August 9, 2020

What awaits Libra from Facebook. Mass adoption or big failure?

The modern financial system is noteworthy in many ways. With a few finger movements you can open a bank account, pay a communal apartment,apply for a loan, transfer money or buy shares. However, this system does not serve everyone. There are 1.7 billion people in the world without access to banks that bear disproportionately high costs for basic financial services.

On average, international money transfer costs 7% (or more for less common currencies). Many people without access to banks live in countries whose economies are extremely volatile.

We deserve more affordable financialecosystem, and, surprisingly, Facebook wants to provide it to us. On June 18, 2019, Facebook announced Libra, a blockchain-based payment network with the expected launch in 2020, which Facebook believes will reduce the cost of international transfers and make financial services accessible to millions of people who don’t receive them around the world.

“If only 15% of 2.4 billion global Facebook users accept Libra, then it will be more widely used than the US dollar.”

At first glance, society should accept thisambitious mission. Consumers in developed countries have nothing to complain about: most of them are more than adequately served by fast and secure credit cards (providing attractive bonuses), checking and savings accounts (accruing interest and insured by the state) and digital payment systems like PayPal or WeChat Pay and Alipay in China.

However, it is clear that consumers are worried about the concentration of power in the hands of a company that has misused public confidence in its privacy practices. (although Facebook promised not to mix financial data with social data)and officials are already expressing concern about the systemic risks that Libra may pose to the existing monetary system.

So will Libra lead to a financial revolution?

Instead of revolutionizing the global financial system, it is more likely that Libra will become one of many services - current and future - that address the financial needs of the world.

Libra faces big challenges on which its adoption depends, and among them some of the main ones are as follows:

  • Obtaining government licenses;
  • Costs for motivating the adoption of Libra by sellers and users;
  • Possible third-party wallet commissions (which can undermine savings);
  • The problem of converting Libra by people who do not have access to banks to physical cash.

If Libra nevertheless reaches a large scale,it will run into governments and central banks that may feel a threat to their monetary power or financial stability. Nevertheless, it will be sad if governments and consumers do not accept Libra, which could potentially bring significant benefits to 1.7 billion people without access to banks and 266 million migrants, who are expected to send home $ 550 billion together in 2019.

To understand what Libra can become, you should study what it is, potential advantages and risks, and differences from existing payment networks.

How does libra work?

In its most general terms, Libra is a securitized digital (“crypto”) currency designed to make payments available around the world with almost zero fees.

Facebook is behind the initiative,who wrote the code for an open blockchain that will underpin the network. However, given Facebook’s 66% drop in confidence after the Cambridge Analytica scandal, Facebook made a strategic decision to decentralize control of Libra. Will manage the currency Libra association, a new consortium of large firms and investors whereFacebook will be just one site. For Facebook, this strategy has the convenient advantage of expanding Libra's potential reach beyond the Facebook ecosystem, while shifting the regulatory and administrative burden to association.

The Libra network will contain several key components:

  • Currency Libra - When a user buys Libra for dollars, these dollars go to the reserve fund Libra reserve and the equivalent amount of Libra is created, which is issued to the user storing it in a digital wallet (such as Calibra from Facebook). Consumers will be able to transfer money, makepurchases from merchants who have joined the system or cash out Libra at any time. Each Libra unit will be provided with a Libra reserve, which will be invested in a basket of low-risk assets denominated in stable currencies. (dollar, euro, etc.)to minimize cost volatilityLibra As a result, Libra cryptocurrency will be a stablecoin, in contrast to other cryptocurrencies such as bitcoin, which are not provided with anything, are extremely volatile and therefore attract mainly crypto evangelists and speculators (only 1% of Bitcoin transactions are used for real payments).
  • Blockchain Libra - In its most “pure” form, the blockchain is an anonymous and fully decentralized public registry that relies entirely on the validation of transactions by network participants (a process known as proof of work)that theoretically eliminates the need fora trusted third party such as a bank or credit card company. However, such decentralization requires concessions in terms of efficiency. Enormous computational resources and energy are required for the Bitcoin network to reach a validation consensus. As a result, Bitcoin is able to process only seven transactions per second, while Visa is able to process tens of thousands. Facebook claims that Libra will be able to process up to a thousand transactions per second due to the relaxation of some restrictions that make Bitcoin so inefficient. Instead of completely decentralizing the blockchain, Libra will be a federation (controlled blockchain) of members of the Libra Association, which will validate Libra transactions and manage the blockchain. Although users will be forced to trust this consortium, the abolition of the cost-effective proof-of-work system can significantly increase throughput, reducing processing costs and mandatory fees.

    Libra association - Facebook announced 28 founding membersLibra Association, including Visa, MasterCard, PayPal, Spotify, Lyft and others, and their total number by the launch of Libra in 2020 should reach 100. In addition to validating Libra transactions, members of this new Swiss non-profit organization will be responsible for the election of a managing director, creation of a common fund to stimulate acceptance by sellers and users (minimum $ 10 million investment) and attracting new founding members forecosystem stimulation. Members will manage Libra Reserve and receive a proportionate share of interest earned by funds that maintain Libra's cost stability after deducting costs. The Libra Association’s investment is also expected to be used to motivate partners and developers to expose clients to legal compliance procedures, such as identity verification and anti-money laundering, which can add additional inconvenience to users, but also reduce fraud compared to other cryptocurrencies. (in 2018, hackers stole $ 1.7 billion in cryptocurrencies).

