Could Facebook’s new cryptocurrency supplant bitcoin?

Facebook will launch its own digital currency in the first half of 2020. What are the implications for banking and finance globally – and how can investors profit?

As I predicted last year, Facebook will launch its own digital currency in the first half of 2020. This will be available on its platform for users to buy and sell products and services, and to make payments to each other. The new digital currency, to be called Libra, will be a stablecoin– ie, unlike bitcoin and Ethereum, it will be backed by a basket of ‘real’ currencies (and possibly government bonds, too). Therefore, so it is hoped, it will not be subject to wild speculation and will maintain a stable value.

Despite Facebook’s hype, this is a collaborative effort – these ain’t ’Zuckerbucks’. Facebook has teamed up with some of the world’s top payment platforms and credit-card companies to roll out this revolutionary medium of exchange. They include PayPal, Visa and MasterCard.

This could turn out to be Facebook’s boldest innovation yet. While the company is known as a global technology giant, to date, virtually all of its revenues have come from advertising. These advertising revenues are possibly already in decline, therefore Facebook is under pressure to diversify its revenue stream.

How much impact will Libra have on the way we live? Will it generate huge shareholder value for Facebook and its partners? How will it impact on banking and finance globally? And −the most important question of all – how can investors profit?

New age, new money

In June this year, Facebook (NASDAQ:FB) unveiled its much-anticipated digital currency – Libra– which it hopes will go live in the first half of next year. In so doing, the social-media titan has changed the nature of the debate about the future of digital, or cryptocurrencies for good.

The new cryptocurrency will be orchestrated from Geneva, by an association of 28 founding sponsors. These include mature credit-card companies like Visa (NYSE:V) and MasterCard (NYSE:MA), but also ‘upstart’ technology companies like Uber (NYSE:UBER), eBay (NASDAQ:EBAY), Spotify (NYSE:SPOT), British telecoms giant Vodafone (LON:VOD) and the Silicon Valley venture-capital firm Andreessen Horowitz. The sponsoring entities might, according to some sources, expand to 100 by next year. The deal is that each association member pays $10 million a year to become a ’validating node’ – a status that enables them to validate transactions conducted in Libra.

Libra will ultimately be ’controlled’ by the Libra Association – of which Facebook is but one (though the most important) member. However, Facebook and WhatsApp users will provide users with their own digital ‘wallets’ called Calibra. This will enable Facebook users to make payments via Facebook Messenger or WhatsApp. Initially, the new digital currency will provide a convenient way for expatriate workers to send remittances to their families back home. (Think of the millions of Indian and Pakistani nationals working in the Gulf region.) Their remittances are often subject to exorbitant fees). But they – and others – will also be able to buy goods online with Libra.

Facebook states that the principal objective of Libra is to deliver a stable, universally accepted currency available to people who do not have bank accounts. In countries with large numbers of people without bank accounts, such as India, where cash is still ‘king’, users will be able to go to kiosks if they want to convert their Libra balances back into physical cash.

Cryptocurrencies, of which bitcoin is the most famous (or notorious), have been around for over a decade, based on the revolutionary blockchain technology developed by the mysterious Satoshi Nakamoto. The problem with bitcoin and its imitators (or competitors – depending on your point of view) is that its value has been subject to exorbitant speculation. Most people who buy bitcoin, it seems, do so because they are betting on its value rather than using it as a medium of exchange. That said, estimates of how many people who use bitcoin et al to buy and sell goods range from seven million to 25 million. Facebook has well over two billion user accounts, and even if many of those are corporate or duplicate identities, that is still nearly one third of all humanity.

Some of those bitcoin aficionados, so it is widely thought, are either criminals or tax evaders. Certainly, a number of cyber attacks using ransomware have demanded ransoms in digital currency. Facebook clearly wants to make cryptocurrency a legitimate means of exchange, and in the first instance, it will probably be made available to more than 200 million WhatsApp users in India. Mr Zuckerberg has carefully cultivated a close relationship with India’s Prime Minister Modi over the years, so one expects that the authorities there will be sympathetic.


Once it is rolled out, users will be able to make payments in Libra to one another as easily as they exchange photos on WhatsApp right now. So far, digital currency has been the domain of online operators of uncertain provenance; but everyone knows what Facebook is – it has an unrivalled user base and extremely deep pockets. (The company has a market capitalisation of $573 billion as I write).

The issue of trust is a delicate one. Facebook has been pilloried for its supposedly unethical and unauthorised use of its users’ data. But, at the same time, all of that data has been freely given by users who benefit from using the platform.

