Libra: Facebook’s Push to Disrupt the Financial Industry

Innovation inside a large technology company

Facebook launched Libra to a less than stellar reception, but if you cut through the noise and focus on the underlying structure and organization, Libra is something to be admired as it seeks to mainstream cryptocurrency. However, don’t take it from me, I first heard about the launch of Libra from Fred’s blog post, and one section sums up the expectations for the whitepaper.

We believe Libra has the potential to be the catalyst that brings the entire cryptocurrency and crypto asset market into the mainstream. When USV invested in Coinbase in early 2013, our rationale was that digital currencies and digital assets (like Bitcoin and beyond) were a breakthrough technology, similar to TCP/IP, HTTP and SMTP. But we also knew that it would take significant investment in the surrounding infrastructure to make them useful for businesses and consumers, just like it did with the Web back in the 80s and 90s.

This post is going to investigate whether or not Libra will hold up to its vision, by diving into Libra’s white paper, then provide arguments for and against Facebook’s move into cryptocurrency. I want to highlight that two discussions are happening within this analysis. My intent is to separate the technology from the company and to keep the commentary on its underlying concept free of bias. But before we get to my opinion on Libra, let’s run through this what Libra is.

Introduction

Internet and mobile broadband have granted billions of people access to information, high fidelity communications, and a wide range of low-cost convenient services. Libra’s whitepaper state:

1.7 billion adults globally remain outside of the financial system with no access to a traditional bank, despite one billion possessing a phone and half a billion connected to the internet.

Communication costs have been driven down due to a simple data plan, yet financial services are limited or restricted for those who need it the most — those impacted by cost, reliability, and the ability to seamlessly send money.

For those who remain on the fringe of the financial system, their income is eroded by fees, wire costs to overdraft, and ATM fees. Blockchain and cryptocurrency have long been poised to address some of the problems regarding accessibility and trustworthiness.

• Distributed Governance: no single entity control the network.
• Open Access: allows anyone with an internet connection to participate
• Security: Cryptography to protect the integrity of funds

However, there is too much volatility in price and barriers to scalability within the current blockchain and crypto landscape, restricting its adoption into the mainstream as a method of conducting financial transactions. The problems lie both in the valuation, or pricing, of the coins themselves, and the strength of the blockchain to not only process the transactions, but to enable a decentralized network to agree on permissions. For those of you not aware of these problems, let’s explore these problems and how the landscape is currently adapting.

Blockchain: Barriers to Scalability

The barrier limiting bitcoin’s scalability is the capacity at which the blockchain can process transactions, taxing the volume the network can support. This is due to the fact that the blocks on the blockchain are limited in size and frequency. Blocks have a limit of 1 Megabyte, which determines the number of transactions on each block.

Bitcoin’s blocks are the records of transactions on the network. It takes a lot of computing power in the form of Graphical Processing Units (GPUs) to process blocks. At the time of writing this piece, Bitcoin’s BlockTime is 8m 11s, and Ethereum’s is 13s.

There are two efficiency improvements which should increase throughput without placing extra demand on the Bitcoin network. The first is a Fork, which increases the network’s transactions processing limit by modifying the rules on the network. The second is to modify Bitcore, the open-source software that serves as a node which forms the network.

Tokens: Volatility in Price

Bitcoin (BTC) and Ethereum (ETH) are priced through supply and demand, creating volatility as its buyers and sellers determine the price. Stablecoins look to solve the volatile price of cryptocurrencies by building stability into the coin through various valuation methods. There are a few stablecoins in the ecosystem doing so already.

Centre, a Boston based company, is developing the USD coin (USDC) for the Ethereum Blockchain in a joint membership between Coinbase and Circle. The token is pegged to the dollar to create price stability. Coinbase raised a total of $525.3M in funding across ten rounds with notable investors including Union Square Ventures, Andreessen Horowitz, and Spark Capital — this will be important in a later section. Circle raised a total of $246M across seven rounds with notable investors including General Catalyst, Accel, and Tusk Ventures.

MakerDao: a Santa Cruz-based company is seeking to keep to minimize the volatility of its Ethereum based coin the Dai (DAI) to keep the price stable at $1.00. MakerDao has raised $27M across three rounds with Andreessen Horowitz leading two of them.

Tether, a Hong Kong-based company producing (USDT) a coin with the same name backed by a basket of fiat currencies including USD, Euro, and will include the Japanese Yen soon. There is some scrutiny surrounding Tether’s USD peg.

