Daniel S. Alter is a Shareholder in the New York, NY office of Murphy & McGonigle P.C. and is the WLF Legal Pulse’s Featured Expert Contributor, Legal & Regulatory Challenges for Digital Assets.
Some people like camels. And some people especially like a clever camel that can wedge its nose under a tent. Those people would like what Facebook and the Libra Association are trying to do now.
In the spring of 2019, Facebook led a consortium of 28 financial companies in announcing the creation of a new blockchain global payments system based upon a universal cryptocurrency called the Libra. Libra was presented as an uncorrelated stable coin (that is, with a value not tied to any particular fiat currency), that would be fully backed by an investment reserve of multiple fiat currencies and high grade, short term securities. Among other benefits, the system promised to eliminate currency-exchange risk and thereby foster an international marketplace.
The news didn’t go over so well. Concerned that Facebook’s global market penetration of approximately 2.4 billion monthly users and the social media company’s reputation, financial regulators became concerned that the Libra Network could quickly become a systemically important financial institution that might adversely affect financial stability around the world.
Congress was having none of it. In a series of back-to-back Senate and House oversight hearings last July, U.S. legislators essentially put the kibosh on Libra. But not for long.
As one crypto-industry expert reportedly observed, “Facebook has spent a lot of money and a lot of resources on this initiative” and it needed “to get something off the ground.” Hence, within ten months, version 2.0 of the Libra white paper (Second White Paper) was conceived and published by the Libra Association in early April. The Second White Paper identifies four “key changes” to the design of the Libra Network, which are intended “to address regulatory concerns.” These include:
- Offering single-currency stable coins in addition to the multi-currency coin.
- Enhancing the safety of the Libra payment system with a robust compliance framework;
- Forgoing the future transition to a permissionless system while maintaining its key economic properties.
- Building strong protections into the design of the Libra Reserve (e. reserve of fiat currency backing Libra stable coins).
The first change is perhaps the most important because it purports to address Libra’s potential threat to global financial stability. It is also the most opaque. And, upon close consideration, one could conclude the change is little more than lipstick.
According to the cover letter for the Second White Paper, the Libra Association’s “vision has always been for the Libra network to complement fiat currencies, not compete with them.” Yet, it also recognizes “the potential for the multi-currency Libra Coin (≡LBR) to interfere with monetary sovereignty and monetary policy if the network reaches significant scale and a large volume of domestic payments made in ≡LBR.”
In response to that concern, the Libra Association proposes to launch the Libra Network “by including single-currency stable coins in addition to ≡LBR,” such as LibraUSD (≡USD), LibraEUR (≡EUR), LibraGBP (≡GBP), and LibraSGD (≡SGD). Each of these single-currency coins would be fully backed by separate portfolios of their respective fiat currencies and securities denominated in those currencies. In turn, the multi-currency Libra coin would be cumulatively backed by the very same assets, making ≡LBR “a digital composite of some of the single-currency stablecoins available on the Libra network.” So designed, “≡LBR will not be a separate digital asset from the single currency stablecoins.”
The beauty of this proposed modification, says the Libra Association, is two-fold. First, people and businesses in countries that have a single-currency stable coin on the Libra Network (e.g., ≡USD, ≡EUR, or ≡GBP) will be able “to directly access a stablecoin in their currency” for domestic transactions. Second, the multi-currency Libra “can be used both as an efficient cross-border settlement coin” and—in countries that do not yet have a single-currency coin on the Libra Network—as “a neutral, low volatility option” for domestic transactions.
But this redesign still seems problematic, in part, because the Libra Association has addressed only certain aspects of the concern regarding Libra’s impact on global financial stability. For example, by introducing single-currency stablecoins into the Libra network, the Second White Paper tries to allay fears that “Libra could increase instability in developing economies, if people were to switch from the local currency en masse.” It does not speak, however, to the serious concern voiced by Federal Reserve Board Chairman Jerome Powell—that the Libra Network could quickly become a systemically important financial institution “due to the enormity of Facebook’s user base.”
In fact, to appreciate the potential risk that Libra could still pose to global financial stability, you need only consider Libra’s anticipated use as the “efficient cross-border settlement coin” touted in the Second White Paper. One source estimates that the value of cross-border payments worldwide in 2020 will be approximately $26 trillion—$23.21 trillion in corporate payments and $2.83 trillion in retail payments. Thus, were the Libra Network (through Facebook’s ubiquitous presence) to corner even a fraction of the cross-border payments market, it would surely become a systemically important financial institution.
There is another possible flaw in the Association’s plan for single-currency stablecoins. It assumes that people will use them. Even the Second White Paper expressly recognizes that single-currency stablecoins “may add complexity for wallets, exchanges, and merchant solution providers” because “exchanges will need to maintain sufficient liquidity across multiple digital assets rather than just one” and wallets “will need to handle cross-currency use cases, such as sending remittances.”
“Complexity” is simply another way of saying laden with unnecessary costs and inefficiencies. With that understanding, the essential question becomes obvious: what economic incentives are there in a more “complex” Libra Network for users of single-currency coins to indulge those costs and inefficiencies if they can avoid them by using ≡LBR? The Second White Paper doesn’t adequately answer that question.
These critical observations should not be read as an indictment of Libra. The concept embodies a paradigm shift in the global economy, offering potentially invaluable benefits at every level. At the same time, though, Libra undeniably challenges established frameworks of monetary sovereignty. Striking an acceptable balance between the introduction of a new economic world order and sound regulation will require additional technological and legal innovations—work that urgently demands Congressional attention.
Any project of this magnitude requires a large tent in which to invite people of different viewpoints and expertise to vet their ideas openly. And though camels may be welcome too—indeed, vitally, important to the effort—they must always enter through the front door for all to see.