The Libra Rationale

One assertion that I’d like to make is that finance is one of the most innovative sectors of the economy.  It’s more innovative than almost any other industrial sector.  People like to poke fun at accountants, bankers, and economists but the financial services industry is the fastest moving industry in the world.  This is the hopeful part of cryptocurrency.  Digital currency married with software ought to speed financial innovation that will benefit more people and lift their lives up.

Read this white paper put out on the Libra coin by Facebook.  As a guy that participated in futures markets for 30 years, I had a little trouble with some of the framing behind the Libra idea. The paper leads off with a “Problem Statement”.

All over the world, people with less money pay more for financial services. Hard-earned income is eroded by fees, from remittances and wire costs to overdraft and ATM charges. Payday loans can charge annualized interest rates of 400 percent or more, and finance charges can be as high as $30 just to borrow $100.4 When people are asked why they remain on the fringe of the existing financial system, those who remain “unbanked” point to not having sufficient funds, high and unpredictable fees, banks being too far away, and lacking the necessary documentation.

Okay fine, but this isn’t a problem that has to be solved with a cryptocurrency.  There are plenty of efficient ways to solve it without using a cryptocurrency.  A root cause of the problem is public policy.  Anti Money Laundering Know Your Customer (AMLKYC) rules in countries keep people from being able to bank.  The opportunity cost of getting rid of AMLKYC is to give free rein to people who engage in nefarious activity.  There is a reason those regulations are in place.

We invested in Pipit to solve parts of the problem that Facebook identifies.  They can use fiat currency to help the unbanked “bank” and pay bills at home. It’s an ingenious solution so that banks can establish relationships with people who might not otherwise qualify for banking services.    Western Union charges an arm and a leg to move money.  Pipit charges 1.5% and uses a secure established network to move it.  When we invested in Pipit, we looked at blockchain as a solution.  It certainly could be but the educational hurdles for using crypto are pretty high.  Maybe Facebook solves those. On the other hand, if you are an unbanked person are you going to have more confidence in Libra or a US Dollar, Euro, or British Pound?  Sure, it’s early and it is certainly possible but I don’t buy the humanitarian tone of the Facebook announcement.

My friend Howard Lindzon identifies why all this action is taking place.  It’s not altruistic.

$1.1 billion in ATM fees.
$2.3 billion in maintenance fees.
$5.4 billion in overdraft fees.

Facebook claims they will have a decentralized chain but I find it hard to believe.  They are a walled garden and by allowing transactional finance on their platform they make the walls higher.  I can see why any company would have their mouth water when they look at fees like that.  Of course, there is a cost to establishing and maintaining a secure network to transact on.  The cool thing about blockchain is that it seems like that can be done in a more cost-effective way than the current centralized networks.

Facebook is going to have a permissioned chain.  It will have an organization overseeing it.  Doesn’t seem decentralized.

Here is another framing problem I have with Libra.  In their white paper, Facebook states that they are creating a reserve, and want Libra to be a “stablecoin”.   That way, when you buy your cup of coffee with Libra the cost will be predictable just like it is with a Euro or US Dollar.  The WSJ quotes Wake Forest law professor Raina Haque, “What makes this better than what exists?”   They have a centralized group of people administering it.  Sounds like a central bank to me.

Stablecoins were created because the underlying cryptos were so volatile.  They are pegged to fiat currency.  Why not use digital fiat currency?

Here is the thing.  Bitcoin isn’t that volatile anymore.  Sure, the price rises with demand.  But, the intraday volatility is lower than it was. When futures were listed on Bitcoin, the volatility was sucked right out of it.  Futures have been around since the Japanese used them for rice in the 11th century and they work really well for managing risk and giving predictability to price inputs.  If you are paying attention, open interest and volume are increasing in the futures market which is a good thing because that provides a base for a lot of other financial innovation.

Currencies fluctuate in value all the time.  The worldwide FOREX market is measured in the trillions of dollars daily.  Underlying goods and services also fluctuate in value.  The price of coffee beans changes daily.  Producers and suppliers incorporate that fluctuation into their operations.  Shocks to those prices occur when interest rates change, or public policy goes awry.  When a country issues too much debt and can’t pay for it, the only solution is to deflate the value of the currency which causes inflation.  Check out what socialism has done to Venezuela for an extreme example.  Or, just look what Argentina has done over the years.  Or Zimbabwe.  Facebook is going to select a basket of fiat instruments to peg Libra.  I am not sure that is any better than what already exists.  FOREX markets are incredibly efficient.

The true promise of decentralized crypto is the same as the promise of competitive markets have had since two men traded resources at the dawn of time.  It can allocate resources to places where assets will get the best return. It has the potential to bring transparency to places that are opaque.  That creates efficiency and drives down the cost of goods and services so more people have access.

What we need in the world is for people to understand how decentralized free markets solve problems better than centralized bureaucracies.