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There's a lot we still don't know about Libra
LAST month, Facebook chief executive Mark Zuckerberg spent over five gruelling hours answering myriad questions from the members of the House Financial Services Committee on issues such as election interference, hate speech, censorship and discriminatory advertising.
While it was an important reminder of the many dangers that Facebook already presents to our society, we did not actually learn much about the hearing's ostensible topic: Facebook's audacious plan to create an association of big businesses to issue a new digital currency called Libra.
It makes sense that elected representatives would steer their questioning towards topics that are readily relatable to the daily experiences of the voting public. But it is important that we understand Libra's many profound economic implications, especially since it appears that Facebook executives still fail to appreciate (or are intent on obscuring) them.
Libra sceptics have largely focused on consumer protection concerns and money-laundering vulnerabilities. While these are undoubtedly important issues, there are much broader dangers in creating a global payments system controlled by the world's largest social media company.
The fundamental problem is that, contrary to Facebook's narrative, Libra is not simply a money transfer scheme. Once launched, Libra will spawn an entire ecosystem of financial services and service providers - authorised Libra dealers, brokers, asset managers, custodians, exchanges, digital identity providers, verifiers and so on - whose identities and qualifications we cannot yet anticipate. These entities may be controlled by Facebook or by other corporate members of Libra Association, operate across multiple financial and commercial markets and not be subject to appropriate supervision and oversight by financial regulators.
For example, what additional financial products and "synergistic" financial services will authorised Libra dealers, or "resellers", offer? Libra-denominated loans? Leveraged investments in Libra coins or Libra-denominated assets? Derivative products referencing Libra? These lucrative activities would immediately expand the reach of Libra far beyond simple peer-to-peer payments or remittances into every corner of the financial market.
Furthermore, will the Libra Association provide some form of liquidity support for these dealers, much like the Federal Reserve does for regulated banks today? This relationship could transform Libra from a "stablecoin" into an elastic (and potentially volatile) currency. It is this type of direct access to the Federal Reserve system that both enables banks in the United States to engage in money creation and subjects them to extensive government regulation, including legal restrictions on their ability to transact with affiliated entities. Yet none of these regulatory constraints would apply to Libra dealers.
In effect, Libra would become the epitome of a "shadow" banking system (a term commonly used to describe the complex network of financial markets and institutions that replicate banking activities outside the sphere of bank regulation).
The Libra Association and its affiliated entities would function as a privately run central bank, with Mark Zuckerberg as the cryptocurrency era's version of Alan Greenspan. It is only when we appreciate this dynamic that it becomes clear how truly problematic Libra could be, and why we should take so seriously Facebook executives' unwavering commitment to plough ahead with their project.
The launch of Libra could enable a potentially significant increase in the volume and velocity of speculative activity in the financial market. Libra could quickly become a systemically important "benchmark" that would serve as the basis for creating other tradable financial instruments, such as derivatives, indexes and investment fund products.
This would not merely inject more complexity, opacity and instability into the financial system - it would also create new opportunities for fraud and market manipulation on a scale likely to make the Libor (London Inter-bank Offered Rate) scandal seem quaint.
Were Libra to grow and become a truly universal means of payment, how would its sponsors ensure that there were enough safe sovereign assets, such as United States Treasury bonds, to ensure that it has liquid and stable backing? Would they lobby the United States government to issue more federal debt? Would they start manufacturing so-called synthetic assets that track the value of real government bonds, instead of actually acquiring them? This latter option brings back bad memories of the pre-2008 growth of synthetic securitisations and other high-risk structured products that contributed to the global financial crisis. The potential injection of significant amounts of privately issued money into the financial system, without regard to the real economy or its productive capacity, would also have significant consequences for United States monetary policy and sovereignty.
Despite its claims to the contrary, the Libra Association would be effectively conducting monetary policy, both when it determines the composition of the basket of sovereign currencies to which the value of Libra is pegged, and when it acts as the "buyer of last resort" for purposes of maintaining the stable value and supply of Libra coins.
