facebook wasn’t the first to propose something like this. Tether shared some of the goals of Libra: fast global money transfer and stability in value. Tether has found a number of use cases in the crypto market already. But Libra aims to address some of the shortcomings of Tether, backed by one of the largest corporations in the world. If anyone has enough clout to launch a game-changing digital currency, it’s Facebook. With over 2 billion worldwide users and many people in developing countried utterly dependent on Facebook, it has immediate access to a market larger than any one country.

There are so many interesting aspects of Libra to talk about. I want to (1) address the viability of the product, and what sort of legal and regulatory requirements it’ll have to overcome in order to come to fruition. I’m also interested in (2) the global financial implications of a full-fledged successful rollout of Libra. It’ll also be interesting to (3) discuss Facebook’s plan for widespread adoption of the token, and the partnerships forged to ease that transition. I want to talk about (4) how Facebook is managing their PR in the context of the new coin, and how the Calibra organization provides an illusion to cover up Mark Zuckerberg’s ultimate plan for world domination (kidding, of course). Finally, I want to talk about (5) the implementation: how it differs from traditional cryptocurrency, how the new programming language (called Move) works and why it makes sense for this project, and what applications we can foresee built on top of a successful Libra.

It’d be helpful to acknowledge immediately that I personally am skeptical of cryptocurrency for several reasons, among which include viability, energy consumption and overall usefulness (comparing blockchain to the advent of the Internet?). But in the end it’s up for the world to decide whether this is the direction we will move in.

Regulation

Facebook has already run into several issues even just after the announcement of Libra. Of course a moonshot project like this from one of the biggest tech companies in the world will turn heads, and regulatory heads in particular. Regulators have procrastinated on regulating cryptocurrency, allowing it to flourish without oversight for several years before implementing any sort of tax code. This is the nature of regulation: the trend has to gain enough traction before the government agencies bother to look at it. With Libra and the threat to upend the traditional financial system, Facebook is forcing regulatory agencies to take a serious look at crypto. Facebook couldn’t promise to “innovate on compliance and regulatory fronts” without painting a picture of a completely successful rollout. The ultimate vision was enough to get even our Congress to act almost immediately. I think the immediate regulatory scrutiny bodes well for the success of Libra, as it provides an extra layer of legitimacy for the currency: governments are taking this seriously, so you should too.

Perhaps it’s in Congress’ best interest to sound alarmist about the new currency. “We cannot allow Facebook to run a risky new cryptocurrency out of a Swiss bank account without oversight”, Senator Sherrod Brown of Ohio said.

I think there are a few things to consider in regulating Libra. First, how does crypto as an asset figure in to capital structures? What is the difference between a crypto token and a security, and what is the difference between a cryptocurrency and a fiat currency? Second, how should governments with fiat currencies react to the threat of goods and services being denominated by a digital currency? The US has an incredible amount of oversight in financial transactions all over the world, precisely because a plurality of transactions are denominated in US dollars. In a world with Libra, will Facebook (ok, Calibra) be the entity with oversight over the world’s financial transactions? Of course governments don’t like the idea of currency managed by a private organization.

In the traditional model of economics, there are essentially three different things you can own: fiat currency, commodities, and securities. Fiat currency only has value because the government says it does. This provides a useful tool for governments to interfere with the economy, allowing them to adjust interest rates, keep inflation under control, and control the supply of credit. In general, people trust the US government and the Fed to keep the dollar reasonably stable. The dollar is backed by a single entity (the US government). Commodities, on the other hand, are physical goods that are homogenous in nature and have intrinsic value based on usefulness or desirability. Fluctuations in the value of commodities follow the basic laws of supply and demand. Securities are essentially pieces of paper that give a the holder the right to a piece of some corporation/entity or some promise of it in the future.

Cryptocurrencies fall in a category of their own. Some, like Tether, function as currency - they are generally a medium of exchange (though not backed by a government: they are backed by a reserve of US dollars, which makes it a sort of currency-by-proxy). Bitcoin acts more as a commodity - the value fluctuates with demand (up to $20,000 in late 2017) and is seen less and less as a medium of exchange and more as an investment. The value of Bitcoin is derived from the difficulty of completing a proof-of-work problem as well as the overall demand. Finally, crypto startups offering digital tokens in initial coin offerings are offering tokens that resemble securities more than anything. Kin is a cryptocurrency designed to bail out a failing messaging app and will at some point become a medium of exchange on the app.

With the variety of different use cases and models for crypto, you can see the challenges that the SEC faces with regulating it. Kik’s Kin currency was in a fuzzy territory because the SEC saw it as a way to fund company operations, while Kik saw it as a medium of exchange. Since the company didn’t follow IPO regulations when ICO’ing, the SEC got involved and Kik had to make an argument for Kin as a currency.