The techno-conservative Europeans, however, are less than enthralled. French Finance Minister Bruno Le Maire pronounced that it was “out of the question” that Libra be considered a sovereign currency. He demanded that the banking committee of the G7 examine whether Libra could be used to finance terrorism or other illegal activity.

Regulating and taxing the internet

The launch of a digital currency comes at a critical moment in the regulation of the internet for Facebook and the other tech giants. Governments are increasingly moving towards tightening control of internet content and taxing cyberspace.

As I revealed last year, Facebook acquired an EU banking license in Dublin back in 2016. More tellingly, this year Facebook has engaged in a PR offensive. Sir Nick Clegg, Facebook’s head of global policy and communications (and, of course, a former UK deputy prime minister), has been extensively deployed to articulate Facebook’s philosophy in the corridors of power around the world – but especially in Europe (Sir Nick speaks five European languages).

In a speech in Berlin at the end of June, Sir Nick spoke about how Facebook wants to work with western governments toregulate the internet without censoring it. One of his (or Facebook’s) big ideas is that of data portability. That means that users could remove all their personal data and content (eg photos) from Facebook and move it as a kind of package elsewhere. (Quite where is not entirely clear since Facebook has no true rival).

Sceptics point out that even if this idea were practicable, it would be to Facebook’s advantage. If users could export all their data elsewhere in one go then, by the same logic, they could import all their data from other service providers (for example, Google) into Facebook.

These days Mr Zuckerberg is saying that he favours “globally harmonised” privacy laws modelled on the EU’s General Data Protection Regulation (GDPR) – even though Facebook moved responsibility for 1.5 billion users out of Facebook’s operation in Ireland and back to the US last year, presumably to escape the impact of GDPR.

Surprisingly, Silicon Valley seems now to regard the EU as the model for regulation. Last year, Tim Cook, Apple’s CEO, told a conference on digital regulation in Brussels that “… it’s time for the rest of the world, including my country, to follow your lead.” Even Mark Zuckerberg wrote in the Washington Post earlier this year: “People around the world have called for comprehensive privacy regulation in line with the EU’s…and I agree.” According to Paul Schwartz, director of the Berkeley Centre for Law and Technology, the EU has won out in the battle of ideas.

Margrethe Vestager, the EU’s Commissioner for Competition, a sworn enemy of Silicon Valley and who fined Google €7 billion, is likely to be ferociously sceptical of Libra. She is thought likely to remain in her post under the new EU Commission President, Ursula von der Leyen, who takes over on 1 November.

Other commissioners have forced Facebook, Twitter (NYSE:TWTR) and YouTube (owned by Google/Alphabet (NASDAQ:GOOGL)) into adopting codes of conduct on fake news, political advertising and hate speech. In Germany, Angela Merkel’s government passed the Network Enforcement Act which sets deadlines for the deletion of illegal content. In France, Emmanuel Macron’s minister for the digital economy, Cédric O, has convinced Facebook to provide French courts with the identities of hate- speech suspects. The US remains one of the few advanced democracies which does not have comprehensive privacy legislation, although the State of California has passed its own digital-privacy bill, explicitly inspired by GDPR.

On 15 July, the Federal Trade Commission  imposed a $5 billion fine on Facebook in connection with data breaches occurring during the Cambridge Analytica scandal in the spring of 2018. Facebook’s share price seemed to take this in its stride – the fine was at the lower end of expectations.


Facebook and YouTube now systematically publish statistics on how much content has been taken down. At the same time, there has been a perceptible shift in opinion since the controversy around the involvement of Chinese tech giant Huaweiin the roll out of the new 5G network, which I discussed in this magazine last month. Essentially, many people, even within the Brussels mandarinate, now believe that the threat of Russian and Chinese cyber-aggression outweighs the threat posed by Silicon Valley’s abuse of user data. Regulation and taxation of tech companies will remain a salient political issue in Europe and America – but ultimately I doubt if they will much stifle the tech giants’ ambitions.

Why the crypto-purists hate Libra

For the free spirits who pioneered the bitcoin boom, Libra is a not really a cryptocurrency at all. They argue that, with bitcoin et al, anyone can run a validation programme and thus verify that all transactions are ‘pukka’. But, within the Libra blockchain, only the association members, who control that blockchain, can do that. So, these association members effectively control the cryptocurrency. That means that, for example, if they think you are a terrorist, or a criminal – or just don’t like your political views – they can freeze your wallet or even empty it on their say-so. Many people would regard that as reasonable – but, for the crypto-anarchists, that represents a fall from grace. That’s why a lot of bitcoin enthusiasts think that the emergence of Libra will actually boost demand for a ’real’ cryptocurrency – and pull bitcoin higher.

