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| No surprise? Facebook leads the charge to establish a new cryptocurrency |
In June, Facebook took yet another step to show its digital dominance, while presuming it has sufficiently managed a batch of issues it has encountered in recent years (issues like privacy, data accumulation, data exploitation, and the call from politicians and editorial writers that it should be broken up).
Facebook, after leaks to the public, announced the creation of a new digital coin, Libra. Instead of observing from the sidelines the fuss and fury of Bitcoin, Ether, Blockchains, and the ferocious volatility in cryptocurrencies, it decided to join the circus by helping to create its own.
Right away, to attract attention and offer comfort to Facebook followers who might buy (or invest in) the coin, it presented a different approach.
The Libra coin, unlike other cryptocurrencies, will have value tied to a basket of bank deposits and government securities in different currencies. Hence, unlike Bitcoin, the underlying market value of Libra will be tied less to emotional and sometimes irrational supply-demand dynamics for the cryptocurrency and more tied to the value of the basket.
But before we understand the potential value and usefulness of the coin, why is Facebook doing this in the first place? Or why is Facebook leading the charge?
In almost none of the announcements has Facebook explained a profit motive, an opportunity to increase long-term revenues and expand into businesses beyond social networking--a strategy that might appeal to long-term shareholders.
But it's not an unusual ploy for large technology companies. They can't stand still; they must do research and invest in the next generation of products/services, because old products die, fade out or must evolve. Facebook the social network may one day reach a top limit in how many billions of accounts it has in place. Hence, the company, in amoeba-like fashion, ventures in many directions. A popular ploy, until now, has been to acquire smaller competing or complementary ventures and experiment with them until they contribute to growth (or they don't) (e.g., Instagram, WhatsApp, etc.).
Another popular big-tech strategy is to step beyond comfortable grounds and do something radically different and take advantage of being big: Amazon acquires Whole Foods and experiments with drones. Google introduces a smart phone and contemplates driver-less cars.
Indeed Facebook, not even two decades old, is big today. It generated over $55 billion in revenues in 2018, resulting in $22 billion in net income. Operating costs are well-managed, sufficient enough for it to spend over $10 billion in research and develop last year (a few dollars of which likely resulted in the Libra venture).
At this point, despite public-reputation woes and everybody's concerns about Facebook being too all-knowing and too powerful, the company by 2019 is generating about $7-9 billion a quarter in new operating cash flow. That helps explain why over $40 billion of cash and cash-equivalents sit on the balance sheet--cash it could give back to shareholders or cash it will likely use to fund new ventures or non-social-network growth. It's cash, too, it has to shoulder it from possible privacy-related settlements and lawsuits or to fund the promised investments in systems to ensure it has the privacy issue under control.
And now comes Libra.
In the aftermath of the announcement, critics have shared their views. (Nobel laureate and Columbia economics professor Joseph Stiglitz in late June wrote an essay lampooning it. New York Times op-ed writers have weighed in quickly.) Tech-industry watchers and market analysts have scrutinized it.
As the coin is unveiled and the system is implemented, there are questions that require answers and issues that must be addressed:
1. What will be Facebook's stated objective to account users, expected users of the digital coin, shareholders and government regulators vs. any underlying, unspoken goals (e.g., increase in account users, increase in site clicks and volume, diversify revenue sources, expand into new markets and regions, etc.)?
Will it aggressively seek to make money from this activity or present itself as a "utility"? Shareholders will question the company's willingness to step into a non-profit, utility role unless there are other expansive, important social benefits.
Initially Facebook has announced the Libra initiative will be managed through its Calibra subsidiary and Libra business operations will be separate from all other activities. The same subsidiary will be a member of the "Libra Association," which will oversee coin operations and the Blockchain.
2. Will it be able to extract and exploit data (metrics, trends, numbers, account activity, etc.) from this line of business for purpose in the core business (increase account activity and account users to attract more numbers and more effective digital advertising)?
For now, Facebook contends data culled and aggregated from Libra will be segregated and not used by the social-network, digital-advertising business model. But Facebook management will certainly need to show and prove how the separation will be enforced.
3. Will it be able to explain honestly and openly the advantages of its currency vs. other cryptocurrencies vs. government-supervised country currencies? What are such advantages?
Will there be vivid, significant advantages in its payment system vs. what exists around the world today? The company and some observers say participants around the world will welcome a system of global payments (among individuals, companies, and institutions) that is cheaper and quicker, embraces technology fully in various ways (mobile payments, etc.), and not vulnerable to cyberthreats or information leakage.
Facebook also contends the system will permit populations not able to have bank accounts to establish accounts and move money in ways they can't do so today.
