Our Review of Facebook’s Libra

Facebook went public yesterday with its long-discussed cryptocurrency initiative, Libra. We found the vision ambitious enough and sufficiently aligned with our own to write down and share our thoughts. In short, we think that the project is exciting, and are delighted to see significant resources and alignment behind a global currency that intends to be value-stable, have a concrete use case and run on a blockchain. We provide an overview of Libra and place it in the context of Terra’s vision and direction. Then we discuss some of the key challenges and risks that we think Libra may come across on its path to genesis and beyond.

Libra in a nutshell

Libra has been envisioned to be a global currency and financial platform to solve the two long-standing problems plaguing the crypto industry: excessive volatility and lack of real world adoption. Libra will be pegged to a basket of major currencies similar to the IMF’s SDR, and will be backed by a full currency reserve held in custodian banks. While heralded by Facebook, Libra is supported by an “Association” of established companies including Visa, Uber, Coinbase and Spotify, all of which have committed funding to the project and are collectively responsible for governance.

The Libra blockchain is initially permissioned and controlled by members of the Association, who act as validators on the network. Libra eventually aspires to become permission-less by transitioning to a Proof-of-Stake consensus mechanism and allowing anyone to participate in validation. The project also plans to support smart contracts in the future via Move, a newly introduced programming language.

Libra falls neatly into Facebook’s long-standing desire to penetrate payments and financial services. Messenger was expected to be the vehicle to achieve this, but simply ended up supporting Facebook’s core ads business instead. Libra is an opportunity to enter payments and beyond, and Facebook has established a business unit with exactly this purpose called Calibra. Calibra is building a Libra wallet to integrate with the Facebook ecosystem, and aspires to become Facebook’s financial services arm.

Vision Alignment

We see considerable alignment in vision between Terra and Libra (speaking of the Libra initiative, not Facebook nor Calibra). Both believe in an open and inclusive financial system. Both aspire to create currencies that are global, price-stable and widely adopted. Both aspire towards frictionless and permission-less transfer of value, and both see blockchain technology as the foundation upon which to achieve this. Both envision financial products that build upon a base layer of currency and payments. While many projects have vaguely phrased a number of those ideas, I think that Terra and Libra have articulated them most clearly and believably. Crucially, both Terra and Libra have access to the platforms and users that can make this vision a reality.

Design Similarities

There appear to be notable similarities between Terra’s and Libra’s designs. Both stablecoins are pegged to basket of currencies, the only two we are aware of to have made this choice. Both blockchains are intended to operate on Proof-of-Stake. While Terra is already running on a Proof-of-Stake blockchain, Libra plans to start out as a permissioned blockchain controlled by Association members and later transition to permission-less Proof-of-Stake. Both Terra and Libra are two-token systems, although the secondary tokens play very different roles in the two projects. While Luna is the mining token in Terra’s ecosystem, the Libra Investment Token is what its name suggests — a token strictly awarded to investors, which for now are only Association members. Libra has not offered color into the mechanics of its Proof-of-Stake transition.

We think that there are significant merits to the permission-less blockchain design Libra aspires to transition towards, which is why we commited to it in our protocol design after having explored many alternatives. We can also confirm that it has performed very robustly in practice: Terra’s mainnet has been live for almost 2 months, the network has a fast-growing set of validators and is actively being used to power payments at TMON, one of Korea’s largest e-commerce companies.

Libra lacks seigniorage

The key difference between the Terra and Libra designs lies in the allocation of new currency. While Terra achieves stability by creating stable mining incentives, Libra maintains a full currency reserve in regulated institutions. What does this imply for the issuance of one new unit of currency? When one unit of Terra is issued, proceeds are split between two destinations: part is used to reward miners by burning some Luna, part is deposited to the Treasury to fund growth. When one unit of Libra is issued, 100% of proceeds are deposited to custodian banks.

Net proceeds from the issuance of currency are known as seigniorage — historically a key source of power for governments that could issue their own currency. While Terra issuance creates seigniorage and gives the Treasury valuable capital to funnel towards adoption, Libra issuance does not. We see seigniorage as the most powerful and exciting part of designing a stablecoin, and the Terra Treasury as the predominant competitive advantage of Terra relative to fiat currency. We have provided a blueprint for the use of seigniorage by a payments application to consistently return value back to users, and are currently putting it in practice with our Korean e-commerce partners.

By restricting itself to a fully-asset-backed reserve, Libra is adopting the economics of Tether, Circle USD and the litany of other fiat-backed stablecoins that offer no fundamental advantage over their fiat counterparts. While Libra aims to offer user incentives with part of the money invested by the Association, this approach clearly does not scale unless current and new members continually pour fresh cash into the reserve.

