Facebook’s foray into financial services is struggling to gain momentum – here’s why

Facebook CEO Mark Zuckerberg has announced the company will launch a digital currency later this year, but already the plan is fraught with issues

Facebook's foray into financial services is struggling to gain momentum – here's why
Facebook CEO Mark Zuckerberg testified in front of Congress, pledging that Libra would not be launched anywhere else before getting the green light in the US 

“It was a neat idea that’ll never happen, and I have nothing else to say about it.” JPMorgan Chase CEO Jamie Dimon didn’t mince his words when asked about the fate of Libra, the digital currency expected to be launched by a Facebook-led coalition later this year. Dimon’s assessment came after several members of the Libra Association, the Geneva-based body overseeing the launch of the currency, withdrew from the project.

The timing couldn’t have been worse. Announced just a few days before the group’s first board meeting, the exodus – which started with PayPal and soon included Stripe, Mercado Pago, Mastercard, Visa, eBay and Booking Holdings – dealt a heavy blow to the currency’s reputation.

Like other cryptocurrencies, Libra has been accused of being a potential conduit for money laundering

“It costs the Libra project some credibility,” John Sedunov, an associate professor of finance at Villanova University and an expert on cryptocurrencies, told World Finance. “You have institutions that are well versed in processing payments and handling data leaving the project. It can survive without these partners, but the costs of doing so will be higher.”

Quick out of the blocks
The mood was very different when Facebook announced Libra’s launch last July. Kevin Weil, Vice President of Product at Calibra, a Facebook subsidiary created to serve as a digital wallet for Libra, expressed hope that the currency would last “hundreds of years”. One of the project’s main goals is to boost financial inclusion by catering to the 1.7 billion adults around the world who do not have access to a bank account. The currency’s white paper set the tone: “Our hope is to create more access to better, cheaper and open financial services – no matter who you are, where you live, what you do or how much you have.”

Facebook is far from alone in its attempt to tap into this booming market. Telegram, a popular messaging app, is planning to launch its own digital token, while other tech powerhouses are rumoured to be experimenting with similar projects. But it is Facebook’s user base of some 2.45 billion people that has raised hopes that digital currencies can finally break the silo of the close-knit blockchain community and gain traction with the broader public. As Sedunov explained: “In some ways, corporate-led cryptocurrencies may be beneficial for currencies like bitcoin, as they may provide an easier gateway into the cryptocurrency world. Individuals may change their dollars to Libra and then move from Libra to bitcoin as they become more comfortable with the idea of a cryptocurrency through a company they already know.”

One reason cryptocurrencies have failed to enter the mainstream is their high volatility. Bitcoin, the first and still best-known digital currency, has been plagued by abrupt price swings, attracting speculators but putting off less tech-savvy users. In December 2017, it reached its peak price of nearly $20,000, before dropping to $7,754 less than two months later (see Fig 1). To avoid this pitfall, Libra has been designed as a ‘stablecoin’ – a low-volatility currency backed by offline financial assets, such as a basket of fiat currencies and US Treasury securities. In September 2019, Der Spiegel reported that Libra’s reserve basket would comprise US dollars, euros, yen, pound sterling and Singapore dollars (see Fig 2), while each partner would contribute $10m.

The structure of Libra departs in several ways from cryptocurrencies such as bitcoin and Ether: for example, Libra units will be issued by partner companies rather than independent miners, while partners will be responsible for the reconciliation of transactions and will have exclusive access to transaction data. Further, unlike bitcoin and Ether – which use public, ‘permissionless’ blockchains that allow all users to validate transactions – the Libra Association is expected to operate as a central authority.

Show me the money
One of the key components of the Libra venture is Facebook’s payment service, Calibra, which some pundits believe could bring about a revolution in online commerce by enabling micropayments. Christophe Uzureau, a blockchain analyst at research and advisory company Gartner, told World Finance: “Facebook increasingly invests in payment systems with services such as Facebook Pay, and that reflects a fundamental shift of strategy. They do not want to be perceived as a media company and they are also trying to reduce their reliance on advertising revenue. Shifting to e-commerce is an important component of this strategy.

