This article was written by Iwa Salami, a Senior Lecturer in Financial Law and Regulation at the University of East London, and originally appeared on The Conversation, a not-for-profit news site dedicated to unlocking ideas and knowledge from academic experts.
Facebook (FB +0.40%) has unveiled Libra, a cryptocurrency that will enable users to make international payments over Messenger and other group platforms like WhatsApp – perhaps from as soon as 2020.
Here's how it looks likely to work: a user would buy Libra and keep a balance of the currency in Facebook's digital wallet, called Calibra. The user could either transfer currency to another user – say a family member in another country – or purchase items or services from a participating online retailer. Apart from Calibra, users could buy and sell Libra through third party wallets or local resellers, such as grocery stores, in the same way as mobile phone owners already top up their data.
A key rationale for Libra, according to Facebook, is to facilitate financial inclusion. It would enable millions of users without bank accounts in far-flung parts of the world to transact in ways that formal financial systems have denied them. Because they could send and receive Libra on a peer-to-peer basis, without the need for a bank, the transactions would be cheaper and faster, too.
Libra appears designed to overcome a common criticism of existing cryptocurrencies like bitcoin and ethereum – that they don't satisfy three essential characteristics of money: a medium of exchange; a store of value and a unit of account. The argument goes that since they are not widely exchangeable, and since their widely fluctuating exchange values make them unattractive for storing wealth or pricing goods and services, they are not really viable as money.
Where the exchange rate of other cryptocurrencies is purely driven by supply and demand, Libra will be priced according to a basket of bank deposits and short-term government bonds in reputable currencies such as the dollar, pound and euro. It will therefore be a "stable coin"; less likely to see the same fluctuations as other digital currencies. Having said that, the new currency raises a number of issues that need to be seriously considered before it launches:
1. Facebook and data
Facebook has tried to reassure the world by outsourcing the management of Libra to an independent foundation known as the Libra Association Council. Based in Geneva, this group will include representatives from mainstream financial institutions like PayPal (PYPL 1.62%), Mastercard (MA 0.86%) and Visa (V 0.41%), who have invested significantly in this project, as well as the likes of Uber (UBER 1.65%), Spotify (SPOT 3.52%) and Vodafone (VOD 0.21%). This grouping is clearly designed to maximize participation in the new currency.
Yet Facebook's recent checkered history of data mishandling is still a cause for concern. Although Facebook assures that it would keep its users' social and financial data strictly separate, the question still remains: if it has mishandled social data in the recent past, can it be trusted with people's financial data?
2. Money laundering
Libra has huge implications for the rules around anti-money laundering. Just like any financial intermediary taking on a new customer, Facebook will have to obtain various verification details through an online form for any users wanting to set up a Calibra wallet, including government-issued photo identification.
But since users will be all over the world, how would Facebook authenticate the information provided? It was the same issue faced by Liberty Reserve, a digital currency that operated out of Costa Rica and was used by money launderers to transfer billions of dollars worth of criminal proceeds until it was closed down in 2013. Prosecutors later described it as possibly the biggest money-laundering case in US history.
Liberty Reserve operated in a similar way to PayPal, except with its own digital currency. It allowed users to register and transfer money to other users with only a name, email address, and birth date. No efforts were made to verify users' identities, and it attracted much illegal activity.
Users would wire money from a traditional bank to a third party exchanger, which was usually unlicensed and not properly regulated. This exchanger would convert money to digital currency, which was untraceable from its original source, and was then deposited into a Liberty Reserve account. No limits were placed on transaction sizes. Liberty charged a 1% service fee on each transfer and offered shopping cart functionality. All transactions were 100% irrevocable.
The investigation that led to Liberty's closure was also very problematic as prosecutors required the cooperation of numerous jurisdictions with lax rules around anti-money laundering or investigating financial crime. Although Libra will be backed by a host of blue chip companies, it looks potentially open to exactly the same kinds of problems.
3. User security
Facebook says it would bear the cost of losses arising from hacks to the Calibra wallet, scams and loss of access to accounts. But how feasible is this even for a big tech company in the face of colossal losses? Facebook or the Libra Association Council would need to accept the same requirements as any other bank to hold a certain level of capital to cover the cost of such eventualities.
4. Systemic risk
The sheer scale of this project is jaw-dropping. Facebook has 2.4 billion monthly users, while WhatsApp has 1.5 billion. Especially if Facebook leverages its relationship with 7m advertisers and over 90m small businesses, Libra is likely to be global in a very short space of time. This has serious implications for global financial stability and systemic risk.
Libra will clearly need proper global regulation, but this doesn't really exist and is highly unlikely to emerge in the next year. Would it fall to one of the bodies that coordinate international banking – the Basel Committee on Banking Regulation, the Financial Actions Task Force or the Financial Stability Board – or to an association of global central banks?
Even before this announcement, the lack of global regulation of cryptocurrencies was already a hot topic: discussions between countries and the main institutions involved in international finance are taking place to address this, but no institution has been designated to provide global oversight.
If these issues can be addressed, Libra would be poised to dominate the crypto space – and could very well become "the" global currency. In the absence of a single global regulatory regime, however, Libra will require a strong degree of regulatory coordination around the world. That is a monumental challenge. At the very least, we could be seeing the start of a major shift.