Why Facebook needs to revamp its business model

First the bad news. The number of Britons using Facebook actively is falling rapidly. The number of mobile interactions made on Facebook’s mobile app in the UK plummeted by 38 percent between June 2018 and June 2019, according to Mixpanel, the data-analytics company. Interactions occur when users click on a hyperlink or ad while they are using Facebook.

Facebook’s own numbers show a slow but steady rise in monthly active users across Europe – which may well be true. But the key driver for revenues is the social-media platform’s ability to convert users into potential buyers of its advertisers’ products and services.

One year ago, in July 2018, an unexpected drop in Facebook users in Europe, plus some disappointing growth forecasts, cost Facebook about $120 billion in its market capitalisation in a single day. Last October, Mr Zuckerberg said that Facebook’s user base in North America was “pretty close to saturation” and that future growth in user numbers would come from the developing world.

Insert Facebook share price chart

These days Facebook prefers to disseminate figures which aggregate user interaction across all of its platforms – Facebook ‘proper’, Instagram and WhatsApp (which is still essentially a messenger service). While the first may now be mature, the latter two are still growing rapidly and appeal to the younger demographic, which seems to prefer images over text.

Conversely, the Mixpanel figures measure how interactively the platforms are used rather than how many times users log on. Their figures suggest that users are behaving more passively. That means that people log on, exchange messages with friends, ’like’ a few cute puppies (pugs are so 2018) − and then go back to what they were doing anyway (probably involving watching a Netflix box set in pyjamas with best friend). Unfortunately for Facebook, this kind of interaction doesn’t generate any revenue. What’s more, the advertising-research consultancy eMarketer announced in May that US users spent an average of three minutes lesson Facebook per day in 2018 than the year before.

Facebook assumes that most of us are connected to the internet in the background most of the day. My laptop is connected continuously −even when I have abandoned it in favour of the garden on a hot July afternoon. Similarly, most under 40s are continuously connected to Facebook through their smartphones (literally day and night). But that doesn’t necessarily mean that we are using the social- media giant more actively. It’s just part of the background décor of modern life.

We prefer shopping online in the second decade of the 21^st century, yet the payments systems we use are firmly anchored in the 20^th century. Facebook will apparently give discounts to advertisers who pay in Libra. I can think of all kinds of accounting issues that might arise there – but no doubt that is a problem for another day. The real point is that if Libra works then Facebook will cease to be a social-media giant; it will become a colossus of fintech as well.That could propel Facebook into a league of its own amongst the tech titans.

Can the Europeans ever catch up with the US and Asian tech giants?

A recent report by investment boutique GP Bullhound argues that Europe’s tech ecosystem is growing faster than the US tech sector. It cites Swedish music app Spotify (NYSE:SPOT) and Dutch payment- systems company Adyen NV (AMS:ADYEN) as fast-growing European tech giants. True, the Europeans have some way to go before they can boast trillion-dollar corporations like Microsoft (NASDAQ:MSFT), Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN). But, according to GP Bullhound, last year was a record year for investment in the tech sector in Europe, with $28 billion in start-up capital raised – that’s nearly 10 times the $3 billion raised just five years ago. GP Bullhound reckons there are now 27 unicorns in Europe with a combined estimated valuation of $80 billion. These include Deliveroo (private), Asos (LON:ASC) and the gaming company Improbable (private). The UK has 11 unicorns followed by Sweden with eight. Five new British unicorns have emerged in the last year including Monzo, Darktrace and BenevolentAI.


But what about specialist expertise in digital currency? In February this year, Facebook acquired a little-known, London-based start-up called Chainspace. Founded by a group of University College London (UCL) academics, Chainspace is thought to be preeminent in designing new financial technology. UCL is a centre of excellence in blockchain technology. Reportedly, former Chainspace employees are playing a critical role in the roll-out of Libra. George Danezis, co-founder of Chainspace, was a fellow of the Alan Turing Institute. What Chainspace has created is a method of making transactions in digital currency more private. With bitcoin, all transactions are recorded on the blockchain – the digital ledger. Chainspace’s technology provides additional layers, called shards, to the blockchain. These layers include an execution layer and a verification layer.

