This post is part of CoinDesk’s 2019 Year in Review, a collection of 100 op-eds, interviews and takes on the state of blockchain and the world. Richie Hecker is an entrepreneur, and management consultant at Traction & Scale.
2019 was the year of Libra rising – an attempt led by Facebook to create a new form of digital currency and banking system. Transformative in potential and huge in aspirations, Libra was the seminal crypto event of 2019. Yet, like most of the ICOs that predated it, Libra is doomed to fail in its current form. There, I said it.
Yes, I’m a big believer in the transformative power of technology for the underbanked to make it easier to save money and build credit. Unfortunately, Libra in its current form is not the solution because it offers an overcomplicated approach which will make it extremely difficult to execute. For background on where I am coming from – I have run a community with 100 million users and spent many years in financial services including working on bank acquisitions.
Facebook could create a global payments network, which can benefit users around the world. With its billions of users and experience with scaling systems, Facebook already has the basic infrastructure in place to create a transformative payments system. If you add in all of the partners lined up as shareholders of Libra, it covers the gamut of global payments and commerce and should be able to succeed.
This opportunity exists because the current banking system is closed. There are a host of regulatory licenses needed to hold, send and store money. Regulatory scrutiny is meant to ensure safety and security, to protect citizens from fraud and to prevent money laundering. But too often these controls kill competition and raise prices, leaving room for improvement in the system.
Often, consumers cannot send wires on weekends and it can take days for global payments to clear between banks. The banks themselves are developing a real time commercial payments platforms but they are not quite there yet. Banks have Zelle for real time peer-to-peer payments, and it works well, but you need to be a bank to use it. PayPal has Venmo, which works for individuals. The banks also have a B2B RTP network through The Clearing House that is live.
It is nascent but it exists and the Fed is also developing their own real time payments network called Fed Now for 24/7/365 payments. This will eventually come to life. This may make it difficult for a startup to compete long term.
So what is Libra and why is it doomed to fail?
Libra creates a digital token representing a basket of assets and a payment system designed to make it easy to send money around the world. According to the white paper, “Libra’s mission is to enable a simple global currency and financial infrastructure that empowers billions of people.”
In a way, it is Venmo with its own currency running on a new real time payment system. This payment system would be open 24/7, as opposed to the current banking system which is only partially 24/7 – those connected with Zelle and RTP.
Libra creates a phantom payment network on top of existing currencies. The phantom currency represents traditional assets like dollars and transfers instantly, and then the actual assets can settle later.
Libra says it will be backed by a basket of assets, but is not clear on exactly what assets will be inside of a Libra. This lack of clarity over what assets it will comprise will likely lead to regulatory, jurisdiction vs jurisdiction hell. Every regulator touched by Libra will begin investigating it. It is not clear if it is a currency, a derivative, a security, a commodity pool, and so on. Thus, it isn’t clear which laws apply. Jurisdictions will likely disagree with each other on this point, as they do already in defining digital currencies at home. Nation-states could easily fight over the aspects over digital money, as there does not appear to be any enacted international trade agreements that govern this type of financial arrangement.
Even after Libra works out its legal jurisdiction, it will still be very hard to create the desired benefits for its stated use-cases. Libra’s stated goal is to provide digital banking for the 1.7 billion unbanked; provide a way for people in volatile markets to hold a stable asset; and offer a cheap way to exchange money worldwide. But these benefits will be extremely difficult to achieve.
In Libra’s proposed system, banking-the-unbanked will still require full due diligence and adhering to “Know Your Customer” regulations to combat money laundering, which could result in that signing up for Libra will be similar to dealing with any bank today with similar challenges. The on/off ramps are different but the regulations are similar.
The expensive part of instituting a currency exchange is the “last mile,” which Libra cannot solve without building its own in-person network or partnering with existing retail and ATM networks. M-PESA, the East African mobile money transfer system regarded as a top system addressing the underbanked, partners with Western Union and other incumbent networks, so users can make it easier to send and receive money. M-PESA has 28 million active customers and facilitates 50% of Kenya GDP. M-PESA’s customers will now be able to send money to anyone in the 200 countries in which Western Union operates.
Libra could set up similar partnerships to withdraw cash, or enable digital transfers and simply do it at a lower cost, by introducing itself as competition. In some countries, replicating local withdrawal networks will prove challenging. The cell networks are the key gatekeepers for mobile money in the developing world. It will be hard to compete with the carriers who have an existing most and user trust. However a new offering could lead to a price war that could help customers or to Libra taking losses to subsidize growth. This is the equivalent of Western Union lowering its fees to add more value back to its customers. This could be a great value-add.
The real-cost of sending a payment is low and the cost of wholesale currency conversion is low so it is possible to do lower cost payments. If Facebook can create an internally coherent payments and consumer ecosystem, it will incur fewer on/off ramp costs. The big opportunity for Libra, aside from developing a wallet, is working with retailers and others to sell consumers products based on their net worth and spending habits. This it can do with the in-network money, without worrying about consumers breaking back to fiat.
Most countries with volatile currencies have currency controls, which they will place on Libra, essentially making it money laundering to create an inflation hedge. For example, a government could make it illegal to buy or transfer more than a government-mandated threshold of Libra each year, and therefore converting out of the local currency would be a crime. Chinese nationals are able to transfer up to only $50,000 per person per year out of the country. China could easily pass a law to say any financial asset or cryptocurrency would fall under the rule as well.
Even if Libra figures out a way to launch and achieve its stated goals, it will likely be crushed by fraud. Libra does not have a clear policy and process for fraud prevention engine or a simple mechanism to solve fraud disputes. Essentially, it creates a wild west free-for all. So, the lack of fraud controls will likely lead to a bad actor immediately creating an app to defraud people into sending their Libra to the scammer. Mobile bankers in Kenya sometimes keep all of their savings on their phone and routinely get scammed into giving up their passwords.
Libra has great promise but has serious challenges to overcome. Many of these issues can be addressed by learning one big lesson from the father of payments networks – Visa. Visa started as Bank Americard, inside Bank of America, as an internal credit system. Then it became a system licensed to other banks and finally an association owned by its members and a public company. This staging approach allowed it to grow steadily and avoid undue regulatory and political burdens until it was ready to take over.
Follow the same path of Visa. One, back Libra initially with only US dollars or another single currency. This will enable Libra to launch within the current US banking regulatory framework. If it launches inside the US banking system, it will be respected everywhere, with the possible exception of China. There are clear ways to set this up, so it would pass all regulatory scrutiny. By including other assets, Libra brings a host of potential regulatory conflicts on itself, so, even if it win regulatory approval, that approval r, willy be expensive and time consuming.
Two, the network should centralize administration, so there is an anti-fraud system in place and a clear body to communicate with for regulatory scrutiny. What Libra proposed is essentially centralized anyway, with a single database to run the system.
Facebook has such a large network that implementing a low-fee payment system would be a huge first step. They can invite others onto the platform and finally turn it into a consortium once the bugs are removed and it has passed regulatory scrutiny. In fact, Facebook already has the infrastructure for this – payments inside of messenger. They already have an anti-fraud system and it is tied to your Facebook ID.
Three, after that, Facebook can enable people to build applications on top of the existing payments system. And this step likely won’t require much additional regulatory requirements. Facebook mastered apps many years ago.
These steps, implemented properly, will make it easy for Libra to launch and avoid being shut down by regulators. The cost of these steps will be steep. They would require almost total centralization and be a continuation of their existing business. But the benefit could be fast, fair global banking.
A friend of mine once said “bring me a small island before your promise me the world.” A simpler staged approach can help Libra prosper – and deliver.
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