While Facebook has stressed this won’t be the case, a potential combination of Calibra and Facebook Pay could be a catalyst for this shift.” The withdrawal of important partners may set back these plans, however. EBay’s departure was particularly damaging, depriving Libra of a global marketplace of 182 million consumers, while credit card companies Mastercard and Visa could have helped introduce the cryptocurrency to older audiences. The project would have also benefitted from access to the global network of merchants using Stripe or PayPal to process payments.

Some experts, though, believe that Calibra could emerge as a competitor to these companies. “In time, the question is whether PayPal and the credit card companies can survive without Libra,” Sinclair Davidson, an associate at RMIT University’s Blockchain Innovation Hub, told World Finance.

Andreas M Antonopoulos, an author and educator who has published several books on cryptocurrencies, believes there is a generational aspect that favours Libra, too: “Libra and other ‘corpocurrencies’ are most threatening to the existing financial system. They can serve the Millennial demographic much better than existing banks and payment providers. It’s most useful to think of them as a super PayPal than a cryptocurrency.”

Others are more sceptical about the threat Calibra would pose to payment powerhouses. David Shrier, an expert on financial innovation who leads the fintech and blockchain strategy programmes at Oxford University’s Saïd Business School, told World Finance: “Apple Card… Google’s rumoured addition of checking accounts to Google Pay and offerings out of China like Alipay are a more serious threat [than Calibra].”

A crumbling coalition
While major partners have pulled out of the project, other organisations are jumping on the Libra bandwagon. In fact, the Libra Association announced in June 2019 that more than 1,500 organisations had expressed an interest in getting involved with the project, around 10 percent of which met the preliminary membership criteria. However, the withdrawal of household names such as Visa and eBay has brought the project’s viability – as well as potential imbalances in its internal governance – into question.

As Uzureau explained: “Facebook, Calibra and the Libra Association are tightly aligned. As of the end of October, all the money invested in the Libra Association comes from Facebook; none of the other members have contributed so far. So, Facebook is likely to shape Libra’s governance model according to its own preferences. Facebook and Calibra engineers are behind the Libra protocol and the programming language Move.”

Although no official explanation was given for the Libra Association exodus, it is widely assumed that regulatory concerns played a crucial role. Sedunov told World Finance: “I think that the companies left the association – at least, in part – because of the high level of scrutiny that Facebook is facing from regulators around the world. It may end up being just too costly to launch the project. There is also risk involved with an innovation like this and perhaps these firms didn’t like the level of risk that the project would require.”

In October 2019, Senate Democrats Sherrod Brown and Brian Schatz warned Mastercard, Visa and Stripe that their involvement could pose a threat to the financial system: “If you take this on, you can expect a high level of scrutiny from regulators not only on Libra-related payment activities, but on all payment activities.” And after the companies announced their withdrawal, Brown commented: “Large payment companies are wise to avoid legitimising Facebook’s private, global currency. Facebook is too big and too powerful, and it is unconscionable for financial companies to aid it in monopolising our economic infrastructure.”

For Antonopoulos, such regulatory pressure stresses the need for cryptocurrencies: “[Mastercard, Visa and Stripe] were basically threatened with audits for even being part of the [Libra Association]. That kind of extra-legal coercion by regulators and legislators is one of the reasons cryptocurrencies exist and are needed.”

Ironically, Sedunov believes the departure of household names from the coalition will make regulatory approval a thornier process: “These exits can also make the regulatory hurdles Facebook is facing more difficult to clear. The credibility loss also matters, as individuals may be less likely to adopt Libra if it is a Facebook-only project, relative to a project with backing from the full association.” For his part, Facebook CEO Mark Zuckerberg testified in front of Congress, pledging that Libra would not be launched anywhere else before getting the green light in the US. He did, however, warn that “if America doesn’t innovate, our financial leadership is not guaranteed”, and pointed to China’s development of a government-backed cryptocurrency as evidence of that fact.