Likely consequences of Libra

Let’s just speculate on how the world might change if Facebook’s new digital currency were widely adopted as a medium of exchange.

First, banks, which are already much out of favour with investors, would face a serious challenge. What ails the banks now is that they have been in retreat at least since the financial crisis of 2008 and their levels of customer service and satisfaction have been in freefall. As they lay off staff (without adequately enhancing the advantages of AI), this can only get worse. One of the inherent advantages that banks have is that, until now at least, we all need a bank account before we can subscribe to a mobile phone or apply for a credit card. Libra will appeal not only to the 1.7 billion adults in the world who do not have a bank account but who do possess a mobile phone – of which several hundred million are in India – but to all those, particularly the younger demographic, who prefer to bypass the banking system altogether.

Second, Libra will be a truly international currency, which makes cross-border transactions more efficient with much lower transaction costs. The internet, as we know, tends to facilitate the creation of monopolies. Just as Facebook is the natural monopoly in the domain of social media, so Libra is likely to become the monopoly digital currency because its user base will be many thousand times that of the exotics like bitcoin and Ethereum. Travellers will no longer need to take foreign currency when they go abroad on business or holiday: they’ll be able to settle hotel and restaurant bills with a swipe of their smartphone – and indeed their cab rides, using Uber (NASDAQ:U). Of course, there are huge security implications associated with this.

Even Facebook has admitted that Libra could be exploited by fraudsters. On 16 July, David Marcus, the Facebook executive who is leading the project, told a Senate hearing that Libra’s governing council will leave fraud prevention to the associated entities which provide digital wallets in which to hold Libra ’coins’. The issue is whether there will be an adequate vetting process before those entities are allowed to provide Libra wallets. “It will be the role of the Libra Association to ensure that there’s proper education so that consumers can make informed choices”, said Mr Marcus. The eminent senators were not impressed.

Quite apart from the risk that Libra coins might be stolen, there is the issue of data security. As a member of the Commons Digital, Culture, Media and Sport Committee, Julian Knight MP, asked: “What are they going to do with the data?” Of course, Facebook users’ spending patterns will be fed back into the increasingly subtle algorithms which will soon be able to predict the product you are going to buy next even before you know that you want or need it…Certainly Facebook and others will learn more about our spending habits and foibles than they know even now.

Also, currently with bitcoin et al you can buy illicit drugs (narcotics) online without censure. Facebook has stated that it will prevent Libra users from buying even prescription drugs let alone illegal ones. That’s fine – except that there will always be ethical disagreements concerning the use of medications, just as there are about dietary supplements, eg anabolic steroids. (If bodybuilders really want to take them, is that really the business of the state? In which case, why don’t we ban sugar, which is by far the leading cause of the obesity epidemic?) Such debates around health are inevitable, but do we really want Facebook to be ‘Chief Nanny’?

Although Libra, a so-called stablecoin, will be linked to the value of a basket of major currencies (certainly including the US dollar, the euro and the yen), it will not be long before the value of those old-fashioned national currencies are widely expressed in Libra.

Thirdly, if people choose to receive their wages in cryptocurrency, then the contraction of the global- banking system could happen quickly. That will have huge consequences for monetary policy and would be deflationary. It would reduce the clout of the central banks to manipulate the economy by setting interest rates and printing money. Eventually, digital banks and fintech champions will begin to offer credit in Libra. But who will set the interest rate? And would reserve requirements be imposed as on conventional lending? Monetary policy – the main characteristic of the contemporary economy as I explained recently −will be rendered marginal. That is why some central bankers are quietly muttering about banning Libra – if only they could.

The Governor of the Bank of England, Mark Carney, said last month that Facebook’s cryptocurrency Libra “should be approached with an open mind, not an open door”. Mr Carney added that if Libra was widely adopted, this would be “systemically important” and that it would need to be regulated. His remarks coincided with an interesting new regulatory development. Historically, only commercial banks were required to maintain overnight deposits or reserves with the UK central bank in proportion to their loan portfolios. But, from now on, payments companies will also be included in the reserve system.


But the most immediate consequence for investors is that – fourthly – Facebook could easily cease to be that nebulous thing, a social-media hub (giant that it is) and become a financial, or at least a fintech, stock. In this respect it is behind the curve. The Chinese messaging app WeChat (owned by Chinese tech titan Tencent (HKG:0700)) has already become a financial colossus which enables users to pay bills, summon taxis and much more.