Unlike the Federal Reserve, however, the Libra Association would exercise these core central bank powers without the legally mandated public responsibilities and oversight framework of the Federal Reserve Act of 1913.
There is currently very little information about how the Libra Association will conduct its monetary operations (an inherently complex undertaking even for the most knowledgeable experts). We do not know which entities will determine the weighting of each sovereign currency in the basket, how management and governance of the Libra Reserve will work, how the Reserve's managers will ensure that its assets always maintain their value and are fully liquid, or how they will handle any potential conflicts of interest.
We also do not know what any authorised dealers - who will have the exclusive right to purchase the freshly "minted" Libra coins from the Libra Association - will charge their customers for the coins. If there are any markups, the size of dealers' markups will directly affect the price of Libra to end-users, and if there are several layers of dealers and sub-dealers, charging separate fees, then the real price of Libra will be anything but "stable". It may also become another avenue for bankers to charge their customers opaque and predatory fees.
More generally, if Libra were to become a ubiquitous global digital currency, it would fundamentally change the relationship between the Libra consortium and monetary sovereigns. Practically speaking, the exchange rates for sovereign currencies would be determined by reference to Libra, and the fluctuations in the value of Libra would be increasingly perceived as fluctuations in the value of the sovereign currencies.
Thus, if the majority of Americans were to get paid in Libra and made their payments to others in Libra, Libra would become the true "constant" value for them; its volatility would become the volatility of the United States dollar. Such a shift would give Facebook and its partners tremendous power over the sovereign governments that are supposed to oversee their business operations.
Finally, despite Facebook's talk of "financial inclusion", its plan might lead to coercive inclusion in, or exclusion from, the Libra system - and, by extension, essential financial services - for many Americans.
This type of abuse of market power can take numerous forms. Individuals' access to, or price for, Libra could be implicitly or explicitly conditioned on terms that include granting Facebook and its Libra partners greater access to personal data or purchasing other goods and services offered by these companies. Tech platforms' data-harvesting and dynamic pricing capabilities would render these practices difficult to detect and punish under the existing laws.
Availability and pricing of financial products and services within the Libra ecosystem could conceivably also be based upon some form of social scoring or loyalty points maintained by Facebook, its affiliates or partners. This would allow Libra to amplify Facebook's and other consortium members' ability to collect and monetise their customers' personal data, only partially constrained by lending, credit reporting and debt collection rules not designed with a closed-loop digital marketplace in mind.
These dangers are real, and they are serious, especially in light of Facebook's troubling track record.
Ironically, despite Facebook's self-serving appeals to anti-Chinese sentiments, China's experience offers plentiful cautionary tales of how Libra could go wrong for American consumers. If Facebook truly cares about consumer "empowerment", the company should put its formidable resources to better use by supporting a range of other proposals that pursue the same goal without creating the risks inherent in delegating critical public functions to a private tech behemoth.
Given the limited information that we have about Libra, any analysis of its implications is necessarily somewhat speculative at this point. And that is the problem. Mr Zuckerberg's testimony was an opportunity to clear up some of the confusion, but it left the public with more questions than answers.
What is clear is that the key participants in a fully developed Libra ecosystem would fit many of the legal criteria for "systemic importance". It is even more obvious that a ubiquitous Libra will make Facebook, and possibly its key partners, "too big to fail".
Thus, if the majority of Americans come to depend on Libra for their daily liquidity needs, or if their 401(k) funds are heavily exposed to Libra-denominated assets, then any significant turbulence in the Libra ecosystem could trigger federal bailout, potentially on an unprecedented scale. That makes Libra, and any of its potential reincarnations, a critically important public policy matter. NYTIMES
- Saule Omarova is a professor of law at Cornell University.
Graham Steele is director of the Corporations and Society Initiative at Stanford Graduate School of Business.