Some think Libra may be more successful in laxer regulatory regimes where the need for alternatives to fiat currency is more evident. As Shrier explained to World Finance: “Political resistance is the big obstacle to Libra’s success. With the major countries in the EU lining up to keep you out – France notably stating [that] Libra will be banned from the country – you lose a market of 500 million people. China is unlikely for market penetration due to the dominance of Baidu, Alibaba and Tencent, plus the launch of China’s [digital currency]. This means Libra could be launched, but will probably have more traction in emerging markets where the political will to ban them is weaker.”

You shall not pass
For the time being, Facebook faces an uphill battle to overcome regulatory hurdles, with critics pointing to its potential threat to national sovereignty as a main point of contention. According to Davidson, cryptocurrencies such as Libra could undermine the ability of states to use financial sanctions as a foreign policy tool. Another risk is that central banks may lose their grip on monetary policy by controlling the supply of money, making them toothless when the next financial crisis strikes.

The advent of corporate cryptocurrencies could force governments and central banks to enter the fray

Dirk Niepelt, a professor of economics at the University of Bern, believes currency exchange rates may also be affected: “When customers hold Libras, they indirectly hold dollar or euro [denominated] securities. Accordingly, the demand for dollars or euros rises if customers who used to hold, say, rupees, switch to Libra. But the demand for rupees would fall.”

In Europe, French Minister of the Economy and Finance Bruno Le Maire dismissed Libra as an “unacceptable” venture that would see “a private company controlling a common good and taking over tasks normally discharged by states”. The European Commission has also launched an investigation into potentially anti-competitive behaviour. And, like other cryptocurrencies, Libra has been accused of being a potential conduit for money laundering, although Juan Llanos, a New York-based expert on fintech compliance, dismissed these concerns as scaremongering in an interview with World Finance: “If a digital record-keeping system had a way to attach the real-world identity of each user to each transaction, it would be less attractive to criminals. Well, Libra is such a system. It’s digital, traceable [and] potentially indelible.”

For Shrier, though, Facebook’s leading role in the project is problematic: “Libra has political toxicity around it due to Facebook’s continued involvement. Arguably, Libra can’t work without Facebook – one of the world’s largest marketing platforms – yet it is that very involvement that makes Libra’s launch so challenging.”

Over the past few years, Facebook has been embroiled in several scandals concerning privacy and manipulation, some of which had serious political ramifications – notably, the role the company’s data played in the lead-up to the UK’s EU membership referendum and the 2016 US presidential election. Shrier continued: “Politicians have Facebook in their crosshairs due to the numerous and repeated privacy violations, mishandling of personal data and suggested impact on sovereign elections, making Libra’s market access problematic.”

Facebook has attempted to alleviate these concerns, clarifying that it will keep transactional data separate from other Facebook services and ensure the identities of users are not tied to transactions. Many critics take these assurances with a pinch of salt, pointing to loopholes, such as asking users to accept sharing their Libra-related data to access other Facebook-owned apps. As Uzureau told World Finance: “If Calibra is the only wallet available on Facebook services, including Facebook, Facebook Messenger, WhatsApp and Instagram, it becomes very easy for Facebook to use Libra as a reward programme for sharing data. So if a user agreed to share more data, they could offer them more units of Libra. The risk is that the customer would be highly dependent on such an ecosystem.”

In Europe, French Finance Minister Bruno Le Maire dismissed Libra as an “unacceptable” venture that would see “a private company controlling a common good and taking over tasks normally discharged by states”

A SWIFT response
The advent of corporate cryptocurrencies such as Libra may force governments and central banks to enter the fray. A 2019 survey of central banks conducted by the Bank for International Settlements found that 70 percent of respondents were conducting research on central-bank-backed digital currencies (CBDCs) or were considering launching digital currencies of their own. Central banks in China, Sweden and Thailand, for example, are expected to issue CBDCs in the coming years, while outgoing Bank of England Governor Mark Carney has called for an international CBDC to replace the dollar as the global reserve currency.