This is all just to say that regulation of such an undefined new sphere is hard. Facebook and Calibra will have to define a new category of asset for the SEC (and regulatory agencies around the world) to regulate. These three categories need to be defined explicitly for the crypto space. Perhaps some coins should be subject to capital gains taxes. Crypto exchanges should be held to some baseline standard of security and durability such that money doesn’t get lost. ICOs should follow disclosure rules governing their IPO cousins.

In the ultimate grand vision of Libra, it exists as a medium of exchange, with which you can order your Uber or pay with Visa. In the ultimate grand vision, your Uber price is denominated in Libra, your payments online processed through Stripe are denominated in Libra, and the dollar is an irrelevant external form of exchange that you don’t care about because you buy everything online anyway. The dollar seems to fluctuate against Libra rather than the other way around, and you suddenly think “why should I even hold dollars if I buy everything online and the dollar price changes every day?” Then Libra becomes your primary form of currency and you immediately turn your direct deposits from work into Libra. Everyone else does the same thing, and suddenly no one actually wants the dollar anymore. The effect of this is that the governments that are quickest to adopt and accept Libra will see inflation as people exchange their fiat currency for Libra. The value of the fiat currency amongst the basket of currencies that backs Libra decreases. It’s in government’s best interest to stall or stop the deployment of Libra altogether. If central banks lose the ability to adjust according to the state of the economy, monetary policy as it stands today doesn’t work.

Now suppose Facebook (Calibra) owns the world’s money supply. Who governs sanctions on countries? Who allows or disallows illicit or questionable decisions? Who stops the funding of terrorist organizations? You’d think that Facebook would, but the blockchain is designed such that no one can actually control these transactions. However, if one were able to discern transaction patterns from the transaction history, validator nodes could reject certain transactions from going through. The idea of private corporations dictating the flow of money scares governments and the public alike. Accounts are tied directly to government identification. Online marketplaces could tie purchases to a particular account, allowing for price gouging and a whole new meaning to the term “surge pricing”.

Traditionally, money changing hands is associated with some sort of premium - specifically, a tax. With cryptocurrency, it could be especially difficult to enforce sales taxes. If Facebook is going to innovate in regulation to make Libra a universally accepted medium of exchange, then they will have to work with the IRS to make more clear rules on how to collect sales taxes on cryptocurrency transactions.

Facebook will have to work very closely with public financial institutions in order to realize their vision. They need to address the issues with monetary policy, fiscal policy, and securities regulation. David Marcus, the leader of the Libra project, is commited to addressing the regulatory concerns, saying: “Facebook will not offer the libra digital currency until we have fully addressed regulatory concerns and received appropriate approvals”. We’ll see how long that takes.

Implications

The impact of a widely-adopted cryptocurrency is far-reaching. First, as we alluded to before, we could see the shape of the global money supply change. We could also see Libra upend payments in the developing world. We could see effects in foreign exchange markets, where fees could be less lucrative.

To throw another buzzword in the mix, Libra is what crypto people call a stablecoin. This means that for every unit of Libra out there in the world, there will be some number of dollars/euros/pounds/yuan/yen in a bank somewhere. These are bank deposits or short-term government securities, with high liquidity and low interest. The only way to get more Libra is to buy it with fiat currency - there’s no mining in this blockchain network. If Libra is widely adopted, this could have profound implications for the banking system. We’ve already discussed some of them above.

Government debts and bank deposits aren’t generally meant to be held for the purpose of backing some other currency - they’re generally seen as a safe investment for individuals and banks. Banks can use their deposits to meet the reserve requirement, upon which they can lever up and take more risky investments. Now, if American banks were to take deposits for backing Libra, the amount of deposits would increase, allowing banks to take more risk in other ways (issuing loans for mortgages or corporations). On one hand, one may argue that banks should not be allowed to take an excessive level of risk on the basis of Libra-related deposits. On the other hand, Libra deposits could be seen as an extra insurance policy, since it seems less likely that Libra would be exchanged for dollars during a bank run (which is why Fed reserve requirements exist). However, Libra reserves will not be held at American banks, but rather overseas at Swiss banks. This could have a negative impact on reserves in the US, potentially leading to less investment opportunity for banks, and thus economic contraction. The Fed could adjust reserve requirements accordingly, at the expense of insurance for those holding their savings in American banks. Alternatively, the Fed could increase the money supply in this scenario, potentially spurring more investment. However, increasing the money supply is often not a sustainable solution, as it could lead to runaway inflation.

