Digital Securities: Libra Threat to Sovereign Currency?

Ever since Facebook’s announcement of Libra last June, there has been a heated debate over its legitimacy and whether it can become the future of money.

Libra is a joint venture between 28 different companies, which intends to create digital payment solutions with their online currency. At its core, Libra allows users to directly exchange funds online through Facebook, WhatsApp, or Instagram without the intervention of banking intermediaries. This will essentially enable hundreds of millions of users around the world to be able to complete transactions and send money across borders as easily as sending a text message.

 

Libra: Centralized Control

While Libra might sound like a cryptocurrency – it’s not. A cryptocurrency, such as Bitcoin or Ethereum, operates off a decentralized process that is open to any user. No central entity has control over the network.

Libra, on the other hand, is a closed system that is centrally controlled. The value of the Libra is pegged to a basket of national currencies and cash equivalents, similarly to many sovereign currencies today. Libra is currently managed by 28 major entities (such as Facebook, Visa, Mastercard, Lyft, eBay, etc.) which are responsible for processing transactions and operating the blockchain. By 2020, when Libra anticipates its launch, Facebook hopes to expand to membership to 100 entities.

This means at launch, Libra will have 100 servers, also known as nodes, to maintain the network. When compared to decentralized cryptocurrencies, this is a minuscule number of nodes — Bitcoin has almost 11,000 nodes. What does this mean? Libra’s highly centralized nature means that the firms controlling nodes will have a tremendous amount of power, sway, and insight into the new monetary system. Since Libra transactions are conducted digitally, it’s theoretically possible for these firms to get insight into how users spend money, leading to an extreme competitive advantage.

A Threat to Sovereign Currencies?

Is Facebook truly a threat to sovereign currencies? Politicians around the world certainly believe so. Many politicians are already assuming that Libra will succeed. France’s Le Maire said that “there is no question of it becoming a sovereign currency. It can’t and mustn’t happen.” Hyun Song Shin, an analyst for BIS (also known as the central bank of central banks), says that Libra needs to be dealt with by a coordinated global policy effort. Katharina Pistor, a professor of law at Columbia Law, states that “a payment system, or currency, requires a level of liquidity that no private actor can provide. Libra is a threat to the entire global financial system.”

It’s clear that a large portion of politicians around the world are staunchly opposed to Libra. However, some of these same parties are advocating for blockchain-based solutions. France has stated that a “Euro Coin” cryptocurrency could be a good idea and Germany has begun discussing Blockchain-based bonds. Not all central banks and governments are opposed to blockchain-based payment solutions. In fact, while anti-Libra rhetoric has been dominating headlines, other similar projects have been quietly growing, such as JP Morgan’s USD-pegged coin allowing for cross-border settlement or Walmart’s USD-pegged stable coin.

An Issue with Facebook’s History

Perhaps a big reason why Libra has caught the backlash of global governments is due to Facebook’s spotty history on user privacy. The limited number of nodes and the projected scale of operations means that each node could see a tremendous amount of financial and transaction-based information on users. This is especially if Libra gets adopted by tens or hundreds of millions of users. For lawmakers, the primary question and concern around Libra becomes, “can we trust Facebook with our money and data?”

This question can be broken down into a few parts. First of all, if Facebook’s Libra grew so large that most of the world’s transactions rely on Libra, how do global governments manage Libra? Libra can likely become too big to regulate. Since just 100 corporations operate the coin, no single government (or Facebook itself) can feasibly enforce regulatory wishes across the board. If Libra in the future becomes that big, simply voting to remove a fiat currency from its “reserve basket” can cause colossal devaluation in that currency. It becomes a weapon that Libra can use against sovereign governments.

The second part of the question focuses on Facebook’s failure. If much of the world’s transactions come to rely on Libra, what happens if Facebook declares bankruptcy? Would global governments have to bail out Libra/Facebook, like the US Government bailed out banks in 2008? More importantly, who would be responsible for putting up the capital?

Finally, buried deep in Libra’s whitepaper are two sentences that imply Facebook’s real goal: to set the standard for global digital identities. These two sentences are likely why global lawmakers are opposing Libra so staunchly. We already know just how damaging Facebook’s data harvesting can be. If Facebook were to scale up and become the digital identity standard, it could have access to an unprecedented amount of personal information.

This concern over privacy and distrust of Facebook is a tremendous barrier to Libra’s acceptance. A joint statement published by the UK Information Commissioner’s Office (ICO) and privacy commissioners from around the world shared reflect this sentiment. The statement points out how Libra’s information handling practices fail to completely secure and protect the personal information of users.

 

Libra and its Future

From a financial perspective, Libra can only become a threat to sovereign currency if it were to grow to a massive scale extremely quickly. Currently, Libra is just a digital payment option that will greatly streamline what people and institutions use today. It’s the future implications that spell dire consequences for global governments.

Lawmakers anticipate this, which is why central banks are rushing to erect safeguards that prevent Libra’s potential “too big to fail” and “too big to regulate” status.

Complicating this process even further is the world’s trust in Facebook’s privacy policies. Even though Facebook has repeatedly stated that it keeps user information and customer information private, the firm’s track record fails to inspire confidence from lawmakers. Part of a senate hearing in the US argued that if Facebook can’t be trusted with user data, how can it be trusted with finances?

In the end, Facebook’s Libra is only a threat if it can proliferate rapidly to the point that it becomes comparable to national currencies. Whether or not this happens depends entirely on Libra’s acceptance by each nation. At the moment, government opposition remains strong. Fortunately, projects similar to Libra may have a chance to succeed where Libra fails.

 

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