Chris Middleton brings us up to date with the social network’s digital coin project: is it a coin or a payment platform? And why are some companies, regulators, and governments worried about it? This new extended analysis includes elements of a previous Transform Finance report.
The European Union has tabled a series of urgent questions to Facebook about its Libra coin project as corporate backers appear to be abandoning the initiative.
Regulators are concerned that cryptocurrencies, digital currencies and tokens pose serious risks to financial stability, fiscal probity, and anti-money-laundering (AML) initiatives by enabling cross-border payments that may be impossible to track.
This has left the EU uncertain about whether new regulations may be required or a coin such as Libra should simply be banned from the bloc unless its originators can allay policymakers’ fears.
Meanwhile, US regulators are also questioning the social network about its plans for Libra in a climate of low trust in the company in the wake of the Cambridge Analytica affair and other scandals.
PayPal was the first of Libra’s founding coalition to walk, citing alarm over Facebook’s apparent lack of action over AML demands.
PayPal may also have recognised an existential threat to its business – concerns that appear to be shared by some of the currency’s other backers. On 12 October, MasterCard, Visa, Stripe, Mercado Pago, and online auction giant eBay – which has strong links with PayPal – also pulled out of the project.
At the time of writing, this leaves just one payments company, PayU, onboard – and perhaps now in a strong negotiating position. The Geneva-based Libra Association has also lost its Head of Product, Simon Morris.
So what are some companies and regulators worried about?
Facebook claims to have 2.4 billion users – roughly one-third of the world’s population, equivalent to the populations of China and India combined. By comparison, the Eurozone has a population of just 343 million people and the US 327 million, though the US dollar is an official currency in several other countries.
In 2017, the US dollar accounted for nearly 40 percent of the world’s cross-border payments. It is also the standard unit of currency in major commodities markets, the world’s foremost reserve currency, and the peg against which most other currencies are valued – including, potentially, Libra as a so-called stablecoin (see below).
Were Facebook, hypothetically, to launch Libra as a standalone currency and give its active users a tranche of the coin or incentivise them to use it – perhaps in recompense for data protection failures – the financial system would face the shock of a new global currency coming into play overnight. More, it would be one controlled by a US corporation and used by up to 2.4 billion people across international borders.
By comparison, the launch of any national digital token, or use of such a token as a bridge between two fiat currencies, would face an uphill struggle against the global reach of a platform like Facebook. In the social network’s view, a global digital ecosystem – albeit one controlled in California – demands a global digital coin or payment mechanism.
But it’s not that simple. There are overwhelming Know Your Customer (KYC) concerns about Libra, which make it a regulatory issue.
While Facebook might appear to be the ultimate KYC resource, a recent report on CNN revealed that Facebook pulled down 2.2 billion fake accounts in the first quarter of 2019 alone – nearly as many as its total number of active accounts. While the social network would claim this as evidence of effective policing, its own estimates suggest that five percent of monthly active accounts are fake. That’s almost certainly an underestimate.
The colossal number of fake accounts taken down by Facebook in just three months should really be seen as evidence of widespread desire to game a flawed system – one that may soon include the Libra coin. Those 2.2 billion fake accounts were set up for a reason, even if Facebook intercepted them. What of the ones it missed?
Other accounts are known to be used for extremist activism, including by hostile states, agencies, fake users, and commercial troll farms that have a shared purpose of destabilising political systems or liberal causes. Might Facebook inadvertently fund these groups, or give them a frictionless means to transfer cash across borders?
This is a key point. Today’s digital platforms are all about removing friction for customers, who increasingly demand instant gratification. Challenger banks and fintechs know this all too well, but in the international finance market not all friction is bad: friction is how regulators and banks stop illegal activity. Authenticating someone or understanding who the beneficial owner is of an offshore shell business takes time.
The EU wants Facebook to explain how the Libra Association, the Europe-based wing of an American corporation, will handle AML, tax evasion, and counter-terrorist financing rules at a time when the EU and US are frequently at loggerheads over regulation. Policymakers are also alarmed about the data privacy and protection implications of an advertising-based business operating its own currency.
According to the FT, Europe’s finance ministers have expressed “strong concerns” that Libra and other digital currencies could destabilise the world financial system and undermine governments and central banks, creating economic chaos. France has said that Libra should not be allowed to operate in the EU.
In the US earlier this month, two Senators wrote to MasterCard, Visa, and Stripe, saying: “Facebook is currently struggling to tackle massive issues, such as privacy violations, disinformation, election interference, discrimination, and fraud, and it has not demonstrated an ability to bring those failures under control.
“You should be concerned that any weaknesses in Facebook’s risk management systems will become weaknesses in your systems that you may not be able to effectively mitigate.” The three companies apparently listened and walked away from Facebook’s table.
Facebook founder and chief Mark Zuckerberg will appear before the US House Committee on Financial Services on 23 October to discuss the Libra project. Hopefully, he will be asked about who the Libra programme is actually for in a world in which barriers to cross-border currency transfer are largely to do with trade regulations and preventing the movement of illicit funds.