In addition to the effects on the banking system, Libra will have very interesting effects on payments in the developing world. In Africa, mobile payments are already mainstream, and mobile phone minutes have become a currency. Libra could be a formal version of a number of different airtime currencies, in that it is a digital form of value transfer with few fees. Facebook, as an essential part of the daily life of many living in underdeveloped countries, can easily tap its network in developing countries to build the Libra currency quickly in Africa and beyond. This level of adoption could undermine any attempt by developing countries to create their own fiat currency.

In the grand scheme of things, cryptocurrency provides a new category for corporations or governments or startups to define their own financial instruments. I’d argue there’s nothing particularly novel about this particular usage of crypto. Facebook could have simply issued a digital token that they keep track of in their own databases, put a pile of stable fiat currencies in a Swiss bank, reduced fees to zero to encourage adoption of the token, and called it a day. The only difference here is that they slapped the word blockchain on it, called it decentralized to boost trust in the token, and voilá, it becomes a part of the nebulous and unregulated space of cryptocurrencies. Perhaps the real innovation of blockain is it’s ability to get other companies to sign on to something like this - if you trust the technical whitepaper, you trust that Facebook can’t be extracting extra value out of it.

Partnerships

Facebook partnered with some of the biggest existing names in payments processing to add legitimacy to their project: Visa, Mastercard, PayPal, and Stripe are all signed on to the project. In addition, Spotify, Uber, Lyft, eBay, and Andreessen Horowitz are among the founding members of the Libra association. These companies, among others, each paid $10 million to join the founding members group, and optionally can set up a validator node for the Libra blockchain. What this means is that if you can collectively trust this group of organizations, you can trust the Libra blockchain. These companies also get to vote on the direction of the Libra.

The incentive for Facebook to collect this group of support is quite obvious: Facebook itself doesn’t have the best reputation on its own, and the partnerships bolster the confidence of any individual contemplating whether to use Libra. On the other hand, the incentive for companies to join the Libra Association is less straightforward - they’re making a bet on the outcome of the project, and hope to use their voice to give direction to the digital currency. The founding members will have a bigger portion of the voting share when more companies choose to join the association. They will also each receive a portion of the Libra reserve’s interest, proportional to their original investment.

Having a seat at the table allows Visa and Mastercard, for example, to keep the growth of the Libra payment system in check. So while Facebook portrays these partnerships as endorsements of their new technology, internally they could be seen as threats to the system. Existing payment processors want to have a say in how the new coin is developed. The incentive is actually similar for telecommunications systems like Vodafone, who have become major players in payments processing in developing countries. Vodafones’ M-Pesa was the original Venmo in Africa.

For Uber and Lyft, the incentive is more symbiotic. First off, Uber has recently gotten into the fintech space with its Uber Card and Uber Rewards, so this investment is another signal that they plan on expanding their footprint in fintech. Clearly these startups are following the Amazon model of growth - instead of maintaining a core business, issuing dividends and buying back equity, they choose to diversify, branching into new fields orthogonal to their core business. But Uber and Lyft process millions of transactions on their platforms every day, and so they influence the adoption of Libra. If Uber offers incentives to riders to pay with Libra, riders will open Libra wallets specifically to hail Ubers. At that point, if the consumer goes online shopping on a site that uses Stripe, they’ll start moving a lot more of their money into Libra. In the end, Uber and Lyft are probably the biggest companies with which consumers do business every day. And Uber and Lyft could well get much more than their money’s worth in interest on the reserves.

For venture capital firms like Andreessen Horowitz, the venture could be purely investment opportunity: the interest returned on Libra reserves could be well worth their $10 million investment (probably a less risky investment than other ventures). On the other hand, they could want a say in how Libra could be used in the investment and venture capital space.

The notable absence on the list of Libra partners, of course, is Amazon. Surely the idea of Amazon and Facebook working together on a project of this magnitude would draw more regulatory scrutiny than needed, and perhaps Amazon itself is working on a crypto project of its own (it did launch AWS Managed Blockchain which is a pretty good sign that it’s working on it’s own).

Perception

In the month since the announcement, Facebook has gone through quite a bit of scrutiny. David Marcus has gone through Senate testimony, AOC has criticized Facebook and likened the new coin to scrip, and Trump launched a tweet storm against cryptos in general and Facebook in particular. The value of Bitcoin has surged as interest for cryptos has increased since the announcement, but subsequently has fallen in the context of the testimony. The fact is that people still don’t trust Facebook after the never-ending feed of bad press since the Cambridge Analytica scandal.

To be continued…