Libra, Hydra or Activa? the Global Challenges of Facebook’s Cryptocurrency

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Senior Fellow - Economy

On June 18, the Swiss association "Libra Association" presented a cryptocurrency project aimed at offering the world a "safe and stable digital currency", Libra, as of 2020, and making it "the Internet of money". The announcement would have gone unnoticed, if the association did not include Calibra, an ad hoc subsidiary of Facebook, and about 30 organizations ranging from corporations like Mastercard, Visa, Paypal, Booking, Uber, Spotify, Iliad or Vodaphone, to venture capital firms like Union Square Ventures, and even NGOs like Women's World Banking. It has caused a real thunderclap, both in the world of finance, where the ambitions of the digital giants are well known and feared, and among politicians, with American Democratic MPs and Donald Trump, in a rare show of agreement, asking Facebook to freeze this project.

Central bankers quit exercising their usual restraint

While banking and regulatory authorities have so far taken a cautious approach to cryptocurrencies such as Bitcoin or Ether, oscillating between regulation and interest in financial innovation, this time the tone is different. As soon as Libra's announcement was made, Mark Carney, Governor of the Bank of England and potential candidate for the post of Managing Director of the IMF, indicated that the project would be screened and subjected to strict regulation. Randal Quarles, who chairs the Financial Stability Board (FSB), echoed this in a letter to the G20 on "crypto-assets used as a means of payment for retail transactions", a transparent reference to Libra. Jay Powell, Chairman of the Federal Reserve, told the House Finance Committee that "Libra raises serious problems", while Xiaochuan Zhou, former Governor of the Chinese Central Bank, was concerned about the trend towards "dollarization" of the world economy, which Libra would strengthen. More directly, Benoit Coeuré, a member of the ECB's Executive Board, urgently requested by the G7 for a report on the subject, humorously borrowed from the start-up lingo to note that now that an elephant had entered the "sandbox" of cryptocurrency innovators, it was time to get down to business.

Let's start by deciphering the project, in order to get the clearest possible picture, given the project’s many grey areas. The launching White Paper explains that Libra's mission is to provide a global currency and its infrastructure to billions of people, including those who have no access to financial services. How? By issuing a stable cryptocurrency, backed by safe and liquid assets, supported by a blockchain technology, accessible to everyone and managed by the Libra association, independently of Facebook. Let us examine each of these points in the light of the technical annexes supporting the White Paper.

A cryptocurrency not quite stable

Unlike Bitcoin and its epigones, whose dollar value has been particularly volatile so far, Libra would be a "stable cryptocurrency", because it is backed one to one by a "reserve", composed of safe and liquid assets, such as bank deposits or treasury bills, issued in currencies managed by renowned central banks. Although they are not specified, we can think of the US dollar, the euro, the yen and the pound sterling. It should be noted that since it is backed by a basket of various assets issued in different currencies, the Libra will not be stable in any of these currencies, even if its sponsors claim that fluctuations will be small. It should also be noted that the interest earned on Libra's counterpart assets will not be distributed to users, but will fund Libra’s infrastructure and pay dividends to seed investors. Finally, the management of the reserve's assets will be entrusted to a network of passive managers with a high credit rating, with the Libra association retaining the right to introduce new assets or liquidate some of them, without further specification.

Blockchain, yes, but not right away

The encryption and security of Libra transactions will be quite far from the blockchain technology used for bitcoin emissions. The remarkable feature of the original blockchain is its total decentralization: everyone can, anonymously, issue new cryptocurrency units (a particularly energy-intensive business) and, in theory at least, verify the integrity of the transactions recorded successively in the chain by downloading it on their computer.

Libra's mission is to provide a global currency and its infrastructure to billions of people, including those who have no access to financial services.

This will not be the case for Libra, whose transactions will be encrypted, but whose integrity will be guaranteed by the consensus of a validators' club (according to a proven protocol, the principle of tolerance to a "Byzantine" fault). Initially, the club will be composed of the founding members of the association, i.e. about thirty entities. Although this is not the intention, this process, called "with permission", will be more energy efficient.

Subsequently, Libra, whose initiators have developed an ad hoc programming language (Move), is supposed to become "without permission", in order to reduce barriers to entry into the Libra technological and economic ecosystem. If the plan is followed, the energy consumption of the new currency could become a serious problem.

Independent of Facebook? Not quite

The Facebook subsidiary responsible for running the Libra project on behalf of the parent company is Calibra. It is also the name Facebook has given in advance to the electronic wallet that will allow Libra to be stored and used for both commercial transactions and cash transfers. Facebook has already announced that Calibra will be available on its WhatsApp and Messenger platforms, used by more than 1.5 billion people.Facebook assures that its subsidiary "Calibra will not share account information or financial data with Facebook" (parent company), except in "limited cases", a grey area immediately identified by the Alphaville section of the Financial Times (very hostile to Libra). These include the need to fight criminal activities, to transmit data to authorities in accordance with local laws and regulations, but also to share customer data with service providers, including... Facebook.