  • Calibra / Wallets - Although in the open-source blockchain Libra anywill be able to develop wallets - or even applications with smart contracts - Facebook has developed its own wallet to support payments and money transfers in the WhatsApp and Messenger applications, seeking to stimulate the adoption of Libra in its huge network of 2.4 billion users. As a result, Facebook will gain a significant pioneer advantage in Libra monetization and will be able to offer additional financial services (for example, loans or investments) through Calibra, as WeChat and Alibaba have successfully done in China.

Libra and other payment networks

The global payment industry is subject to very high and growing competition and attention from regulators, especially with the transition of economic activity to the Internet.

Libra will have to compete with all other types of paymentsincluding credit and debit cards, transfersbetween bank accounts, digital payment services such as PayPal or Chinese WeChat Pay, international transfer services such as Western Union, other digital currencies and offline methods such as checks and cash (which still account for 40% of transactions in the United States).

These countless forms of payment serve a wide range of applications, customers and territories. Many firms are huge and systemically important. Why does the world need Libra?

The most direct market that Libra seems to be looking at is international transfers, an industry that charges an average of 7% commission and costs migrants $ 50 billion a year.

Controlled (or in other words inclusive) Libra blockchain may take an intermediate placebetween centralized systems like PayPal - used by 277 million people around the world, but with high international commissions - and decentralized systems like Bitcoin - whose token is extremely volatile and therefore undesirable for purposes other than speculation.

However, it remains unclear how Librawill combine the two ends of international transfers, since at least one of them is usually associated with cash. The money transfer giant Western Union boasts an extensive network of 500,000 physical branches around the world where users can send or receive cash.

Scenarios and Consequences

Libra's risk / reward ratioultimately depends on her future level of adoption. Consider the following scenarios: 1) mass adoption; 2) failure or failed launch; 3) something in between.

1) Mass adoption

For analysis purposes, let Libra receivewidespread adoption and displace a significant part of the existing payment ecosystem. It will not only simplify international transfers for 266 million migrants around the world, but also a huge part of 2.4 billion Facebook users will use Libra for everyday transactions using their smart devices. Libra Association will have to attract hundreds of members (most likely, including banks that are not yet represented)that will have to allocate billions of dollars to motivate sellers and consumers to use Libra.

Such an extreme scenario, in my opinion, is the least likely, mainly due to two limitations.

  1. First, Libra will face toughcompetition from the current financial system in developed countries. Credit cards are widely used because they offer users convenience, bonuses and access to a non-securitized loan. Consumers like bank accounts that charge interest and offer state insurance. 900 million Chinese people use WeChat Pay because everyone already communicates using WeChat and transaction fees are <0.1%. Libra is unlikely to completely push out services that bring real benefits to billions of people.
  2. Secondly, in order to reach critical proportions,Libra will have to resolve conflicts with politicians and central bankers due to economic influence. Countries with less stable economies and currencies - whose consumers can truly benefit from the use of Libra - can show a strong reaction to the threat of their financial power. In addition, global adoption will be limited due to government restrictions in China and India, which together account for 37% of the global population. Facebook and most Western social networks are banned in China, where cryptocurrency trading and ICOs have also been banned. Due to India’s growing hostility towards Western technology and cryptocurrencies in particular, Facebook has already confirmed that Calibra will not launch in India.

2) Failure or failed launch

Now to the other extreme. At the moment, Libra is just a whitepaper and test code supported by a group of large companies, which have so far made only preliminary promises (i.e., none of them wrote a check for $ 10 million). Facebook credibility plummeted and officials inThe US, Europe, and elsewhere responded quickly, expressing concern over the systemic risks that Libra ecosystem dominance may pose. There are no precedents for the massive use of blockchain technology, so regulators will act prudently.

Acceptance of Libra will depend on friendlyrelations with politicians and regulatory bodies of the world. A number of countries may impede the launch of Libra or delay it in order to prudently take more time to evaluate it or openly ban it.

However, it seems very unlikely thatLibra will be banned everywhere before it even enters the market. Libra has a valid value proposition - to allow 266 million migrants and their families to keep more earned money - and for most, if not all, countries it will be sad (and unlikely)if they openly reject a system capable ofServe genuine service to those who need it most. Officials will need to justify why they deliberately limit competition in financial services and potentially deprive their citizens of a more inclusive financial system.

3) Something average

Given the challenges of each of the extreme scenarios, the most likely outcome for Libra is something in between.

Libra may address a number of pain pointsglobal consumers, especially 1.7 billion people without access to banks. Libra may affect the cost of international transfers. It can be an alternative payment option for digital and physical retail stores, reducing the burden of credit card fees. Developers can create applications with smart contracts on top of Libra, which expands its potential applications.

However, Libra's total reach will be limited.due to the many alternatives in developed countries such as the United States, widespread mistrust of Facebook and the likely exception of China and India. Libra may launch later than 2020, and adoption may be much slower than Facebook expects.

Libra will not crowd out traditional currencies, but maybecome a valuable alternative for those who have historically been deprived of benefits. Libra will also be a critical test for the massive use of blockchain technology, which will either signal an important milestone for innovation, or show that expectations have already reached a peak.