Why consumers must beware Libra
Business promises of new and better services have a way of succumbing to the siren song of profits. When cable television first began, consumers thought fees would ensure programs without ads. Long ago, frequent flyer miles could actually be redeemed to get airline tickets. But that was then. Corporations today have a way of reneging on deals that seem too good to be true. So buyer beware the new Facebook money known as Libra.
Libra is a cryptocurrency that will be managed by the Libra Association, an organization owned by numerous corporations led by Facebook. Libra is a cryptocurrency that will be bought, sold, and traded using an official approved mobile app. Libra is not the cryptocurrency of your grandfather. The Facebook sales pitch is that, because Libra is backed by assets, it will hold its value better than dollars or euros and will be cheaper to use than existing bank accounts. Call me cynical, but this Facebook money could very easily be the incarnation of cable television and frequent flyer miles.
The official white paper explains that Libra pays no interest to those that own the cryptocurrency but requires owners to pay fees to do anything with Libra. This cryptocurrency looks to be a gold mine for Facebook and the other Libra Association members with the gold mined from the wallets of the unfortunate souls who decide to switch to using Libra as currency.
To understand Libra user fees, you have to understand how Libra works. Firms will provide consumers with virtual wallet services for their Libra through internet accounts where consumers hold and trade their Libra, which will not pay interest. Libra wallets will not be federally insured, so consumers will be out of luck if someone hacks their Libra wallet. If firms do not charge a fee for managing a Libra wallet, they will probably sell customer data in order to cover costs and make a profit.
Consumers must buy Libra from an authorized reseller in a transaction similar to buying a security. Here come the fees. It will cost more to buy Libra than to sell Libra. The reseller pockets the “bid ask” spread, which will vary with demand. If everyone wants to sell Libra simultaneously, resellers will offer to buy Libra at a much lower price than if there were many willing Libra buyers. Unlike getting money from a bank, the dollars you receive when you cash out Libra will depend on how many other people are waiting in line to buy or sell Libra on the day you cash out.
Once you own Libra, you can use it to buy stuff or pay bills online by transferring it to another Libra wallet. The transfer of Libra requires the services of a validator that also charges fees. You need to designate the maximum fee you are willing to pay to process the transaction, and the validator may refuse to process it unless you increase the specified fee.
Because Libra promises to be backed by a basket of assets in different currencies, minting a new Libra coin incurs all of the costs of buying the reserve assets. Moreover, the financial assets that back Libra will regularly mature and need to be replaced in a process that must be managed. The manager must be paid and the fees add up. It is unclear that buying and transacting in Libra will end up being cheaper than using existing bank accounts. The irony is that Libra may not have to be cheaper to catch on.
The lure of Libra is its ease of accessibility through a mobile app. There is a whole generation that has grown addicted to mobile apps, and most people have learned to hate bank fees. Libra will have instant appeal for many. But the fees to use Libra will be high and mostly hidden until a consumer starts using Libra. Once adopted, Libra will be expensive to cash out. History shows that people are slow to change financial service providers, even when they are faced with strong incentives to do that.
In the short term, the transaction fees may be subsidized by the Libra Association to attract users and get Libra up and running. Indeed, this seems to be part of the agenda. In the long run, Libra provides an ideal platform for Facebook and the other founding members of the Libra Association to harvest transaction fees from Libra users and pocket the interest paid on reserve asset balances. In the end, it will be far safer and cheaper for consumers to continue using dollars in the banking system.
Paul Kupiec is a resident scholar at the American Enterprise Institute.