By Mike Mazier
Facebook’s announcement of its entry into the cryptocurrency space with “Libra” has created quite a bit of attention and controversy. Understanding what the underlying technology is and what Facebook’s intent is will help individuals better evaluate if it is a welcome addition to the blockchain conversation—or not.
Libra is planned as a form of digital money with a trusted third party. The operative word here is trusted third party, which makes it different from decentralized blockchains like bitcoin or Ethereum, which operate without a trusted third party. The trusted third party with Libra is a consortium of founding members such as Facebook (via its subsidiary Calibra), Mastercard, Visa and many others that collectively form the Libra Association.
Digital money with a trusted third party has a history that pre-dates bitcoin and blockchains. In the 1990s, Microsoft reportedly wanted to integrate electronic cash payments into the Windows 95 operating system, and offered $100 million for DigiCash, a then-rising tech star in the ePayments space. The deal never happened. That early form of digital money ultimately required a trusted third party—a regular bank account—for settlements.
The trend toward a cashless society means all form of money is becoming digital. However, financial intermediaries have largely remained in control of money. It wasn’t until 2008 that bitcoin introduced a way for two parties to transact with each other without a trusted third party, hence starting a new wave of innovation around blockchain technology. Anyone can join Libra, but only the private members of the Libra Association can verify transactions. Here the verifiers (Libra Association) hold all the market power. As a potential user, I can trust that I won’t lose all my money in a transaction. But giving up market power is subtle (for details see prior AMA article on private vs public blockchains.
So what is different about Libra if it uses a trusted third party (i.e., the Libra Association)?
Libra is attempting to innovate around government regulations. According to the Libra whitepaper, “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.” Based on the objectives in the whitepaper, it is almost certain that Libra could have been programmed in the 1990s, years before Satoshi’s 2008 bitcoin whitepaper. Libra would fail Andreas Antonopoulos’ five pillars of open blockchains test: open, public, borderless, neutral, and censorship-resistant (see “The Five Pillars of Open Blockchains”). Libra is not a direct alternative to, or competitor of, bitcoin or Ethereum or any other open cryptocurrency without a trusted third party. These are different-use cases. But the entire ecosystem around blockchain may benefit from Libra’s confrontations with politicians and regulators. Libra is getting people to talk about blockchains.
So if Libra is not really blockchain technology, why the big deal?
Financial innovation is often about getting regulatory approval for something new, then trying to maintain a regulatory entry barrier for competitors. Filing patents is one way to slow down the competition. The future of a bitcoin exchange traded fund (ETF) remains in the hands of Securities and Exchange Commission (SEC) regulators. If we’re still waiting for approval of a bitcoin ETF from the SEC, what does that say about a global cryptocurrency?
Governments have multiple reasons to regulate money.
At a macro level, the controller of money has political and economic power. Because the U.S. dollar is the world’s reserve currency, the U.S. government gets to borrow at cheaper interest rates. Foreign central bank holdings of U.S. Treasury bonds reduce 10-year yields by around 80 basis points, according to economic estimates culled by the Council on Foreign Affairs (see “What Would Happen if China Started Selling Off Its Treasury Portfolio?” or “International Capital Flows and the Returns to Safe Assets in the United States, 2003-2007.” It pays to have a global reserve currency. And as with the British pound in the 19th century, the global reserve currency is historically held by the country with the biggest army.
Regulators hold power and self-interests that don’t always line up with business interests. As a form of money, Libra may fall under multiple regulatory jurisdictions. The SEC, Commodity Futures Trading Commission (CFTC) and the states (via state money transmitter laws) all may claim jurisdiction over Libra. The role of regulators is to protect individuals and, as such, they tend to be very (very) conservative.
All progress carries risk. The headline risk of one person being harmed is so bad and potentially career ending to a regulator that any one of us in the same bureaucratic shoes would probably make the same risk/reward calculation and be extremely conservative in approving something new. Milton Friedman once argued that the Food and Drug Administration has cost more lives than it has saved because of the onerous process of approving new drugs. The benefits of saving lives are offset by the costs of harmful side effects.
In the case of digital money, the societal cost is the potential for money laundering, tax evasion, criminal activity or the unimpeachable rationale of our times: terrorist funding. Yet, frictionless global money has huge potential to unleash unimaginable economic activity. The Libra whitepaper itself makes a case for the millions of unbanked people around the world who would benefit from frictionless transactions.
Other countries in which Libra operates would also have something to say about money within its borders. Libra is backed by a basket of fiat currencies (similar to the IMF’s Special Drawing Rights basket of fiat currencies). Would the underlying collateral be held in multiple regulatory jurisdictions? China or Russia would have a reasonable concern about money transactions within its borders controlled by a consortium of mostly American companies that are subject to U.S. law. The U.S. would have the same concerns about digital money under the control of Chinese companies.
The value of Libra is that it drives the conversation about blockchains.
The political and regulatory hurdles for Libra are very onerous. Will a Libra payment button ever appear inside Facebook? One exit strategy for the Libra Association may be to amass Libra currency positions then open it up and profit from a rise in Libra’s value. Many startups have already attempted to enter the payment space, but the marketing cost of customer acquisition is a hurdle when you need to achieve large scale to be viable. Many of Facebook’s ready-made two billion users would be happy with a Libra transaction button. For Venezuelans facing hyper-inflation, the Libra would be a safer stable currency. Yet the fact that Libra is centrally controlled means the Venezuelan government has a single point to target if they seek to ban Libra.
So if Libra is in essence a “corporate currency,” what is the downside of this corporate money?
The answer to this question is market-driven and political, not technical. Users collectively underestimate the value of their privacy. And we know this because the flip side is true: companies earn huge profits by monetizing users’ private data. In any marketplace users may need to keep some information close to the vest or else give up advantages to a counterparty. The devil is in the details of Libra’s future implementation.
Will the Libra Association be forced to grant back door access to governments in return for regulatory approval? Will we have a family of Big Brothers—corporate brothers, government brothers, American brothers, Chinese brothers—watching our every move? What is your perspective—just how much privacy are you willing to give up?
About the author:
Mike Mazier is a financial technology entrepreneur, adviser and consultant to Fintech and blockchain companies. He founded and holds a patent pending on bondirectly, a peer-to-peer bond trading platform and co-founded LendingCalc, a peer-to-peer marketplace loan analytics firm and was previously was chief quantitative strategist and portfolio manager at Van Eck Global, where he managed $5 billion in exchange-traded funds, and advised on hedge fund manager selection. He has also been a bond analyst, information technology manager and analytics developer at Morgan Stanley, vice president and closed-end fund analyst at Bank of America/Merrill Lynch and product manager at Citibank. He began his career designing hardware for military communication satellites as an Electrical Engineer at General Electric. He has BS in Electrical Engineering from Syracuse University, an MS in Electrical Engineering from Villanova University, and an MBA from Columbia University Graduate School of Business.