Understanding what Facebook's Libra is — and what it isn't

Understanding what Facebook's Libra is — and what it isn't
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When Facebook announced its own blockchain and cryptocurrency (both referred to as "Libra"), everyone from late-night comedy hosts to mainstream media outlets to regulators offered possible interpretations, implications, use cases and reasons for both encouragement and prohibition.

In order to determine the usefulness (or lack thereof) of Libra, it is helpful to quickly demystify what these things are. After all, Facebook claims Libra “will enable a simple global currency and financial infrastructure that empowers billions of people.” That is quite the goal.

Simply put, a blockchain is just a new way to verify and record the exchange of value among an interconnected set of users; it is a fancy form of accounting ledger. Each transaction is a “block” and the cumulative record of transactions is the “chain.”

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It is true that a blockchain offers benefits compared to legacy ledgers, including automated transactions, needing special permissions to access specific transactions post-facto and all users having identical copies of the record.

That said, while a blockchain may be an improved way for a network of users to track and trade anything of value, it is not a magical, revolutionary technology that can solve intractable problems.

Broadly, there are two types of blockchains: public and private. Public blockchains are open to anyone and anonymous, and, as such, require the use of native mediums of exchange (i.e., cryptocurrencies) in order to use them (e.g., if you want to do a transaction on the bitcoin blockchain, you have to use bitcoin as the medium of exchange in order to do so).

Private, or “permissioned,” blockchains do not require a native medium of exchange, as use of private blockchains require permission, and hence, the identities of all users are known.

This leads us to the fact that “cryptocurrencies” are not actually currencies at all, nor are they a magical, revolutionary technology that can solve intractable problems. They are only the native mediums of exchange required to use this or that public blockchain.

As with any emerging technology, it is helpful to focus on what problems these things actually solve, and what else exists to solve the same problem.

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Libra (the cryptocurrency) is designed as a “stablecoin,” i.e., a basket of assets will back Libra with the goal of mitigating volatility. This is a reasonable idea, as legacy cryptocurrencies experience(d) wild price fluctuations (making them poor stores of value and mediums of exchange, which inhibited use).

While Libra will be backed by a basket of fiat currencies, it is currently unknown which ones will be selected, and the fact remains that currencies are not assets; fiat currencies have no intrinsic value, just value relative to other fiat currencies.

As the relative value of fiat currencies depends on trust in the issuing authority, acceptance in transactions, reliable store of value, etc., it is unclear how the Libra will be priced and what will drive fluctuations in its price.

Furthermore, while Libra can be priced, it will always remain remarkably difficult to determine its value (as with all cryptocurrencies).

Of course, in order to use a cryptocurrency you need a digital wallet, and wallet security is notoriously poor. Wallets get hacked and drained on a regular basis, and there is no recourse for the victim.

Facebook created a subsidiary (named Calibra) specifically to manage the separation of a user’s social and financial data and “to build and operate services on its behalf on top of the Libra network.”

It is unclear who will develop the wallet for Libra, but either way, Calibra gives one pause, given Facebook’s recent data and privacy breaches.

The Libra blockchain appears to be designed for speed, scalability and transaction throughput; it promises up to 1,000 per second. Indeed, scalability has been a challenge for legacy blockchains (e.g., bitcoin and ethereum can only do 7 and 15 per second, respectively).

Should the Libra blockchain’s throughput prove reliable at scale, it would reason that for blockchain applications, Libra could be a preferred channel. The fact remains, though, that for the overwhelming majority of daily transactions, existing ledger technologies suit many (or all) needs just fine.

Additionally, as Mastercard and Visa can process nearly 40,000 and 25,000 transactions per second, respectively, will 1,000 be good enough?

Ultimately, Facebook’s expressed goal with Libra is a noble one and their intended use case (cross-border payments) is the most obvious one to tackle first.

However, curiously, Facebook already offers multiple ways to send money to anyone else with a Facebook account. Additionally, Libra appears to resemble other existing solutions (e.g., PayPal) already sufficient for the use case.

Finally, independent of its lofty, noble goals, it remains unclear in general how a ledger technology and its medium of exchange can increase access to financial services, inexpensive capital, financial inclusion and support for ethical actors (all Libra claims).

What's more, what sovereign nation would allow an externally managed medium of exchange to fiddle in its monetary policy or capital markets?

Perhaps this is not the goal of Libra, though. Since Libra (the blockchain) is permissioned, and permissioned blockchains require no medium of exchange, perhaps Facebook simply is attempting to convert a portion of its user base into payments-related revenue (the payments industry generates around $2 trillion in industry revenue per year).

Were this the case, they would not be alone; other technology and social networking companies have explored entering the financial services space over the last several years (notably Amazon and Snapchat, among others).

While I remain deeply skeptical that Libra can achieve its mission, if it is able to scale, there might come a day when Facebook becomes a payments company that also happens to offer a social network platform. This would certainly have implications for regulators and industry alike.

Aaron Fernstrom is director of the Richard A. Mayo Center for Asset Management at the University of Virginia Darden School of Business.