If Libra is poised to drive tokens into the mainstream, it must combine the benefits of a stablecoin, while solving the network’s scalability problem. If it is looking to uphold itself to public scrutiny, it should also aim to work with the existing financial system to build trust into the blockchain. Mainly to improve the effectiveness of anti-money laundering, but it would need to innovate on compliance and regulatory fronts to hold up to its vision.

Enter Libra

Libra is a simple global currency and financial infrastructure that empowers billions of people built upon three pillars that will work together to create a more inclusive financial system.

1. The Network: Built on a secure, scalable, and reliable Libra Blockchain powered by its open-source programming language, Move.
2. The Coin: The Libra coin is backed by a basket of bank deposits and treasuries from high-quality central banks designed to provide intrinsic value and stability.
3. The Governing Entity: The Libra Association is an independent group comprised of 28 Members set to and oversee the evolution of the ecosystem through voting rights to fulfill Libra’s purpose.

Libra Blockchain

Unlike previous blockchains, which view the network as a series of blocks, the Libra Blockchain is a single data structure that records the history of transactions and states over time through validators.

The function the validators serve is to process transactions and maintain the state of the blockchain. The validators form the membership of the Libra Association, establishing Libra as a permissioned blockchain — meaning not everyone can run a node giving access only to the Association. The goal is to transition to a permissionless blockchain, where anyone who meets technical requirements can run a validator node.

The whitepaper highlights three critical decisions that make up the Libra Blockchain.

1. The Byzantine Fault Tolerant (BFT) enables a secure and scalable solution by protecting the integrity of the transaction data. By utilizing BFT Libra will be able to scale billions of accounts, which require high transaction throughput, low latency, and an efficient, high-capacity storage system known as validator nodes.
2. Move, the open source programming language used to define the core mechanisms of the blockchain. Libra will design and leverage the programming language to ensure a highly secure environment to protect the integrity of financial data widely and funds.
3. Adopting and integrating blockchain data structures to ensure flexibility and to power the Libra Ecosystems privacy and regulatory impact.

The technical paper on the Libra Blockchain highlights the components of the Libra Protocol. I highly recommend reading the technical documentation if you have time, it’s pretty impressive.

The Libra Association

The Libra Association is the governing entity comprised of diverse and independent members to oversee the Libra Reserve and Blockchain. The Libra Association is an independent, not-for-profit membership organization headquartered in Geneva, Switzerland — furthering the Association’s neutral stance. The Libra Association has three main functions:

1. Coordinating agreement — the Association is governed by the Council represented by one individual per validator node over the network and reserve. Decisions over major policy or technical decisions require the consent of two-thirds of the votes — the same supermajority required in BFT protocol.
2. Facilitate the operation of the Libra Blockchain — through the Association, the validator nodes align on the networks technical roadmap and development goals. Libra will rely on open source contributors to grow the community. The Association is tasked with creating protocols for the blockchain.
3. Manage the Reserve and growth of the Libra Economy — The Association is the only party that is responsible for the minting and burning coins.

• Mint: Authorized resellers have purchased these coins from the Association with fiat-assets to fully back new coin Association.
• Burn: Authorized resellers sell Libra coin to the Association in exchange for underlying assets.

Additional Roles of the Association for future Libra Development;

• Recruitment of founding members to serve as validator nodes
• Fundraising to jumpstart the ecosystem
• Design and implementation of incentive programs
• Establishment of the Association’s social impact growth program.

Source

There are 28 founding Members of the Association from a wide range of industries.

• Payments: Mastercard, PayPal PayU (Naspers’ fintech arm), Stripe, Visa
• Technology and marketplaces: Booking Holdings, eBay, Facebook/Calibra, Farfetch, Lyft, Mercado Pago, Spotify AB, Uber Technologies, Inc.
• Telecommunications: Iliad, Vodafone Group
• Blockchain: Anchorage, Bison Trails, Coinbase, Inc. Xapo Holdings Limited
• Venture Capital: Andreessen Horowitz, Breakthrough Initiatives, Ribbit Capital, Thrive Capital, Union Square Ventures
• Nonprofit and multilateral organizations, and academic institutions: Creative Destruction Lav, Kiva, Mercy Corps, Women’s World bank

There are plans to scale the number of members to 100 by the target launch in the first half of 2020. Facebook created Calibra, a regulated subsidiary, to ensure separation between social and financial data. Calibra will also act as a wallet, but will not be the only option for users to obtain and spend Libra. Paypal and Mastercard will also be able to Mastercard to build their own digital wallets. Buy-in for each member is $10M to operate a validator node.