Although national digital currencies wouldn’t compete with the likes of Libra – due, in large part, to the fact they would be pegged to fiat currencies and would be centrally controlled – they could contribute to the acceptance of cryptocurrencies as a legitimate means of transaction. Shrier believes the announcement of Libra’s launch may have concentrated minds: “If anything, Libra served as a wake-up call to governments to move faster… Libra’s biggest threat today is [China’s state-backed currency] and Alipay. Tomorrow, it’s possibly a federation of government digital currencies.”

As for commercial banks, Libra is an enigma wrapped in a riddle. By rattling the cages of the financial system, it may push them to reconsider some of their practices – especially the use of services like messaging network SWIFT, which is often dismissed as being antiquated. Some fear that Libra may turn Facebook into a competitor, with the Libra Association effectively operating as a private central bank. In an interview with the Financial Times, Weil acknowledged that Calibra could offer services traditionally provided by banks, but dismissed speculation that Facebook has bigger ambitions: “We’re not a bank, we don’t view ourselves that way. We’re not offering interest, for example, and things that banks do.”

Chain reaction
For the blockchain community, the advent of Libra has been equally frustrating. Some pioneers have hailed it as a major event that will make cryptocurrencies more popular, but critics see it as a betrayal of blockchain’s libertarian origins. Bitcoin’s greatest selling point was the creation of a decentralised financial system that wouldn’t allow any participant to become dominant, effectively ending the monopoly of governments and central banks over money supply.

By rattling the cages of the financial system, Libra may push commercial banks to reconsider their practices

According to Llanos, though, that was a naive vision from the outset: “They overestimated the capabilities of the technology and underestimated the power of the market constraints. On the one hand, the technology itself is very immature – as are, one may argue, many of its supporters. On the other hand, human nature hit the ceiling of the law and indifference of public opinion.”

Libra is closer to a centralised model, only permitting members of the Libra Association to process transactions via the blockchain. The authors of the currency’s white paper express hopes of moving to a permissionless system within five years, but acknowledge that no solution currently exists “that can deliver the scale, stability and security needed to support billions of people and transactions across the globe through a permissionless network”. Many experts doubt that such a transition is feasible, or even desirable. “The white paper was a naive pipe dream,” Antonopoulos told World Finance. “Without decentralisation of control, you cannot have permissionless operations or any of the other characteristics of cryptocurrency.”

Given the amount of research showing that permissionless consensus mechanisms can be improved, Uzureau believes scale is being used as an excuse to justify a centralised governance structure: “Being centralised or decentralised is not a dichotomy – it’s a continuum. You could move a bit more towards decentralisation, but the question is, can you reverse it? If Calibra becomes the main wallet used for Libra transactions – and Facebook has a lot of power on how Libra is used as part of its ecosystem – they could influence the evolution of Libra and reverse the process of decentralisation.”

Some go one step further, pointing to Facebook’s track record. “Libra, as a cat’s paw for Facebook, has no strategic interest in becoming permissionless or decentralised,” Shrier said. “Zuckerberg swore when he bought WhatsApp that he wouldn’t break the end-to-end encryption and run ads, and WhatsApp’s founder left Facebook when ‘plans changed’ to do exactly that. So I wouldn’t count on much in the way of consistency in Libra’s strategy.”

But should Libra’s partners manage to build a cryptocurrency that is permissionless and scalable, the rewards could be massive. “This is a $29trn question,” Davidson said, referring to RMIT Blockchain Innovation Hub’s estimates of the size of the booming cryptocurrency economy. “I’m not greedy, I would just like one percent.”