Facebook should also be probed about what an advertising- and data-based business stands to gain from creating a global currency or payment platform. Of course, that question answers itself. Facebook’s mission is to connect people, but the privacy, security, and transparency risks of users’ transaction data perhaps being passed to a vast network of advertisers and commercial partners are enormous, with innumerable points of failure and abuse.
One of the mantras of the digital world is ‘move fast and break things’, but constant, faddy disruption is the diametric opposite of security by design. If proof of that is needed, regulators only need look at Facebook itself. The social network is now, retrospectively, trying to secure something that was designed to break things. But it is easier to design security into the core of a platform than to bolt it on when 2.4 billion people are using it and it has become vast, leaky, and complex. That’s the environment that Libra is being bussed into as a supposed solution to cross-border finance.
On 9 October, the Bank of England’s Financial Policy Committee added its voice to the debate about the project. “The FPC judges that such a system would need to meet the highest standards of resilience and be subject to appropriate supervisory oversight,” it said.
The announcement explained that, for the time being, the Bank planned to apply existing regulations to Libra, which it described as having the potential to become “systemically important”.
The latter comment revealed just how quickly things can change in a financial sector that is being disrupted by digital innovations. In March 2018, Bank of England Governor Mark Carney slammed digital coins in an aggressive defence of traditional banking which claimed that cryptocurrencies were “failing” as money.
“The long, charitable answer is that cryptocurrencies act as money, at best, only for some people and to a limited extent, and even then only in parallel with the traditional currencies of the users. The short answer is they are failing,” he said. “Cryptocurrencies have neither intrinsic value nor any external backing.”
But in Facebook’s case, of course, Libra may be backed by the real gold: the world’s deepest mine of user data – while the network’s trolls, fakes, and hostile actors may represent an AML nightmare.
Either way, for policymakers in the finance industry all this represents a troubling shift of power. From value-free tokens backed by nothing more than hope to “systemically important” in just 18 months: an example of the speed of transformation sweeping through the sector.
Yet while it is easy to dismiss Carney’s speech as a dinosaur roaring at an asteroid, his underlying points should not be dismissed. First, the challenge with all cryptocurrencies is establishing a fair value for them – one that includes the cost per watt of mining them.
In recent years and in volatile markets, some crypto miners have found that the cost of purchasing and running expensive, energy-hungry GPU mining rigs has been greater than the market value of the resulting tokens. Many gamblers would have done better by buying shares in hardware companies such as NVIDIA five or six years ago.
Who pays the energy bills in a distributed network remains an important question, and the answer is invariably the network’s members rather than its owners. The carbon impact of distributed networks – such as a number-crunching network for a global coin – should also be a much bigger concern than it is.
Also in the frame for Carney was another issue: trust, which goes to the heart of what money is. With either a fiat currency, or a currency backed by a commodity such as gold, users trust that a coin has real value and can be exchanged for goods or services. The issuer itself must be trustworthy, while users trust that the transaction will be honoured and is secure, private, and above board.
Facebook’s poor reputation for managing privacy and security is a serious trust concern, along with its ability to authenticate users and ensure its systems are not being abused. Arguably, a token that can’t be trusted and may be ensnared in a billion advertising strings cannot be regarded as money.
Yet the banking industry itself has abused customers’ trust. High-stakes gambling is still rife in the industry, European banks have been flooded with illicit cash from the former Soviet Union, international exchange rates have been rigged, frauds have been committed and policies mis sold. Few major banks have not been implicated in at least one of these scandals.
But is Libra even designed to be a currency? A recent report on TechCrunch has cast intriguing new light on the project. Speaking onstage at a TechCunch Disrupt event, Chris Dixon, a venture partner in Libra Association member a16z Crypto, said, “My understanding is the intention was never to create a new currency. It’s much more focused on the payment rails.”
Dixon appeared to suggest that the coin may now be intended as an intermediary mechanism for international currency transfer, which offers a different perspective on the exit of digital payment specialists from the project.
He went on to suggest that, as a stablecoin, Libra could be pegged to the US dollar rather than to itself or to a basket of international currencies. In effect, it could become a tokenised dollar, largely in order to assuage the US government and regulators.
But whether Libra is intended as a global currency in its own right or merely as an intermediary exchange token is, in a sense, irrelevant. The core issues remain trust and transparency, along with Facebook’s deep links with advertisers and its apparent inability to authenticate users and prevent abuse of its systems.
So here we are. And in a networked, platform-enabled world, the emergence of a global digital coin such as Libra was inevitable. But whether a poorly designed, user-corrupted, advertising-based social network that regards its customers as product should be trusted with founding a global currency or payment platform is another matter.
But perhaps that, too, was inevitable. The world’s data bank and the world’s banking system were always going to smash together, as data becomes the real currency – or rather, the real gold – of our age. Governments crave that level of insight into users’ behaviour and the future of Libra now rests in their hands.
So the core questions must now be: Is Facebook more useful to government than it is a threat? And: Will the geek inherit the Earth? Place your bets, please – in dollars.