Libra Currency and Reserve

“Libra is designed to be a stable digital cryptocurrency that will be fully backed by a reserve of real assets — the Libra Reserve — and supported by a competitive network of exchanges buying and selling Libra.” There are four Attributes Libra is looking to achieve:

1. Stability
2. Low inflation
3. Wide Global Acceptance
4. Fungibility

Libra will be backed by a collection of short-term government securities and bank deposits from stable and reputable Central Banks. The whitepaper doesn’t mention any in particular, but a few banks come to mind, such as the Federal Reserve, The Bank of England, The Bank of Japan, European Central Bank, and possibly others such as the Central Reserve Bank of Peru.

The reserve gives Libra an advantage over other cryptocurrencies while retaining the same benefits of a cryptocurrency:

• Ability to send money quickly
• Security of Cryptography
• Freedom to easily transmit funds across borders

Libra will pay for itself through interest on the reserve assets, which will cover the cost of the system, ensure low transaction fees pay dividends to investors who provide capital to jumpstart the ecosystem, and support future growth and adoption.

The Path Ahead

There is much to do leading up to the target launch in the first half of 2020, all of which will be handled by the Association.

• Blockchain: perform extensive testing from protocols to constructing a full-scale test of the network in collaboration with wallets and exchanges
• Reserve: Establish operational procedures for the reserve to interact with authorized resellers
• Association: continue decentralization and develop a path for permissionless governance and start this transition within five years.

Argument Against Libra

Regulators were caught by surprise with Facebook’s announcement. The G7, the seven largest IMF economies, will establish a working group to examine such cryptocurrencies. Rep. Maxine Waters, who chairs the financial services committee, and Rep. Patrick McHenry called for a hearing, with Waters asking Facebook to pause their work.

Federal Reserve Chairman Jerome Powell has high expectations for safety, soundness, and regulatory standpoint if Facebook decides to go forward with something. The Fed doesn’t have plenary authority over cryptocurrencies, though it does have input in payments. A hearing is set for July 16th on the project with David Marcus, who oversees Facebook’s blockchain efforts, is expected to testify.

According to the New York Times sources:

“Facebook approached a number of financial companies, including Goldman Sachs, JPMorgan Chase, and Fidelity about participating in the project. The financial companies declined to join, in part of regulatory questions about cryptocurrencies.”

Employees at Coinbase expressed concern about working with Facebook around privacy when the partnership was announced internally. It comes to no surprise that people would have reserves over sharing information with Facebook, especially financial information. The company is known to take a lax attitude towards user information.

Argument Supporting Libra

Most of the concern surrounds Facebook and its control over privacy. Giving them access to financial data while they already have a stronghold on social data is a concerning thought — especially with their checkered past regarding privacy and user data.

This concern is made worse upon reading that the Libra Blockchain is granted permission from the outset giving control to the Libra Association. While analyzing Libra’s strategy, it is evident that Facebook thought through this problem by leaning on the other companies to comprise the membership, as well as forming Calibra to separate social and financial data. The fear is that Facebook will use this technology for malicious intent but is leveraging the reputation of Association members to mitigate this fear.

The forming of the Libra Association to act as a governing entity does create a distributed governance by distributing voting power and the creation of Calibra. It is a smart move on Facebook’s part. My trust lies heavily with the Association to pull this off.

Three members of the Association are already invested in the crypto ecosystem through their investments into companies like Coinbase and Circle. These members also come with their reputations in the space, like Union Square Ventures NYC-based Venture Capital fund co-founded by Fred Wilson. As someone who reads Fred’s Blog daily, which focuses on his investments and his corresponding theses, especially in regards to crypto, I personally have faith that he’s done his due diligence on this matter.

Another notable member of the Association is Andreessen Horowitz, known for their ability to assist founders to scale tremendously. The team at Andreessen have been involved in numerous successful investments and as investors and operators. If they’re on board, they must have done their homework.

The combined involvement of these two members, as well as the rest of the Association, should keep Libra from being used for malicious intent. The main objective of the Association going forward is transitioning the network from Permissioned to Permissionless, and this is the approach Libra is taking to fulfill its vision.

Final thoughts

Facebook has a track record of innovating and improving upon an existing idea and taking it mainstream. The company improved upon the social media formula and quickly overtook Myspace as the largest social network in the world.

If Libra were a separate startup, pursuing a large market with an experienced team that can execute, the core risk which VCs mitigate for is already accounted for. This would make Libra a rounded investment in the crypto landscape.

There are a lot of possibilities for Libra in the future, especially when you consider that Facebook, in addition to their already vast network, owns Whatsapp and can leverage its 1.5 Bn userbase to mirror Wechat, the Chinese-based social media app used for everything from messaging to finance. Upon announcement of Libra, it was reported that Wechat is also considering a token launch of their own. Facebook’s move has its competitors scrambling to catch up.