Is Facebook a Supernation?

Facebook increasingly resembles, and is potentially more influential than, many nation-states. It is now minting a supernational currency.

Facebook Engineering, “Visualizing Friendships”

The nation-state has been the most powerful social structure ever created. Millions of people connecting over one reason or another to draft laws governing a societal network. Reasons for network organization can be as arbitrary as belief in inalienable rights, or common language, geography, economy, etc. As a result, bureaucrats and autocrats, elected or not, coordinate to draft laws to influence communications, administer social organization, build infrastructure, and make economic decisions for their society. In turn, the decisions of the few come to affect the lives of many, for better and for worse.

Facebook oversees a platform that influences communications, administers social organization, builds infrastructure, and makes economic decisions for the most gargantuan societal network in all of history. While beholden to corporate shareholders, and kept in check by some U.S. and European regulators, Facebook is encountering many of the conceptual territories and existential obstacles traditionally upheld by the nation-state:

Inalienable rights, infrastructure, foreign policy, and now money

Economically, Facebook’s current market cap of 528.94B would approximately equal Sweden or Poland’s total Gross Domestic Product of 2017 (World Bank). However, unlike Sweden or Poland which mint the Krona and Zloty currencies respectively, Facebook has not minted its own currency. That is about to change.

Facebook’s foray into money creation will influence hundreds of millions if not billions of users, worldwide. Interestingly, similar to the Swedish Krona or the Polish Zloty, Facebook may operate a monetary regime that resembles that of the world’s Central Banks. If initial reports are true, then according to the New York Times, “Facebook could guarantee the value of the coin by backing every coin with a set number of dollars, euros and other national currencies held in Facebook bank accounts.” For reference, the value of the Swedish Krona is backed by the following reserves:

Riksbank Reserves by Percent, 2018

Foreign exchange reserves are held, sold, and rebalanced for a variety of macroeconomic reasons and national goals. Often reserves backing a national currency such as the Krona are not directly pegged, as direct pegs introduce the threat of speculative currency attacks or balance of payment crises.

Drawing from initial reports, Facebook’s main goal will be simply to ensure price stability for its currency. Facebook is attempting to create a unit of account on a digital ledger- perhaps on a publicly distributed ledger a.k.a blockchain- that is “pegged” to the value of a basket of national currencies. Similar to how Central Banks buy and sell various FX Reserves in order to stabilize the core currency, Facebook will conceivably operate in a similar manner.

In the cryptocurrency world, stabilizing a digital unit of account against a national currency makes for what’s called a “stablecoin”. With regard to the U.S. dollar, the current ideal candidate for providing the reserve basis of a stablecoin, a prototype system has been pioneered by Mark Zuckerberg’s nemeses: with the Winklevoss Twins’ creation of the Gemini Dollar:

Gemini Dollar Examination Report, April 2019

Backed 1:1 in a publicly audited manner for GUSD in circulation vs. USD reserve balance in bank accounts, the Gemini Dollar posits a number of potential innovations over the legacy monetary system: such as near-instantaneous, 24/7/365, cheap, and global transfer. Traditional systems for money transfer like SWIFT or Fed Wire only operate during business hours, can be expensive and burdensome to use, and can take many days to process.

A surface-level business model for Gemini’s Dollar, therefore, is that custodians can harvest interest on the bank account reserves at the current U.S. Federal Funds rate of 2.5%. Actual Gemini Dollar users outside of Gemini defer the interest as a fee for using the service to Gemini as custodian. Similarly, Circle, another major cryptocurrency firm which issues the USDC stablecoin, has announced intention to profit from and maintain reserves by “investing these fiat funds in highly-liquid, AAA-rated fixed income securities.

Facebook’s stablecoin plan goes beyond the tried-and-true stablecoin model of maintaining stability via 1:1 USD reserves or augmentations by AAA-rated fixed income securities (which also is essentially backed by the strength of the U.S. economy in a similar way as USD itself). When Gemini buys or sells the underlying Dollars across State Street-backed accounts (one of the oldest banking institutions in the world today), it is a relatively risk-averse and manageable business process. The 2.5% annual interest received by Gemini brings the venture closer to profitability.

On the scale of macroeconomics, the United States is the strongest horse in the race. Therefore, Facebook’s plan for a more diverse reserve regime with other currencies such as the Euro may be fraught with long-term peril. As the United States is currently the healthiest major economy, it also maintains the highest interest rate of all, unlike the Euro which is subject to Zero and Negative interest rate penalties. Furthermore, the U.S. Fed rate of 2.5% for the strongest national economy in the world, is still at unprecedented lows following a decade of economic prosperity.

Central Bank Interest Rates custom chart, created on Tradingview using Quandl

In the global race of the bottom of Central Bank interest rate policy, the United States Dollar is the only remaining viable candidate for a stablecoin peg. Attempting to maintain a stable peg-to-value for a Facebook coin against multiple national currencies will require maintaining and navigating global interest rate environments on a scale as grand as Central Banks. As second place interest rate leaders like Australia and Canada re-entertain cutting rates, and Europe ventures further into Negative Interest Rate territory, the U.S. Monetary Regime will start to feel lonesome.

So let’s say 1 Facecoin always equals 1$ + 1€ + 1¥ as declared by Facebook in a hypothetical future. Representing a truly global currency (backed by 1:1:1 reserves Dollars, Euro, and Yen), Facecoin can be transferred globally, instantly, and is easily redeemed into traditional bank accounts so long as all parties have provided KYC identity information on their Facebook account.