Fifth, there will be people for whom all this feeds into a credible, global conspiracy theory. Alex Mashinsky, chief executive of Celsius Network, a kind of cryptocurrency bank, has written: “From the people who brought you fake news and fake friends and a fake president…now you get a fake blockchain…” Ultimately, Libra has to be the anti-globalists’ worst nightmare. It means that nation-states – including emerging multinational states like the European Union – which issue fiat currencies and enact fiscal and monetary policy, become beholden to global digital corporations.

Concerns about privacy

In June, cryptography expert Peter Todd, who was a bitcoin pioneer, declared that Libra was poorly designed. He said that Libra’s privacy features were “even worse than bitcoin’s”. Facebook claims that Libra is designed such that individual Calibra wallets cannot be linked to people’s Facebook personas. The company says that it will not share account information or financial data with third parties without their consent. This is qualified by the statement that there may be “limited cases” where data could be shared to prevent fraud or ensure compliance with the law (a reference to money laundering). The company says that it will make future decisions about the future of Calibra transparent. The fact is, however, that the details surrounding Libra’s blockchain architecture are scant.

How the central banks might respond

Given all of the above, it is possible that with the launch of Libra – and if it is rapidly and widely adopted, which I expect it will be – the central banks will be girded to respond by accelerating their own programmes to launch state-sponsored digital currencies. Agustín Carstens, chief executive of the Bank for International Settlements , is a keen supporter of digital money – so long as it remains under state control.

Let’s just remember that the use of physical cash is in terminal decline across the developed world. In Sweden few retailers even take cash any more – and the Bank of England’s recently published Future of Finance report suggests that the UK is only about five years behind Sweden. Add to that the secular decline in the role of banks within the international financial system which central banks may regard as their duty to reverse. That said, the Bank of England said last month that it has no plans to issue a digital currency. It said its main focus was to ensure the resilience of the next generation of electronic payments systems.

The Libra Association

This Association offers a line-up of some stellar companies. Visa (NYSE:V) is a truly global payments platform which processed 100 billion transactions in 2014. Its shares have done well year to date and the company is now trading on a P/E ratio of about 40. MasterCard (NYSE:MA) had revenues of $12.5 billion in 2017. Its shares have followed a smooth upward trend yeartodate. Opening at $180 on 3 January, they are trading at $275 at time of writing. PayPal (NASDAQ:PYPL) is probably the dominant global payments system on the internet with about 277 million users. Its shares have gone from $82 at the beginning of the year to around $118 at the end of July. Uber (NYSE:UBER), the global taxi-hailing app with about 110 million regular users worldwide, had its debut on the stock market in early May. Its shares are trading only just above the initial offer price as of the end of July.

Competitors

The question is not whether Libra will happen – it has been a long time in gestation – but how the other tech behemoths  will respond. Amazon, Apple and Google are not likely to sit back serenely while Facebook takes over the world. Jamie Dimon, the long-time chief executive of JP Morgan, told shareholders in his annual letter a few years ago: “Silicon Valley is coming…There are hundreds of start-ups with a lot of brains and money working on various alternatives to traditional banking…”. At least one bank chief executive is aware of the challenge to traditional models and is preparing to adapt. Watch this space.

Action

If you believe as I do that Libra will be transformative then there must be a case to put together a Libra Association portfolio consisting of all of the listed entities in the 28-member consortium[i]. Whatever reservations you may have about the direction of Facebook’s share price, the payments-platform sector has been having an amazing run this last year, which will only be enhanced by Libra.

The risk is that excessive regulation may hold back Libra’s potential, but countries like India with large numbers of unbanked citizens are likely to adopt a permissive stance. And if Libra works in India, what justification would the authorities have in restricting it in Europe and North America? The worst-case scenario is that the Libra Association will have to suspend the roll-out of Libra – which will not damage its existing revenue streams at all. (Perhaps because numerous big central banks advance their plans for monopoly digital currencies – which is quite possible in the medium term). The upside opportunity, therefore, is much greater than the downside risk.

In contrast, this development is very bad news for traditional commercial banks. I explained back in January why I am very bearish about the banking sector. Since then, if anything, the outlook for banks has become even gloomier with Deutsche Bank (ETR:DB) a sobering case study in how the mighty can fall.

The direction of travel is clear.

[i] For the full list see: https://www.theblockcrypto.com/2019/06/14/facebooks-cryptocurrency-partners-revealed-we-obtained-the-entire-list-of-inaugural-backers/