By Avery Rogers
Part of “Complexity Theory,” a new column on the tangled questions of our technological age.
On June 18, Facebook formally announced plans to build Libra, a cryptocurrency available to Facebook users around the world, in partnership with high-profile companies like Visa, Stripe, PayPal, Uber and Lyft.
To those familiar with Bitcoin’s infrastructure and functionality, Libra will not much resemble a cryptocurrency at all. First, Libra’s value will be tied to several “low-risk” assets, including the US dollar, the euro, the yen, and other stable bonds and securities. In this way, Libra is more like a stablecoin, which pegs its value to some currency or asset to avoid price fluctuations. If and when Libra is established and dominant in the global marketplace, it is unclear whether or not the Libra Association will choose to decouple it from existing currencies.
Second, Libra will not be administered based on mining activity, in which added value is created by providing computing power to process transactions in the blockchain. Instead, Libra’s value will come from initial investments from its member companies, each of which must pledge at least $10 million in funding to the reserve. As people buy Libra with cash, the reserve will expand, and the interest gained on the reserve will go first to operating and research costs, and then to “pay dividends to early investors in the Libra Investment Token for their initial contributions.” In this sense, too, Libra is nothing like Bitcoin, which promises value only to those involved in mining and trading the currency.
Finally, Libra diverges from other cryptocurrencies because it plans to be, at least initially, a permissioned system — that is, transactions with Libra will be facilitated by servers at the tech companies in the Libra Association. This is in stark contrast to Bitcoin and other cryptocurrencies, where transactions are completely decentralized and handled by the machines of many users. For crypto enthusiasts, Libra’s permissioned system is completely antithetical to the purpose of cryptocurrency, sacrificing privacy and decentralization. On the upside, though, centralization might make money laundering and selling illegal items more difficult with Libra than other cryptocurrencies.
Libra may be a cryptocurrency insofar as it is entirely digital and not regulated by a national central bank, but in many ways contradicts both the conceptual and practical functioning of other cryptocurrencies. It is tied to low-risk assets, generates investment gains for its early investors and is regulated through members of the Libra Association. Coupled with Facebook’s monopolistic domination of social media and unsavory reputation among legislators, it is no wonder Libra has come under attack by governments across the developed world.
In the United States, Congresswoman Maxine Waters (D-CA), chairwoman of the U.S. House Financial Services Committee, called for Facebook to halt progress on the development of Libra in June 2019 until legislators could agree to a regulatory framework for the currency. The response in Europe has been even more skeptical; France and Germany released a joint statement in September, stating that “no private entity can claim monetary power, which is inherent to the sovereignty of Nations.” The countries plan to fight Libra’s development and frustrate any efforts to introduce the currency in Europe.
With so much regulatory animosity, many large companies have withdrawn from the Libra Association. Since Oct. 4, PayPal, Visa, MasterCard, eBay, Mercado Pago and Stripe have all left the organization.
Politically, Libra has proven increasingly fragile along two important dimensions. Those with regulatory power have implicitly pointed at the following questions: First, should Facebook and other Libra Association companies be involved in the creation and management of a global currency? Second, and more broadly, how should governments approach cryptocurrencies that may threaten their own monetary policy while increasing financial inclusion worldwide, as Libra promises to do?
Concerning Facebook’s majority oversight of the Libra project, it is reasonable for regulators and private individuals to be alarmed. As discussed before in this column, Facebook has a dismal track record of protecting user privacy, from using facial recognition algorithms to targeted advertising and political persuasion. With Libra synced to apps like Messenger and WhatsApp, both owned by Facebook, it is conceivable that Facebook could use Libra to track personal payment choices and sell this information to advertisers, who might exploit payment data in any number of ways. So long as Libra is a permissioned system, these risks remain. Testifying before Congress, Mark Zuckerberg admitted that Facebook “may see a positive business impact” — that is, more advertising dollars — from rolling out Libra on its platforms.
