Crypto currencies suddenly became front-page news over the past few weeks, due entirely to the “Big Reveal” of Facebook and its proprietary “Project Libra”. The degree of hype that this one storyline has received has not been witnessed during the decade-long history of the crypto world. If awareness leads to acceptance and then full adoption by the mainstream, then Facebook in one fell swoop has boosted Bitcoin and its altcoin brethren to the forefront of public popularity.
Everyone and their second cousins have written articles on this topic, but confusion still reigns in most quarters as to what impact Facebook’s Libra token might have on Bitcoin. The misinformed have already made outrageous claims that Libra will be the death of Bitcoin and so on, but the two systems, at least the way that Libra is envisioned to be in its publicly revealed 12-page “whitepaper”, are diametrically different on at least five major counts. Whitepapers are typically well thought out documents, but Libra will not be launched until 2020. As any innovator knows, the final product that hits the street is never anything like what was originally conceived. In other words, expect changes.
Before even looking at the two crypto coins side by side, Facebook has already instituted significant organizational changes for its new “baby”. Yes, there will be many internal benefits within the Facebook infrastructure for having “Libras”, but the entity will operate as a separate corporate being, managed by a “Libra Association” that will include such names as MasterCard, Visa, PayPal, Ebay and Uber, who will ultimately manage the day to day operations, board meetings, reserve investment decisions, and ultimately profit distributions (Yes, Libra will, no doubt, be a profit making enterprise).
Why are organizational changes necessary? Although not discussed in the whitepaper, payment companies liker Visa and MasterCard confronted several legal, control and privacy issues in their evolution from privately owned associations to wildly successful publicly traded corporations. In order to avoid these problems altogether, Facebook took preemptive action. These issues fall into three categories of risk mitigation, if you will:
- The first issue is trust. Facebook has had a multitude of problems with government authorities and the public over privacy compromises of its customers’ personal usage demographics in the pursuit of corporate profit. An independent, separately owned and managed entity was necessary to bridge the chasm of complaints that could arise and thwart the Libra mission;
- Visa and MasterCard learned long ago that their banking owners had to give up ownership in order to stop the multitude of “self-dealing” lawsuits that were consuming an inordinate amount of time and expense. Better to have a separate management structure in place at the get go to blunt these types of attacks;
- Lastly, Facebook is a publicly traded entity, whose valuation is based on its current balance sheet ratios and estimates of future profit streams. Its “P/E multiple’ could be severely reduced if suddenly a “banking” type of entity were consolidated into its overall results. Bank multiples are typically under “10”, while FB currently enjoys a figure much higher. No sense in giving up high valuation criteria, if not necessary.
There will inevitably be an issue of profit distributions. We are certain that Facebook will earn a notable stream of revenue, but without the “baggage” that goes along with owning and controlling the profit generator, i.e., Libra operations and interest on its reserves.
What are the five major differences between Bitcoin and Libra, as now conceived?
Daniel Amerman, a CFA, has taken a quick read of the “Libra Whitepaper” and detected at least five major differences between the world’s favorite cryptocurrency and Facebook’s planned Libra token. He freely admits that:
The above analysis was compiled rather quickly in the first few hours after the release of the Libra Association white paper. It is based on a reading of that twelve-page white paper. Far more information is likely to come out, and the nature of Libra itself is likely to rapidly evolve based on input from governments and participants, as well as the public.
#1 – Permanent Recording and Tracking of All Transactions
Libra’s blockchain will beat to a different drummer than does Bitcoin. Anonymity will not be an attribute of Facebook’s new innovative:
So, right from the beginning, Libra is stating that they intend their new cryptocurrency to be the direct opposite of Bitcoin. It will be set up for regulatory compliance, and they intend to work together in an innovative manner with regulators to find the best ways to defeat such things as using Libra for money-laundering, or tax avoidance, or any other potential nefarious purposes that involve personal privacy when it comes to money.
In other words, Libra plans to work with all regulatory and government officials to give them and law enforcement whatever they may want. Ostensibly, this decision was necessary to “grease the regulatory wheels”, so to speak. Other cross-border payment companies like Western Union and Moneygram have been dealing with the minutia of these global regulatory details for decades upon decades. It is no simple task, and many observers think that a 2020 launch is way too aggressive, due to these obstacles alone.