Let’s then assume that most redemption happens natively on Facebook: I am a German citizen, and I have racked up One whole Facecoin for the month of May by being rewarded for what I normally do: scrolling my Facebook feed and watching the occasional targeted ad.

In order to combat the public relations Achilles’ Heel that the “User is the product”, Facecoin is not just a global payments system; It is also the new framework for directly passing its corporate value to millions of users.

As a result, hundreds of millions of global Users now receive a degree of “Universal Basic Income” paid for by advertisers, with Facebook as the mere middleman. As the WSJ has reported, Facebook is considering such a described system, which at first glance is very similar to the Basic Attention Token model. Typically the realm of governments, Facecoin may ultimately become the most democratic and widespread redistribution of wealth in history.

Anyways, let’s assume that after a month of scrolling Facebook, I’ve accumulated One Facecoin, which represents One Yen plus One Euro plus One Dollar. As I do not care about Yen or Dollars since I am a German citizen, I only care about redemption in Euros. Therefore, I plug in my European bank account information to Facebook, verify my identity by providing my ID card, and proceed to redeem my Euros. There is a small fee for the process, and I receive 1.75 Euros sent from Facebook to my traditional bank account. On a small scale, this process is entirely manageable by Facebook.

But what happens if Germany undergoes an economic crisis, and suddenly millions of German citizens are selling all of their Facecoins to redeem in cold Euro? Suddenly the Euros in Facebook’s pegged reserves are being depleted at a much faster rate than the Yen or Dollars held across Facebook official accounts. In order to maintain the 1€ aspect of the Facecoin peg, Facebook suddenly has to buy a lot more Euros, which are now expensive and are essentially being subject to a “run on the bank.” Either Facebook incurs the expense to maintain its treasured 1 Euro aspect of the peg, or it lets it fail. Either option is catastrophic for Facebook’s business.

This is an oversimplification that lays the metaphorical groundwork for one of the biggest existential threats in the macroeconomy: Balance of Payments crisis. Regardless of a full-fledged Run-on-the-Bank type crisis, there are many other ways for a Central Bank to encounter a Balance of Payments issue.

Of course, Facebook will hopefully be smarter than Central Banks of the past, and will not “peg” Facecoin to the values of multiple currencies at once. Despite initial reports.

Initial reports can only be left to speculation, but at first glance, it is logically unnerving to anyone with a basic knowledge of macroeconomics. Regardless of a German crisis or a simulated “run on the bank” scenario, it will be incredibly expensive for Facebook to maintain and balance FX Reserves. While there may be downstream business profits that are not currently considered, it will be hugely expensive to continuously buy and sell FX reserves across multiple banks and currencies.

Navigating interest rate environments between multiple national currencies means that holding and transferring some currencies will be much more expensive than others. Holding 1:1 USD reserves may make sense as Facebook can harvest profitable interest. Yet the Yen and Euro currencies are subject to monetary suppressions such as Negative or Zero Interest Rate policies. That is the reason there are currently no Yen or Euro stablecoins on the market, as Hasu has pointed out:

When there’s no interest, on the other hand, there’s no business model. So as a result of the zero interest rate policy of the BoJ and ECB, there is no competition for a EUR or JPY stablecoin.

In a true black swan scenario, even the Dollar may one day be subject to Negative Interest Rate policy. As of now, however, it likely makes more sense for Facebook to peg their stablecoin 1:1 to the USD alone. In a way similar to Gemini, perhaps augmented by AAA-rated fixed income securities in the same way as Circle. Granted, such a USD system may be difficult for international redemption, and is therefore at odds to some of Facebook’s ideals of a global currency, especially in countries with strict capital controls.

A potentially interesting alternative route could be for Facebook to also hold digital gold, a.k.a. Bitcoin, as a proportion of their FX Reserves. Just as Central Banks such as Sweden always hold a meaningful proportion of Gold to back their currency reserves, Facebook could pioneer Digital Gold as a basis for the future of Central Banking. In the end, a multiple national currency reserve, perhaps partially consisting of Bitcoin, may be possible so long as Facecoin is not directly pegged at value.

I am afraid that Zuckerberg, however, the primary stakeholder of Facebook, would never want to enrich his rivals the Winklevoss twins by announcing Facebook’s embrace of Bitcoin (the Winklevoss are famous early-adopters and proponents of Bitcoin, likely funded by their Facebook lawsuit fortune). If this is not a roadblock, Bitcoin could potentially be a significant and intelligent candidate to augment USD reserves:

Prior to accumulating Bitcoin, the announcement itself would inherently boost the value of such Bitcoin reserves. In the event that Facebook underlies a truly Global Economy, optionality for redemption will be incredibly important for Users. In the event of a local Economic crisis, let’s say a European Debt Crisis, when suddenly millions of Europeans are trying to redeem their Facecoin for Euros, optionality could potentially depressurize a looming Balance of Payments crisis.

Rather than simply redeeming Euros, many European users may instead redeem for Bitcoin, which was in itself created as an alternative to the 2008 Financial Crisis. The option to redeem for Bitcoin instead of Euro would depressurize exorbitant and sudden Euro demand.

Facecoin has the ability to drastically shift the World Economy as we know it. I am greatly curious to see how their project develops, and to see how its implementation differs from initial reports. If Facebook is truly so ambitious in its plan to re-architect Global Central Banking, it should be ready for future Financial Crises. In the end, Bitcoin may be worth considering as a means for reserve diversification, especially as a substitute for Zero and Negative interest rate-ridden Euro and Yen currencies.