The recent release of plans by Facebook for its proposed stablecoin, Libra, will dominate discussions about digital assets, payments and fintech for the coming months – and maybe years.
One thing is clear: the business model of transaction banking, i.e., getting paid to move other people's money, is coming to an end. Bitcoin was the first salvo. Libra is a much bigger disrupter. Whether Libra lives up to its lofty expectations is not a given – see below. But if it isn't Libra, it will be something else.
How Libra works
Libra is Facebook's attempt to realize the idea of the "internet of value" (building on today's "internet of information"), in which sending money is as simple and effortless as sending text or a photo by email or instant message. Libra is to be a global digital currency, and supporting infrastructure, to let billions of people move money via their phones.
It is based on three elements: a blockchain, a backing reserve of assets to keep the Libra's value stable, and an independent governance body to manage and extend the ecosystem.
The blockchain is called the Libra Blockchain. It is meant to provide the kind of scale, efficiency and security of bitcoin, but with some important differences. The Libra Blockchain will rely more on proof of stake mechanisms, with ecosystem partners (joining price: $10 million) running validator nodes. There are so far about 30 such members, with Facebook hoping for another 70 or so.
The idea of a validator node seems similar to EOS and other hybrid protocols that rely on decentralization only to a point. The idea is that combining a permissionless, public blockchain with certain VIP nodes that do the actual minting and authorization of transactions is meant to allow for huge volumes at speed – unlike bitcoin or Ethereum, which are slow because every participant in the network has to confirm all transactions.
However, for the time being, Libra Blockchain will not be permissionless – that is just the objective. For now, it will remain controlled by the governing members of the Libra Association (see below). The ledger will be public, however, to help authorities or others look out for fraud.
(Also notable: Ethereum has been trying, so far without success, to also move from proof of work to proof of stake. More here on what proof of stake is all about.)
The software behind Libra Blockchain is open-sourced, and Facebook wants to see independent developers create apps and new features.
The reserve of assets
Unlike bitcoin, whose volatility makes it impossible to use as a means of payment, Libra is meant to be stable versus a basket of bank deposits and short-term credit instruments, which seems to imply liquid paper and government securities in dollars and euros.
The reserve will act similarly to Hong Kong's currency peg to the U.S. dollar. And just as the introduction of paper money in the 19th century was based on pegging it to the gold standard, as managed by the Bank of England, so Libra Coin is meant to win trust by being pegged to reliable "safe" fiat assets, assuming users become confident they can exchange coins back to fiat securities on demand. For details on how the reserve will work, see here.
This creation of trust is what will drive adoption. It is similar to how the 17th century Wisselbank (the old Amsterdam Exchange Bank) created "bank money", returning deposits in the form of high-quality guilders. The money backing Libras will come from investors in the separate Libra token (members of the Association) and by users, whose demand will require the reserve board to purchase more fiat securities. The reserves will not pay out a return but will accumulate interest; the reserves will be held among a distributed number of top-tier global custodians.
The Libra Association
Facebook is the instigator but it has brought in a consortium of global corporations to jointly oversee the ecosystem, the reserves and the blockchain. These partners and Facebook will set the rules of the game from the Geneva, Switzerland-based Libra Association.
These companies include payments players such as Visa, Mastercard and PayPal; technology companies like Uber; telecom companies such as Vodafone; blockchain companies like Coinbase; and venture capital and non-government organizations.
No banks! No J.P. Morgan or Goldman Sachs! No BlackRock or AXA or Allianz!
The Association is supposed to be a non-profit organization. But it has been registered in Switzerland as a Gmbh, i.e., as "Incorporated". This might change but for now it's still wholly owned by a Facebook legal entity based in Delaware.
Facebook itself will be represented in the Association by a new company it created, Calibra, which will develop Facebook's financial services to be offered to Libra holders - deposits, and at some point, loans and other financial products.
Will Libra succeed?
Libra is meant to launch in mid-2020. Based on the corporate partners and the reserves, it represents a Western, status-quo set of interests. There is no representation from Asia, not even Softbank.