Zuckerberg, however, has also proven unwilling to fight U.S. legislators on Libra. On Sept. 18, Zuckerberg told Congress that Facebook would be “forced to leave” the Libra Association if members decided to push ahead with the currency before receiving U.S. regulatory approval. In the same hearing, he acknowledged that “there are a lot of people who wish it was anyone but Facebook who proposed this.”
With legislators in many countries pouncing on Facebook’s Libra, it is perhaps more interesting to consider the broader implications of a global cryptocurrency developed by a more neutral agent or corporation. Ought a private organization of this kind be allowed to create a currency that competes with well-established fiat currencies on a global scale? Is a cryptocurrency like Libra an appropriate way to implement it?
There are compelling, welfare-enhancing reasons to introduce a global cryptocurrency with highly accessible banking and low transaction fees across national borders. The 1.7 billion individuals around the world without access to formal financial institutions have a much harder time accumulating wealth. Due to the volatility of many foreign currencies and the risk of theft, many people in developing nations “keep” their wealth in assets like farm animals, jewelry and property. When animals die, jewelry disappears, or property is destroyed in a natural disaster, a person’s life savings may be obliterated. A stablecoin cryptocurrency like Libra might revolutionize finance for the global poor by making banking services affordable and trustworthy.
A cryptocurrency like Libra would also make wealth transfers across borders much cheaper, allowing immigrants to send money back to their families for much lower fees. Given that about $445 billion were transferred this way in 2016, this could add up to billions of dollars per year going to low-income families instead of accruing to bankers’ pockets.
The benefits of such a cryptocurrency may be vast, but the potential disadvantages are far more striking. Beyond issues of privacy and illegal purchases, there are formidable monetary theory questions to be answered. Would a globally popular cryptocurrency destabilize the same fiat currencies it is tied to, eroding the value of national currencies and rendering monetary policy useless?
Here is how such an unraveling might happen. Let us call our hypothetical cryptocurrency Crypto. If Crypto became the common currency of the internet — facilitating most purchases with Amazon, streaming companies, and the online versions of big-box retailers like Walmart — and if online purchases became even more dominant in the United States, Crypto could become the most-used currency for daily transactions in the U.S. and other developed nations. If this were to occur, Crypto might be in a position to break ties with fiat currencies and float on its own, deriving its value not from other currencies but from its own valuation, just as the U.S. dollar is valuable insofar as people believe it to be.
At this point, with much personal and corporate wealth held in Crypto, the U.S. Federal Reserve and its international equivalents could be rendered unable to set interest rates or adjust inflation to any meaningful ends because the currencies they tinker with simply don’t matter anymore. Nations would no longer have monetary autonomy; all would be at the mercy of Crypto’s rates.
Whether or not this would precipitate a worldwide financial meltdown or a utopian period of monetary stability is beyond my speculative powers, and is an open question for economists as well. In any case, the risk is enormous: the world’s wealth would rest on Crypto’s probably ill-prepared shoulders, whether run by Facebook or any other organization.
Is global financial inclusion worth the risk of global financial collapse? It depends on the probability that a collapse would happen, but given how much uncertainty there is at the moment, it would seem the risk is far too high. Any currency attempting to rival the large fiat currencies of the world ought to, at minimum, make detailed plans in conjunction with major central banks about how to coexist without financially destabilizing entire nations. Unfortunately, monetary theory is notoriously complicated and contentious among even the brightest economists of the day, so working out such a plan might not eliminate much risk.
Perhaps a better solution is to work on increasing global financial inclusion without introducing a new currency. For example, M-PESA in East Africa allows individuals to save and send money from a mobile bank account, and tens of millions of people rely on its services today. Microfinance institutions have had mixed success, but surely their methods can be improved to fund entrepreneurial ventures in the developing world more effectively.
As fintech matures, there will inevitably be a flowering of new ideas for financial services to help the global poor. Before creating a global cryptocurrency, we are probably better off developing projects with more modest but stable benefits in the short term, and having more in-depth conversations about global monetary policy in the long-term. For the sake of everyone, let us not empower Libra before we are ready for a total unraveling of the global financial order.
Contact Avery Rogers at averyr ‘at’ stanford.edu.