Photo by Benjamin Dada on Unsplash
Libra. The announcement of the new cryptocurrency network, spearheaded by Facebook, has caused the level of commotion that one would expect. Proponents and press releases argue that it will spur widespread adoption among consumers/merchants and open access to a large portion of the globally unbanked. Crypto purists hate the centralization inherent in the permissioned network and worry about potential abuses of power. A broader group takes exception to the particular consortium of companies that will oversee and govern the network. Many are concerned about the data privacy implications. Others believe that this is nothing new, that this launch will simply allow Facebook to copy WeChat’s model.
What is the real significance of the Libra announcement?
In my view, none of the above, not exactly. While much of the crypto community is in an uproar over the centralization of the network, the regulators are in an outrage over Facebook’s perceived monopoly power, and users are concerned about an expansion of “surveillance capitalism,” people are too distracted to realize that this isn’t just the launch of a cryptocurrency, this is the creation of what looks a lot like a bank.
The Libra Association is a 28 entity consortium (striving to reach 100) led by Facebook and including the likes of Mastercard, Visa, Coinbase, Paypal, etc. The Association has announced a cryptocurrency, called Libra, and Facebook has built a wallet, called Calibra, which will support the cryptocurrency and integrate with WhatsApp and Messenger. Each entity in the Association paid $10M to purchase Libra Investment Tokens, allowing them to participate in the Association and optionally run a validator node on the Libra network. By running a validator node, members gain view access to the transactions they process. Via ownership in the Libra Investment Token, validator nodes share in a percentage of the return generated by the reserve pool that backs the Libra (which is a stablecoin collateralized by a basket of developed nation currencies and short term investment securities) proportional to their Investment Token ownership. The bigger the reserve, which grows via the usage/creation of collateralized Libras, the larger the returns. This is not WeChat.
I’ll define the WeChat model as the integration of payments with messaging in a way that allows the near entirety of one’s online behavior to occur within one app’s ecosystem, resulting in habitual usage and dependence.Facebook was trying to figure out how to influence its users towards the WeChat model back in 2014 when I covered the company as an equity research analyst. It was pretty clear that the company didn’t pay $19B for WhatsApp for nothing; it was also clear that they were going to wait a while until they figured out exactly how to monetize that asset. Time didn’t work in their favor, however, given numerous data privacy scandals and backlash against “surveillance capitalism.” In this context, the WeChat model won’t work for Facebook. Companies like Elixxir, David Chaum’s privacy preserving app for payments and messaging, are already working to create viable alternatives. So Facebook had to come up with another plan.
This is About the Libra Reserve
Excluding the cost differential derived from eliminating payment processing fees, the primary difference between the Libra model and other models (such as WeChat and even AliPay/Ant Financial) is the the potentially massive value of the Libra Reserve. Launching a stablecoin is what allows for the creation of this Reserve. Traditional payments models charge a fee on all transactions. According to Boston Consulting Group, in 2016, global payments revenue (including current account balances) was $1.2T. That’s a lot of money, but it pales in comparison to the value of all global payment transactions, which was $420T.³ Some of that is netted out, of course, and therefore wouldn’t require the creation of new Libra on a one-for-one basis. Even still, in contrast to other payment models, the requirement to post fiat collateral into the Libra Reserve allows holders of the Libra Investment Token to access a much larger portion of global payments value via the return those reserves generate. Were the Reserve to be fractionalized (as in the traditional financial system) it could eventually generate much higher returns. In my view, it’s not long before this pool is invested in higher return generating assets or even used to provide financial services such as lending.
This is About Identity
Facebook says any information a user shares with Calibra will be kept separate from information they share on Facebook. It would be reasonable to be skeptical of that. But I don’t actually think the goal is to tie this data back to a person’s Facebook profile… because they don’t need to. Each entity running a validator node will have view access to payment/meta data for the transactions they verify. This data is orders of magnitude more valuable than “likes” or “shares” with acquaintance level connections. Social media data is comprised of what people say or project, often times to people they barely know, while transaction data represents what people actually do. And who they do it with, and where, and when.
In order to use the Calibra wallet, each user will go through an official KYC (know your customer) process. Knowing a user’s verified identity is extremely valuable and using Libra for payments will allow this verified identity to be tied to peer-to-peer, online, and point of sale transactions, which is a unique combination. Tying this data to verified identity is powerful. It also means that advertising isn’t the only use for this data. Underwriting, for example, is a more lucrative one. This makes the transition to a permissionless network less likely, as it would erode this informational advantage.
This is About Incentives
Like them or not, the incentives of the Libra Association should promote widespread adoption. Libra Investment Token holders gain a proportion of the return generated on the Libra Reserve, which incentivizes the entities operating validator nodes to promote widespread usage of Libra. The more places users can use Libra, the less likely they are to cash out of the system in exchange for fiat, maintaining the reserve pool. The more assets in the Reserve, the larger the ROI for validator nodes. As a result, Association members are incentivized to promote widespread usage of Libra and should be happy to provide a discount on transactions using Libra to purchase their products or services, so long as it is below the rate of return they earn on the asset pool. The Libra Association also plans to provide explicit incentives to validator nodes that sign up other members, wallets that complete user KYC processes and/or that keep user engagement high for over a year, and merchants that accept Libra.⁴ The design of a consortium structure that not only makes the Libra Association more difficult to regulate, but that also results in various dynamics that properly incentivize adoption, is impressive, whether you like it or not.
This is About Regulation
Since it’s a cryptocurrency, regulators still don’t know how to regulate it; since its operated by a consortium, it is harder to shut down. Beyond the typical regulatory dynamics, this announcement raises so many concerns that regulators are divided on the very nature of what they perceive as the threat. US Congresswoman Maxine Waters, Chairwoman of the House Financial Services Committee, is focused on past data privacy issues, highlighting “the privacy and national security concerns, cybersecurity risks, and trading risks that are posed by cryptocurrencies.”¹ French Finance Minister Bruno Le Maire is worried that the goal of Libra is to become a replacement for sovereign currencies. Could Libra theoretically take over existing national currencies in developing countries? Yes, but I don’t think that’s actually the goal, and even if it were, it would look more akin to dollarization than a zero reserve system.
In contrast, Markus Ferber, a German member of the European Parliament, is focused on the crux of the matter. He states:
“With more than 2 billion users, [the Libra Association] could become a “shadow bank” and … regulators should be on high alert.”²
Could this “shadow bank” eventually become too big to fail? Maybe. Will incumbent financial services companies whose businesses this threatens (Western Union) make a lot of noise about this? For sure. Will regulators have to spend a lot of time determining how to regulate a cryptocurrency focused not-for-profit organization governed by a consortium council in which each entity has 1% or less of the total vote? I’ll let that one be rhetorical.
The motives behind Libra are not altruistic, it’s a very well designed shift in strategy for Facebook. The Association is comprised of many organizations that have demonstrated time and again that profit is their primary motive, at the expense of absolutely everything else if need be. This network still relies on traditional financial institutions and therefore, identity remains a barrier to access. As a result, it is very hard to believe that this is about empowering the globally unbanked. I also don’t see this as a maneuver to further Facebook’s existing advertising business.
Facebook realizes it has to move towards privacy, not away from it, and that it has to figure out a new business model that doesn’t rely on persistent violations of user privacy and that works for private channel communications. This business model depends on identity, this business model requires data to be used in a different way, this business model relies on a large capital base. This business model is about the Libra Reserve. This business model becomes banking.
***These views are my own. None of these views have been confirmed with any of the above mentioned entities. ***