Crooks will not be able to evade detection, hide their tracks, or hide within the confines of the Libra blockchain. In order to understand how this will play out, one needs to get into the technical details, which are mind numbing, but suffice it to say that Libra will not be Bitcoin in this regard. New FATF regulations, set to be approved this week in Japan, proscribe something along these same lines for other crypto blockchains, but industry executives are already trying to find an accommodation that G20 finance ministers can accept. The industry will need time and creative solutions to resolve current differences.
#2 – Permissioned Node Verification
Once again, we get into technical matters: “Blockchains are described as either permissioned or permissionless in relation to the ability to participate as a validator node. In a “permissioned blockchain,” access is granted to run a validator node. In a “permissionless blockchain,” anyone who meets the technical requirements can run a validator node. In that sense, Libra will start as a permissioned blockchain.”
As you might have surmised, Libra will be a heavily “centralized” system, while Bitcoin purports to be highly decentralized, as its originators intended. The “validators” in the Libra world will be a chosen set of entities. This group of “insiders” will be the only ones that can verify transactions. Today, the group includes Facebook, Mastercard, Visa, PayPay, Stripe, eBay, Lyft, Spotify and Uber.
#3 – “Stablecoin” Means No Monetary System Hedge or Investment Status
This bit of news is not new. Facebook’s new token was always discussed as having to be a “stablecoin”, backed by reserves, so that the value remains reasonably stable, according to some financial basket of assets. Unlike Bitcoin, there will be no reason to invest in Libra. Its value will be pegged to certain fiat currencies, suggesting that no hedge against the dilution impacts of central banking monetary policies will be present.
Per the whitepaper: “Unlike the majority of cryptocurrencies, Libra is fully backed by a reserve of real assets. A basket of bank deposits and short-term government securities will be held in the Libra Reserve for every Libra that is created, building trust in its intrinsic value. Libra is designed to be a stable digital cryptocurrency that will be fully backed by a reserve of real assets — the Libra Reserve — and supported by a competitive network of exchanges buying and selling Libra.”
#4 – Complete Tracking of All Minting & Burning
In the Bitcoin world, token supplies are controlled by “halvening” events, which restrict the supply by design to protect it from the whims of central banks and their tendencies to inflate fiat currencies via unlimited monetary creation. By design, Libra will be 180 degrees on the other side of the spectrum. The association will be in charge of “minting” and “burning” tokens, based on the buying and selling of authorized resellers.
Capital will flow in and out of the “Libra Reserve”, the basics of a stablecoin, where every token “mined” must be backed one-for-one by assets held in reserve. The blockchain design will also allow for complete tracking of every coin minted, as well. Big data will be at work, but since Facebook has insulated itself from the process, why would anyone fail to trust this new entity from leveraging the buying and selling habits of consumers. The jury is still out on that issue. Data analytics and Artificial Intelligence go hand-in-hand these days to produce profit opportunities… enough said.
#5 – Interest Income Goes To Association – Not Consumers
Now we get to the interesting difference: “Interest on the reserve assets will be used to cover the costs of the system, ensure low transaction fees, pay dividends to investors who provided capital to jumpstart the ecosystem (read “The Libra Association” here), and support further growth and adoption. The rules for allocating interest on the reserve will be set in advance and will be overseen by the Libra Association. Users of Libra do not receive a return from the reserve.”
For the sake of example, assume there is $1 trillion in the Libra reserves, and that investments in government securities pay 2.4% a year. If you do the math, there will be $24 billion on the table to divide up. Presumably, funds will be used to lower transaction fees (we have not discussed these), but the association will be opening itself up to the same litigation over consumer disclosures that plagued MasterCard and Visa, i.e., self-dealing at the expense of consumers. Good luck with this concept, and by the way, Bitcoin does not have reserves or interest. It is not a stablecoin.
Concluding Remarks
At this juncture, Libra appears to be a cryptocurrency that regulators and government officials could fall in love with, since the design features actually align well with what have been called “Central Bank Digital Currencies”.
Per Daniel Amerman:
Libra could be seen as the first real world example of the “Fedcoin” crypto alternative, that is being researched by the Federal Reserve and other central banks. Like Libra, a national blockchain currency could be verified not by independent computers, but by the central bank’s own computers. This would give the central bank or government an unparalleled degree of knowledge and control over its currency – and its citizens.
He concludes:
Bitcoin was to some extent an exercise in monetary idealism that has given rise to its direct opposite, Libra. What Libra could give rise to, how it could be used, or what could replace it – can’t be known with certainty now, but fundamental change does seem to be on the horizon.”
As we have learned from the innovative product cycle, Libra will morph many times before it ever hits the mainstream public. For now, we only have a “sneak preview”.