A technological response intended as universal

Although Libra is presented as the solution for the masses without access to the financial system - one cannot help but smile at the argument that anyone can buy a smartphone for $40 while the Internet services of these smartphones are still inaccessible to a large part of humanity -, it must be recognized that financial innovation in payments has not followed technological innovation in the exchange of information through social media. This is Libra's main argument: if an electronic wallet accepted by all Internet service providers and merchants in general could be loaded, payments would be highly simplified. In the ideal world described by Calibra, sending money to a parent, paying for coffee or an online transaction would be as simple as sending an SMS. This world is not a utopia, since it is taking shape in China, where, it is said, even beggars use Alibaba's Alipay or Tencent's WeChat Pay. However, there is an essential difference between the Chinese systems and the Libra project: neither Alipay nor Tenpay, nor ApplePay nor Paypal for that matter, issue cryptocurrencies, as withdrawals are made from the user's bank account. From this point of view, Libra would be closer to M-Pesa, the mobile payment and transfer service developed by Vodaphone and Safaricom in several African countries and India. With one more critical difference: while M-Pesa is a service offered by mobile operators to its customers and only works in the currency of the country where the subscriber resides, Libra is truly universal and as transnational as Facebook can be.

If Libra is born, the IRS will hunt it down...

As it stands, the Libra project is far from operational; it even gives the impression of certain haste. Many obstacles and issues are avoided or addressed with some artistic vagueness in the various documents provided to date. I will mention three of them.

First of all, the reserve of assets supposed to give value and stability to the cryptocurrency will have to be managed by entities (the "resellers") registered as financial intermediaries, not only in Switzerland, where the association resides, but also in each country of origin of the assets used as a reserve. As these assets will be intended to generate interest, and their values will depend on fluctuations in the financial markets, the very status of the association that oversees the whole will have to be clarified. It seems to be close to that of an asset manager, which could lead to strict financial regulation. The association's potential profits, which are supposed to finance the infrastructure and remunerate the initial investors, could, if the operation were to take place on a global scale and if the reserve were to reach hundreds of billions of dollars (Visa processes more than eight trillion dollars annually, and Paypal more than 600 billion) become an exorbitant source of income for the members of a theoretical non-profit association, without users ever seeing a dime. Wouldn't there be very strong social pressure for profits to be redistributed to Libra holders? This would raise the problem of their tax treatment.

Then, the transactions carried out in cryptocurrency could generate profits or losses for the user. Let's imagine that I load my Calibra electronic wallet for 100€, and later purchase a service charged 100€. In the meantime, the value of my portfolio will have changed, depending on the price of the assets on which Libra is pledged, and I will have recorded a capital gain or loss. In the latter case, I will have to replenish my wallet by the amount of my loss to complete the transaction. In the first case, I will have realized a capital gain. Since it is hard to imagine the tax authorities turning a blind eye to capital gains, which, once aggregated, could be considerable, will each user have to declare to the tax authorities their transactions for the year?

Libra is intended to facilitate money transfers, including cross-border transfers, there will inevitably be the problem of controlling capital movements, at least in the many countries whose financial balances are too fragile for capital to circulate freely.

Finally, since Libra is intended to facilitate money transfers, including cross-border transfers, there will inevitably be the problem of controlling capital movements, at least in the many countries whose financial balances are too fragile for capital to circulate freely, and which are precisely those where Libra's promoters intend to provide access to financial services to the most deprived. The authorities in charge of combating money laundering also closely scrutinize money movements. Digital companies that already allow transfers, such as PayPal or M-Pesa, have solved the problem by limiting transactions to modest amounts. But again, Libra's potential size and supranational status, due to the basket of currencies that will support it, could encourage the authorities to be more intrusive.

Can we think that the technology company that would benefit the most from issuing its own cryptocurrency, Amazon, anticipated and analysed these difficulties and that this explains its deafening silence?

Hydra or Activa?

But let us imagine for a moment that the previous obstacles have been overcome, thanks to technological innovations that are still unsuspected, and given that Calibra employs a lot of high-level researchers. Libra would then become a true international currency, not only for transactions or transfers, but also for deposits, due to the asset reserve. Once a certain size is reached, the Internet currency would become systemic in the monetary sense: its expansion or contraction, which should be mechanically followed by the management of the asset pool, will partly determine global inflation or deflation. Systemic, in the sense of financial stability as well: if an accident, unintentional (no software is immune to malfunctions) or malicious, were to occur, Libra could be the subject of a run, contrary to what its promoters ensure by arguing that the value of the cryptocurrency is at all times guaranteed by the assets of the reserve. A sudden loss of confidence would cause a sharp contraction in the outstanding amount of Libras and therefore a depreciation of the assets used for the reserve, since the securities held would be sold automatically. To spin the metaphor, Libra would then turn into Hydra, the mythological monster.

In view of the immediate reaction of the authorities, this scenario seems unlikely, at least in the short term. But given the power of Libra's promoters, from Facebook to Visa and Mastercard to name but a few, these companies should not be expected to give up. A race between innovation and regulation will probably begin, the ball now being in the regulators' court. As Benoit Coeuré and Huw van Steenis, Mark Carney's advisor, have both pointed out, financial systems must adapt to digital innovation and have already taken too long to do so, whether it is the central banks, regulators or commercial banks themselves.

From this perspective, it is to be hoped that Libra will act rather as a powerful incentive for innovation throughout the financial system. In this regard, a proposal by Jean-Pierre Landau, former Deputy Governor of the Banque de France and author of an excellent report on cryptocurrencies, deserves consideration: that central banks issue their own digital versions of the currencies, for which they have a monopoly. Thus, consumers and companies wishing to go digital could have their accounts with the central bank, and settle their transactions in this central digital currency. The first to take the first step could be the Riksbank, Sweden's central bank, where cash is less and less used, and the People's Bank of China, which would rather take the lead than be challenged by China's giant digital platforms. The Bank of England and the ECB would not take long to follow, in my opinion.

Rather than transforming into a Hydra, Libra would then deserve the nickname of Activa.