There are probably technical reasons why Chinese internet companies would not want to participate. The Libra blockchain allows pseudonymous, allowing users to hold multiple addresses not in their own name. This approach does not work in China. There would also be questions raised about a big Chinese company working with a Silicon Valley rival that is blocked in mainland China.
The list of founding partners also includes many companies banned from doing business in China, or which have faced regulatory restrictions that are protectionist in nature. But the lack of a Grab or a Go-Jek also suggests this is a project cooked up in the West.
There's nothing wrong with that, of course. But Facebook's vision for Libra is predicated on emerging markets – that's where the unbanked are, that's where the greatest need for something like Libra exists. So why no emerging-market or Asian firm among the founding companies? There’s something patronizing about the proclaimed mission to save the developing world’s unbanked with zero representation from such places.
Even in the U.S., the announcement has triggered the likelihood of deep scrutiny by the Federal Reserve and Congress (WSJ). One influential Congresswoman is even demanding Facebook freeze the entire project (Coindesk).
Facebook has, to put it mildly, a trust issue. There will be concerns that the company's "move fast and break things" ethos, which has wreaked havoc in U.S. and European politics and society, could disrupt financial services and monetary stability.
But in practical terms, it may be Asia and emerging markets where Libra faces the biggest obstacles.
Facebook, including its affiliates WhatsApp, Instagram and Messenger, has a huge population – at 2.38 billion active users, as of March, it's twice the size of China. But for Libra to succeed in these markets, Facebook will need the support of emerging-market authorities. The company's co-founder, Chris Hughes, writing in the FT, says emerging-market central banks should view Libra as a threat.
Meanwhile, on LinkedIn, here is what Prajit Nanu, CEO of payments fintech Instarem, has to say:
Out of US$680 billion cross border remittance market, about 20% is digital. This market is over served with Transferwise, WorldRemit, Remitly and Instarem – charging between 30 bps to 100 bps and delivering the funds in few mins to 24 hours based on the market coverage. There will be not much value of Libra in this customer set as speed and cost issues are already solved. The balance 80% of the market is where the real opportunity lies, but: does Libra solve the distribution problem? For e.g. today Western Union and Moneygram are able to deliver cash to deepest corners of the world, how can a user convert Libra to fiat at a low cost? Conversion cost will be a key point as this segment is hyper price sensitive.
Education – You need millions of dollars to educate the lowest strata of the society on how this would work compared to giving cash to [Western Union] and family members receiving cash instantly.
Top up – How will you top up the wallet? Regulators hate cash top up of wallets.
Finally regulation- Most markets where un-banked population is high for e.g. India, regulators are extremely wary of crypto and they won't allow only Libra.
DigFin also notes that stablecoins have yet to be tested in the heat of a financial crisis. The experience of the British pound being forced out of a European monetary arrangement in the 1990s by aggressive hedge funds shows what can happen. Facebook's white paper does call for the Libra Association to serve as a "lender of last resort" but we have yet to understand what this really means; in the early 1930s, the Fed was meant to be such a lender, but it failed to act, and thousands of U.S. banks went under.
There's also the matter of impacting the money supply, once Libra is used for issuing credit. What happens when Libra becomes de facto a fractional-reserve credit institution? Of course, some 95% of today's money supply is created by private lenders (not by central banks – sorry, gold bugs). So maybe the answer is: it's just another plank in today's fiat world. But given the ambitions behind Libra, and its corporate backers, expect plenty of arguments over this.
On the positive side, Libra is in keeping with how financial innovation has worked. The backers seem to have learned why Bank of England was uniquely successful at printing paper money backed to gold, thanks to its trusting private individuals to run the bank. While many people have been waiting for a central bank digital currency to emerge, it's possible that governments, at least in the West, will see how Libra fares before deciding whether to issue their own. And Facebook's biggest P.R. argument should be simple: "Just look at how the banks are ripping people off."
But this raises the stakes for Asian governments and companies. It's a direct challenge to closed-loop payment ecosystems such as AliPay and WeChat Pay. It would be a shame if Libra serves as another wedge between East and West at a time when supply chains and technology sharing are coming undone. If Facebook really wants Libra to become the currency of financial inclusion, it needs to get Asian partners on board.