By Raphael Tressieres and Paul Li
Both mainstream and blockchain media last week reported extensively on Facebook’s announcement that it is planning to launch its own digital currency. This announcement is a significant development in the digital asset space as it represents a level of institutional interest and potential uptake that goes beyond even what was announced by JPMorgan earlier this year. While the potential boost that such developments may have for digital asset and blockchain mass adoption is to be welcomed, we have identified many questions which may arise from this project based on available information.
In particular, we note our concern that a corporation (or a group of corporations) controlling the flow and use of both data and money would have a position too dominant in society, with the potential to become overly influential and to wield greater influence on many established governments.
Based on the information which has been released to date, we do not consider the Libra proposal to be a true cryptocurrency. Instead, we see Libra as being halfway between the traditional central bank currencies and true cryptocurrencies such as Bitcoin or Ethereum. It is also quite clear that, at least for the initial phase of the project, it won’t do much to promote decentralization, openness, and trustlessness: underlying principles of the development of blockchain and digital asset technologies.
From a conceptual point of view, given the centralized control over the value of each Libra in its current proposed form, it may actually be better to consider Libra as analogous to the frequent flyer miles offered by many airlines with a cryptographic technological element providing the infrastructure support for its deployment, with fungibility with fiat currencies as main difference. Given the numerous summaries which have already been published on the Libra proposal, we do not intend on providing another detailed overview in this article. Instead, our aim is to provide our views and immediate thoughts on what Libra represents and what it could be, based on currently available information.
Query #1: Centralized (or little decentralization)
According to the Libra whitepaper, the Libra Foundation selects the validators meaning its consensus mechanism is permissioned. Even though the whitepaper notes that a transition to a permissionless environment is being considered, under the initial proposal the Foundation appears to be cartel-like with the added fact that 75% of its founding members are from the US. Most members are large traditional payments processors (Visa, Mastercard) and large tech data collectors (Uber, Lyft, Paypal, eBay, Mercado Libre, Farfetch, Spotify, etc.). The lack of decentralization will force users of Libra to trust those participating large corporates with both their money and data. The infrastructure will also rely on a special form of the Byzantine Fault Tolerance-consensus algorithm which technically is not a blockchain, as there is no block but a single data structure instead. This calls into questions the ultimate intents of the project and whether its aims are indeed to promote decentralization. While the whitepaper claims that Libra would aim to become more decentralized as the project progresses with the “ambition” of becoming a permissionless network, there is no guarantee nor a clear roadmap on how it would be achieved. Further to this, should there be a successful adoption and uptake of Libra in its currently proposed form, there would be little incentive for further changes towards greater decentralization to be made. As Joe Lubin, the founder of ConsenSys and co-founder of Ethereum, wrote in an article published by Quartz last week, Facebook is “imploring us to trust in Libra” which he described as “like a centralized wolf in a decentralized sheep’s clothing”.
Query #2: Controlled and can be stopped (if it ever launches)
The Libra announcements already mentioned that it will share user information with governments, which will be facilitated by mandatory KYC when setting up a wallet. More problematic is the fact that its service can be halted or shut down anytime, possibly under government influence or by founding members (1/3 quorum). If a government is willing to shut down Libra, it will reach out to its members (validators). This is a key difference to true cryptocurrencies such as Bitcoin or Ethereum, as for these, a government has no point of contact, nor the power, to go out and stop them directly. Instead, governments seeking to stop cryptocurrencies have to date resorted to imposing restrictions on the users (citizens) within their own jurisdictions. We already know that Russia will not allow Libra, while India (> 250m Facebook users) and China (where Facebook cannot operate) are likely to follow next. Major concerns have also been raised in the US and Europe, with multiple hearings by regulatory and governmental bodies scheduled in the coming weeks. Libra might not even launch because of regulatory hurdles.
Query #3: Facebook & privacy issues
We are probably all familiar with the massive data leaks and scandals such as Cambridge Analytica or election manipulation currently surrounding Facebook. The privacy threat to individuals resulting from a loss of control over our personal data is real. Despite claiming that there will be safeguards related to data monetization, we find it hard to believe that Facebook and other participants will not find a way to monetize data related to consumer purchasing habits. At this stage, it is unclear how such monetization might occur, but it must be remembered that going forward Libra is not intended to operate in isolation, but rather it will be able to operate within the wider Facebook ecosystem (encompassing at this stage services such as Facebook, Messenger, WhatsApp and Instagram) and it is likely that this ecosystem would be expanded further going forward. It would not take a great mental leap to consider that the operation of Libra adjacent to systems which exist for the collection and monetization of data will provide new sources of data to be collected and monetized even if not done directly through the Libra offering itself. Data will also be shared with governments under the Libra proposal and given the desire for this to be an effective global digital currency, it would also be interesting to understand which governments would ultimately have access to which users data and under what circumstances. For instance, would a government in a country that a user is not a resident be able to gain access to that user’s information as a result of the terms of service or as a result of some other reasons linked to their use of Libra? Beyond Facebook having a bad reputation for protecting privacy of individuals, the other partners also have questions relating to their conduct. Uber is not reputed for ethics, Paypal is not known for censorship resistance and associating Visa / Mastercard with decentralization seems insincere. The creation of Libra feels like an attempt from Facebook to protect and expand its monopolistic business model and for the other partners to hedge their bets whilst gaining a slice of this ever-growing global pie. Lastly, one may remember that Facebook was banning advertisings related to cryptocurrency not so long ago hence demonstrating its censorship power.
Query #4: Banking the unbanked… really?
