Last year, Facebook announced its plans to venture forth into becoming a currency issuer. The name of the currency will be LIBRA. Details suggest that its value will be based on a combination of leading global currencies. It will be a crypto currency, using block chain technology for its operations. In its efforts, Facebook is joined by leading companies like Uber, Mastercard, PayPal and Visa.
The basis for venturing into this realm is explained in terms of empowering billions of people through a global currency working in financial ecosystem. Billions of people who are devoid of financial services will become part of the formal system given that Libra’s introduction will eliminate barriers to entry (high fees and charges of financial institutions).
The question is: will it work? The simple answer is nobody knows! As with all such initiatives, it is like diving into the unknown. The following is a brief discussion of some aspects of this debate.
Let us start with the basics of how a currency becomes acceptable and widely used. We turn to something called the ‘network effects.’ Basically, information dissemination about a certain asset leads to formation of a network over time in which that asset is valued, accepted and used for exchange. Owners of residences in highly valued, posh areas in cities like Islamabad (for example) collect their rents in dollars rather than rupees. Dollar is neither the currency of Pakistan, nor has government stipulated its use in rent agreements. Yet dollar is more than acceptable in transactions since its more valuable and readily acceptable, thanks to network effects.
Facebook has over 2.4 billion active users, having the advantage of a network in place
Facebook has over 2.4 billion active users, thus having the advantage of a network in place. Just like the dollar’s eminence is perpetuated by backing of the largest economy of the world, libra’s popularity would be driven by a platform whose market capitalization stands above $500 billion and net worth above $125 billion. That should hypothetically be enough to make libra an in-demand asset.
But libra may even be a failure. Currencies such as libra have been tried before, but they all failed. Kredietbank’s EUA was introduced in 1961, Rothschild & Sons introduced the Eurco in 1973 (made up of nine currencies), Hambros Bank introduced the Arcru in 1974 (comprising twelve Arab currencies), and Barclays Bank introduced the B-Unit in 1974 (made of five currencies). None of these privately issued currencies survived. Only the IMFs SDR has survived, which is accepted by all governments around the globe. But nobody uses it in daily transactions, and assets are hardly quoted in terms of SDR.
The failure of these to become acceptable tells us a lot about why currencies work and don’t work. First, there is a difference between a government and private organization issuing currency. Moreover, a government has the discretionary power to tax. In times of recession, for example, government could immediately increase its spending by printing more in order to beef up the economy. Plus, they can tax to meet their expenses. For private organizations, these two feats are difficult to achieve, which makes them less credible in the eyes of currency users. Second, it took a long time for leading currencies to establish themselves. In that time, one thing that never disappeared was the government. In contrast, the fortunes of private organizations can go through wild swings, making them less credible in the eyes of the users. Compaq, Kodak, AOL, Netscape and Enron were some of the leading companies of their time, but have vanished – either gobbled up by other firms or losing out to competition. A government faces no such competition. Hence its products (like a national currency) comes with certainty that is absent in terms of private issuers.
Then there are other issues that militate against libra. First, it will face intense competition from hundreds of other crypto currencies (like Bitcoin, based on block chain) that have already established themselves. Second, governments are now especially becoming averse to the idea of block chain based currencies for a genuine reason: they offer safety to drug peddlers, smugglers and terror financiers. A defining characteristic of block chain is the anonymity it offers to its users. There is no way of knowing who carried out a transaction. In essence, this would make it much harder for governments to track them. And third, block chain based platforms use tremendous amounts of energy to operate, making them environmentally unfeasible. They extract a heavy cost in terms of their carbon footprint.
It is perhaps opportune to explore an enticing question: what drove Facebook to venture into this idea? To my mind, two important developments were instrumental. First, Facebook is increasingly being scrutinized around the globe, especially in the aftermath of the Brexit and Russian meddling in 2016 US elections. In both these cases, social media platforms like Facebook were relentlessly exploited to influence peoples’ opinion, something that Facebook’s management later acknowledged. Last year, Facebook confirmed that Iran and Russia were trying to influence voters for 2020 elections through their platform.
As the scrutiny intensifies and more tight controls are being demanded of Facebook, it is logical for its owner to think in terms of divesting away from a single activity towards other promising platforms, which may be less scrutinized and less open to abuse.
The second factor is purely financial in nature. A smart investor would want to diversify his investments. And a promising investment avenue is the ‘internet of money.’ This is the purported evolution of the internet from the initial ‘internet of things’ (that envisaged a globally connected, networked society). If there could be a globally networked society that shares information, why can’t there be one that is financially networked and connected? In some ways, it already is through e-commerce and other such developments. But there is still potential, and Facebook is well placed to take advantage of such ‘network effects’. The potential of earnings, if it works, is enormous. To give the reader an idea, the accumulated profit on global payments in 2018 totalled $1.9 trillion (source: McKinsey& Company). Time will be the final judge of whether this project will meet success or fail.
The writer is an economist