Risks inherited from Facebook

While Libra is intended to be independent of Facebook and is to be governed by an Association where Facebook will have limited voting power, the umbilical cord between the two will be hard to sever. Libra was conceived as a solution to Facebook’s long-standing goal to enter payments and fin-tech, and serves what many would call a vital strategic purpose for the company. This is especially true in the wake of the privacy scandals that forced Facebook to re-brand itself as privacy-friendly, and have raised the question of the long-term sustainability of its core privacy-invasive advertising business.

Specific risks that we see:

• Significant ill-will from governments and regulators: Facebook’s relationship with regulators has always been strained given its far-reaching power on users’ lives and the fact that in many countries it is almost a social media/messaging monopoly. The strain reached new heights after the Cambridge Analytica scandal. And yet very little regulation currently applies to Facebook — much of the controversy was centered on exactly that. The world of finance is the polar opposite, of course. The more Facebook approaches regulated waters, the harder regulators will work to give Facebook the treatment they have long wished for. Matt Levine could not have put it better: “Regulators are chasing after Facebook, but here Facebook is, running to meet them.” No sooner had we started writing this piece than regulators in the US, UK, France and Germany opened fire on Libra.
• Breach of trust with many users: Facebook breached the trust of many users as a result of the aforementioned scandals. Whether or not users are willing to trust Facebook’s brainchild with their money is very much an open question.
• Potential for use of Libra data in advertising: The holy grail of advertising measurement has always been closing the loop between views and purchases. For instance, as a shoe advertiser on Facebook I want to know how many shoes I sell for every 1,000 ad views of my shoes. If I have no idea what that number is then I have no way of quantifying the effectiveness of my ad spend or of justifying ad spend in the first place. Closing the loop between views and offline sales was an insurmountable hurdle, until companies like Facebook started joining fragments of offline spending data collected from retailer loyalty cards with Facebook user data. Despite the limited scope and depth of this data, tricks like this have allowed Facebook to give advertisers what they’ve been asking for. Now imagine if Facebook had direct access to a user’s entire spending history… While Facebook has denied any data share between its core business units and Calibra, Facebook’s wallet app for Libra, the company’s poor track record in privacy and its long-standing effort to link ads to consumer purchases will have many of its users doubting. The same concern naturally applies to all Association members with the potential to join user data with user-identifiable spending data from the Libra blockchain.

Challenges in Libra’s global expansion

While Libra’s ambitions are global, the Association is heavily US and Europe-based. Given that the payments and financial services landscapes exhibit strong regionality and local idiosyncrasy, we think that Libra’s battle towards global adoption outside of the US and Europe will be very uphill. We focus the discussion on the Asia Pacific region, Terra’s initial target market, though we expect Libra to face challenges of similar nature in Africa and Latin America.

We consider payments and messaging/social media, the two verticals Facebook is hoping to marry via Libra. Both payments and messaging exhibit strong regionality, despite the global dominance of the American card networks and Messenger/Whatsapp respectively. The South-East Asian mobile payments market is particularly fragmented and highly regional, while mobile messaging also exhibits a significant amount of diversity across Asia. In particular, despite the popularity of Messenger and Whatsapp in the US and Europe, neither is the top messaging app by usage in many Asian countries including South Korea, Japan, China, Taiwan and Thailand. Seeing as messaging is a potential trojan horse into mobile wallets and payments, a strategy that Facebook seems to be eyeing for Libra via Messenger and Whatsapp, we see Asia as a challenging market for Libra to penetrate. Terra, on the other hand, has firmly planted its flag in the region, counting e-commerce partners in several countries with more than 50 million combined users. One notably hard to penetrate Asian market is Mongolia, where Terra is soon launching a mobile payments app in partnership with the capital’s local government.

A separate challenge for building financial infrastructure in Asia is regionality in currency. The vast majority of Asian economies use their own currency, which is bound to be volatile vis-a-vis any single basket or benchmark. While an SDR-like currency basked like the one Libra will be pegged to is likely to have lower volatility vs regional currencies compared to the USD, it may still be unacceptably high for consumers looking to hold Libra for more than a few days. Terra was designed as a family of stable cryptocurrencies, each pegged to regional currencies like the KRW, JPY and SGD, to solve precisely this problem.

Parting thoughts

Libra is an ambitious project with a vision that is dear to Terra’s heart: a stable and adopted global currency and an open financial system. While there appear to be similarities between Terra’s design and Libra’s long-term permission-less version, Libra lacks what we consider Terra’s key competitive advantage relative to fiat currency: seigniorage. We predict that it will be expensive for Libra to create strong user incentives without this. We outlined two categories of challenges that we expect Libra will face. First, risks inherited from Facebook that may significantly burden Libra’s growth and regulatory approval. Second, challenges associated with global expansion that will make penetrating markets outside of the US and Europe an uphill battle, particularly against competitors like Terra that have a deep understanding of local markets and are already live and growing.