The existential threat of Facebook's digital currency
Facebook’s recently launched Libra promises a lot: a new construct made up variously of a virtual currency, a payment system, a digital wallet, a remittance service, a new financial-intermediation vision ... and a whole lot of rhetoric about the liberation of roughly 2.6 billion people from the thrall of traditional banking.
In the white paper behind the announcement, Facebook provided details on the things it knows well. For example, much thought is given to software in hopes that someone will figure out how to build capacity on what the fine print describes as this financial prototype.
But for Libra to be a robust product with the capacity to both cross-sell Facebook services and handle the thousands of transactions a second its ambitious flaunt anticipates, Facebook or — more likely — global and U.S. policymakers need to quickly determine whether Libra is more than an astute way to bypass growing U.S. antitrust, privacy and content-regulation challenges.
There’s even more at risk than election integrity, personal privacy and the free flow of information. If Libra springs free and becomes a major financial force, then the household savings of vulnerable consumers and the stability of global finance are on the line.
Libra’s coin of the digital realm is founded on what is usually described as a “basket of currencies.” But what’s in the basket? Libra is said to be a “stablecoin,” making it better than a bitcoin because, as Facebook promises, its medium of exchange (i.e. new currency) won’t gyrate wildly like other virtual currencies. This works well in virtual-currency trading venues but is it a medium of exchange in its own right?
Even a simple basket of currencies akin to the International Monetary Fund’s longstanding currency benchmark fluctuates daily, even by the second, based on volatile exchange rates. The value of a fixed fiat currency such as the dollar is that: except for inflationary effects, its value is fixed immutably for exchanges within its own currency framework. Simply put, a dollar is a dollar through which you can buy and sell what’s worth a dollar; even if the dollar in comparison to another currency is worth more or less than it was a moment ago. Indeed, the dollar is a reserve currency precisely due to its stablecoin value and trust that the U.S. will not set exchange rates for political expediency.
Moving away from a single, fiat currency raises a lot of questions for monetary policy should Libra cut loose. But it’s also a critical safety-and-soundness question. Who picks what is in Facebook’s basket and how much volatility might result? Who wins or loses based on what’s in the basket? Theoretically, a global Libra balances everyone’s interests across each national fiat-currency regime.
Practically, users in each nation might take considerable exception if its citizenry loses its shirt vis-à-vis the hometown coin, based on decisions made in Switzerland by Facebook and its partners. When a citizen trades in the currency market, his or her proceeds are fair game, as most nations recognize. When a national household-payment system depends on a supranational entity, it’s quite another.
Libra’s basket gets even more fragile because Facebook says it might value its Libra currency based not only on a currency basket, but also on allowing investors to hold a handle or bit of the basket’s bottom by taking a stake in the exchange medium. And then, perhaps, even trading in it. This raises myriad questions:
Whose funds would be involved? On what terms could they be redeemed? Are investors limited only to Libra’s members who build the reserves that appear to fund the transactional basket? How much liquidity risk is for whom? Is this a security or some form of a mutual fund? Is Libra a trading platform? Who’s in charge of some or all of this?
Further, Facebook suggests it could also include bank deposits. Or, perhaps, the basket and the funds in it from investors would become a bank deposit. Whether the basket is a liability to Facebook in terms of being an instrument that accepts third-party funds for safekeeping, or an asset because funds are on deposit with one or more regulated banks in multiple currencies in the basket, remains to be determined.
What happens if a payer doesn’t actually have the funds sent through the system but Facebook promises to pay because Libra is a deposit on which payees may draw? Conversely, if Facebook is a depository, are depositors on their own?
Facebook does say that its new subsidiary, Calibra, would run all this in a regulated fashion. But it’s unclear who would regulate Calibra and for which transactions, customers and in what countries. Any big bank will say this raises a lot of not-so-minor operational and legal-risk considerations as well as recovery-and-resolution challenges.
This brings me to one final caveat: What happens if something goes wrong in the single operational infrastructure behind Libra within its vast reaches of Facebook’s empire?
Global regulators are deeply, and rightly, fearful that concentrated operational risk creates single points of failure with sweeping systemic consequences if too many counterparties or customers rely on a single system. Understanding this, Congress created “financial-market utilities” in the Dodd-Frank Act and targeted them for top-down systemic regulation.
Libra has a long way to go before it’s as essential to global or U.S. finance as designated infrastructure and utility companies. But now might be a good time to be sure that a system with Libra’s ambitions is tempered by advance thought about its infrastructure implications and all of the potential risks.