4. How will regulators intervene?
When the new idea of "ICOs" (initial public offerings of new companies by issuing digital coins instead of stock and, therefore, bypassing regulators and investment bank underwriters in the process) sprouted, government regulators (the SEC in the U.S. notably) opined and offered public statements soon afterward. They explained situations ICO activity would be stepping out of beyond into realms of illegality and rationalized how the SEC must be involved.
In Libra's case, regulators will step up to review, examine and opine--especially if there is any indication that users (including individuals) would be deceived, exploited or disadvantaged in hurtful ways. As a vast payments system, it will justify intervention because of potential impact on financial markets and the global financial system.
For now, Facebook states the organization structure will be under the umbrella of a Libra Association (including other known companies like Mastercard, Uber, eBay, PayPal and Visa). Hence, it won't act alone to determine the rules and requirements of the system. The early members of the association will make cash investments to cover initial operating costs to get the system started (technology, administration, and legal expenses, e.g.). Governance will include other corporate parties, none of which are (to date) sovereign government entities (central banks, government agencies, etc.).
Just like familiar cryptocurrencies, BlockChain transactions (or Digital Ledger Technology) will be under surveillance and confirmation by designated "miners" (participants who confirm transactions on behalf of all other participants and who earn a new coin (or commission or fee) for serving in the role). The Libra Association will define how miners will be compensated.
5. Will the currency be subject to vast swings in value, unexpected and intolerable volatility?
Perhaps not, if it is possible that owners of Libra will
(a) know the value will be tied to a basket of well-known, government-sanctioned global securities in several currencies and
(b) know any holder of the currency can cash out within a reasonable time (a few days?) from the sale of low-risk sovereign securities.
In some ways, the set-up of Libra can be viewed like an open-ended mutual fund (or an "Exchange-Traded Fund" (ETF)). Libra coin holders can use Libra units for payments with other users and can choose to cash out into dollars or other currencies within a short time period.
Like an ETF, Libra coin holders can acquire and deliver among themselves. Like a mutual fund, Libra coin holders can require the Association to cash out securities to redeem units in cash.
Libra owners will have claim on a large pool of deposits and sovereign securities (including U.S. Treasury securities), but not as a source for an investment return. Interest income from the Treasury pool (after other operating costs) will accrue (at least for now) to "miners" and to members of the association. (In a traditional mutual fund, the interest income, of course, accrues to investors who own fund units.)
Libra "value" will be a function of the value of the securities basket, which in theory should not fluctuate significantly. (Within the basket, if the dollar depreciates, then the Euro or the Yen might appreciate.) The intrinsic value of the basket could be updated daily.
Because the system appears to look somewhat like a mutual fund with large numbers of purchasers of "units," U.S. regulator might have a convenient path to show the coin must be regulated. If we don the regulatory cap, we might deduce what regulators will expect to see. They could argue:
(a) "Investors" or users of the coin will require various forms of investor protection.
(b) Investor-users must be informed at all times of the value of the underlying securities that back the coin and that value should include a margin or cushion above the value of the coin outstanding.
(c) Regulators should, therefore, be permitted to review the Digital Ledger and exclude undesirable participants and approve who will act in the role of "miners."
(d) Regulators may require the "association" establish a reserve to ensure that losses from investments in Treasuries (from interest-rate swings) will not result in losses in value of Libra.
(e) Regulators may require the “association” to increase its commitment to purchase a minimum amount of the coin (“skin in the game” notion). And they may stipulate that if the organizers and administrators of the system do not perform duties, income or compensation should accrue to coin holders.
(f) Regulators, of course, will also probe for concerns about money-laundering and suspicious activity and will find a way to force Libra organizers to comply with bank-secrecy rules financial institutions must comply with today.
(g) Regulators, central bankers and politicians will argue that if the system proves to have exceptional influence on global payments and the financial system, there will be systemic risk, which must be supervised. (Could Facebook and the association one day find itself designated a "Significantly Important Financial Institution"--especially if total coin value exceeds, say, $500 billion?)
Because the “association” will be entitled to interest income from the Treasury pool, there is money to be made. That will be tied to volume. Therefore, Facebook and its association cohorts will likely seek to promote the advantages of usage of the coin. In this case, it’s not about the number of account users, but also about the magnitude of coin each user is willing to buy.
Facebook promises Libra and the social network will operate separately. No doubt, however, the social-network users will be subject to advertising from and tie-ins to Libra.
Facebook announced the project before it was ready, because of reported leaks. The implementation is still a year or two away. What wasn’t leaked (at least not yet) was projections of long-term earnings and value that could accrue to the company as a result of this expansion into a new venture. Few will believe this is primarily a venture in social justice and empowerment for the populations that don't have access to the banking system.
Tracy Williams
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