Libra claims that it will be able to serve the 1.7bn unbanked in the world, over half of which are located in Bangladesh, China, India, Indonesia, Mexico, Nigeria and Pakistan. However, the reality is that Libra will not be able to reach half of these countries as either cryptos are banned or Facebook cannot operate freely or the country is under FATF restrictions. Further, it lacks the ability to trade with other cryptocurrencies. In other words, to a true believer of decentralization, while Libra is an upgrade to central bank-controlled fiat currencies, it lacks the ability to hedge against “central bank risks”, which is a key feature and benefit of cryptocurrencies.
Greater concerns arise from the fact that Libra’s value will be pegged against a “basket” of currencies that may include USD, Euro, Yen and GBP, with the basket makeup to be managed by the Foundation. This approach makes Libra dramatically different to the other stablecoins which currently operate in the market. Whilst other stablecoins also attempt to create a level of stability in their value through pegging to an underlying asset, in those cases the asset is generally a single currency and so its “value” is not controlled by the entity releasing it, but rather the market’s confidence in that particular stablecoin. In those situations, the releasing entity itself will strictly speaking not have the power to determine the value of the stablecoin as if it is pegged 1:1 against a fiat currency, then it will be worth “1” of that particular currency. Under the Libra proposal, the claim is that the “Libra Reserve” which is created will be administered with the objective of preserving the value of Libra over time; this is not the same as maintaining a stable value against a particular chosen asset. Instead, those administering the Libra Reserve will have the power to determine what they consider to be a “stable value” for Libra. This could mean changes to the amount of assets within the Libra Reserve or even changes to what assets may be used to form its makeup. In the long term, should there be a significant uptake in the use of Libra globally (or even within certain regions of the world), this has the potential to impact the global banking system. In a worst case scenario, if Libra’s uptake were to become high enough, it could also have the impact of reducing the ability for central banks to effectively manage monetary policy within their respective jurisdictions. Attempts by central banks to expand or reduce money supply in their countries could be rendered ineffective if there is shadow currency such as Libra existing alongside, as its supply is managed separately by a group of corporations seeking different outcomes to the central bank. The potential for Libra to create systemic risks to the global financial system should not be underestimated and this has been immediately identified by central bankers.
Query #5: the regulatory conundrum
The global regulatory environment for financial services and products is not standardized. Many cryptocurrencies and financial services providers more generally have encountered significant difficulty providing cross-border services or systems which are capable of operating across different jurisdictions. One of the great issues is that even from a definitional perspective there is often no consensus, with one jurisdiction potentially classifying a product like Libra as being security whilst another jurisdiction could classify it as forming part of a stored value facility and others may consider it not requiring regulation at all. Following on from this are the differing requirements in place for products and services even when there are instances of the products or services being classified in the “same” way (for instance, the way a security and its offering is regulated is the US is different to how it will be regulated in any other country).
This lack of standardization in laws and regulations is not a new concern, but it has meant that to date the offering of financial services and cryptocurrencies has necessarily been heavily driven by local jurisdiction requirements and restrictions. Without standardization across jurisdictions, satisfying requirements in one jurisdiction may have the resulting impact of preventing its operation or use in another jurisdiction (for instance, as a result of restrictions on the use of personal data and transfer of personal data between different countries). As noted, traditional financial services have had to deal with these issues and the approach that has been taken to date has generally been to effectively set up shop of businesses within each of the desired jurisdictions they intend on operating within and to then ensure that each of those address the particular legal and regulatory requirements imposed on them. Given the desire of Facebook to create this global currency through Libra and taking into account the difficulties that traditional financial services providers have faced, it is unclear how Facebook intends on resolving these issues for the purposes of the Libra proposal without at the very least creating or using multiple centralized distributions or controlling entities within each of the jurisdictions they intend on operating (for instance, what role or responsibilities would the validators be forced to take in each jurisdiction that Libra intends on operating within). Such an approach does not accord with the idea of greater decentralization.
Query #6: Profitable for founding members but no financial incentive for end-users
While Facebook claims that Libra will be able to help the 1.7 billion people globally without bank accounts conduct cross-border payment and transactions, it is not immediately apparent what other financial benefits Libra can bring to most other users. Shockingly, there is apparently no financial incentive for users! Many of the founding members’ business model is to generate the highest ARPU (Annual Revenue Per User) through selling data for ad purpose. It seems fair to share a small part of the profits generated by data monetization with users. Today, only foundation members will benefit from transaction fees.
Beyond the Libra project itself: positive macro implications for digital assets and blockchain
Yet even with all these potential questions about the Libra proposal, we also do see plenty of potentially positive ramifications for the crypto industry in general.
With Facebook’s global reach, this will certainly also create the perception that increasing numbers of large companies are adopting cryptocurrencies and this can only support our goal of mass adoption for blockchain. In fact, the mere introduction of the proposal along with the nature of the partners involved demonstrate a level of institutional interest and commitment which has been unseen to date. Also, whatever work is done by the Libra Foundation on laws and regulation is likely to provide further clarity and encourage discussions by both regulators and industry participants. This, in particular, could be a catalyst which not only encourages but may potentially force a significantly greater level of global regulatory standardization and normalization which would help to break down existing jurisdictional barriers. Such an outcome could help to reduce the costs associated with financial services generally and help to provide for a greater level of access to all within the greater general population.
Last but not least, by addressing its user base, the Libra Foundation will be educating people around the world on blockchain and teaching them basic concepts such as how to set up a wallet and increase financial security relative to the status quo banking system. Blockchain and cryptocurrency have been discussed at a near-incessant level over the last two years, but the level of uptake is still only a fraction of the population. Increased education and knowledge will likely help to provide the general population with the confidence necessary to interact with and use this technology to a greater degree in their lives.
Authors Tressieres and Li are business development director and general counsel respectively at HK-based OAX Foundation, which is creating a decentralized exchange. The article was published on Medium.
