What happened during the Facebook hearings?

VeradiVerdict - Issue #46

TL;DR

  • Facebook recently launched a cryptocurrency called Libra, which is governed by an independent association called the Libra Association. Facebook is also working on a product called Calibra, which serves as a wallet to interface with Facebook’s products (Instagram, Facebook, WhatsApp).

  • This past week, Congress held 2-day hearings regarding the anticipated impact and regulation of Libra and Facebook. Some of the biggest concerns raised included:

  • Defining Libra within the current financial ecosystem. It’s unclear whether Libra will function purely as a payment vehicle, or also has the potential to act as a commodity, security, or ETF.

  • Financing criminal activities. Concerns abound about how a decentralized, unregulated financial ecosystem might be a gateway for those looking to finance human trafficking, drug trade, terrorism, etc.

  • Widespread, economy-threatening growth. Libra’s potential almost entirely relies on Facebook’s 2.4 billion user base. Once Libra launches for the general public, rapid widespread adoption might drastically hurt the value of the US dollar, threatening the country’s position in trade and economic systems.

  • Poor data privacy. Facebook’s no stranger to its data privacy scandals; though Libra is supposedly independent from Facebook, the ties between the two are undeniable. Libra may present a vehicle for Facebook to access financial information from its users, hurting its data privacy even further.

  • Ultimately, the hearings raised more and more concerns about the potential for Libra to change the world; but the key here is that all of these concerns demonstrate the genuine potential for Libra to disrupt the status quo of payments. Whether that disruption is for the better or worse is still up for debate.

To no surprise, the talk of the cryptocurrency town this week has been Facebook’s new cryptocurrency Libra. This past Tuesday and Wednesday, executives and developers from Facebook testified in front of the US Congress defending the good intent and financial potential of Libra amid concerns around Facebook’s data privacy laws, incredible user base, and monopolistic tendencies. The hearings delivered some key questions about how to regulate a monolith like Facebook in the modern-day and if decentralized financial systems truly benefit society if architected by a centralized, profit-driven agency.

What is Libra anyways?

Put simply, Libra is a cryptocurrency that Facebook developed to allow for decentralized financial transactions and wealth management across the world with hopes of bringing financial power to millions of unbanked individuals, easing the process of sending money internationally, and creating a user-driven financial system where individual users own their data. Though developed by Facebook, Libra is managed by the Libra Association, which will ultimately have 100 partners that govern the Libra blockchain; some current partners include Facebook, MasterCard, Visa, etc. but that list will only grow in the next few months.

Libra is starting as a permissioned blockchain––meaning only a select few will have the ability to mine transactions, interact with the blockchain, and use it for financial means. The idea behind this is to allow Libra to simmer with a few users for a short period of times to identify pain points and problems in the blockchain architecture; once the Libra Association and Facebook works that all out, the blockchain will become permissionless, allowing anyone to use it. 

Facebook also announced their new product, Calibra, which is a wallet for the Libra blockchain that makes an easy user interface for non-technical users to use Libra to carry out transactions. Calibra natively integrates with all major Facebook products (Facebook, Instagram, Whatsapp––bringing access to the Libra blockchain and the decentralized payment ecosystem to its 2.4 billion users worldwide.

You can read more about Libra here.

So, what is Congress so worried about?

The U.S. Senate and House of Representatives had a two-day hearing this past week to discuss how to think about, interact with, and regulate Libra today and after its anticipated growth. A lot of concerns from tons of different representatives were raised during the hearings, but most of the discussion boiled down to four main spaces.

1. Understanding What Libra Is

Cryptocurrency is a nebulous concept to most, so it’s no surprise that Congress had a ton of questions regarding how to financially define what Libra is and what that means for the US and global economy. Many lawmakers consider Libra to be a security or an exchange-traded fund (ETF), since the Libra coin is tied to a basket of securities. 

David Marcus, head of the Libra project at Facebook, denies that Libra is a commodity, security, or an ETF. He reasoned that Libra is purely a payment tool; since Libra’s intent is to be an entirely new payment mechanism, it is not a security. Securities generally create profit from speculating the value and price of the item, and trading to optimize one’s own individual profit based on the current price. Libra is a stablecoin, meaning its price or value will not be as subject to fluctuations as securities or ETFs, creating little value over trade due to speculation. 

Still, Congress, particularly former CFTC chair Gary Gensler, retained many concerns regarding the nature of Libra. Many other cryptocurrencies today function similarly to securities and are traded to profit off of price fluctuations, rather than to purchase items like conventional fiat would be. Libra might try to act like pure cash, but the way people use it might differ drastically.

2. Illicit Potential

If Libra is a decentralized currency regulated by an independent association and not the US Government, many critics argue that it has the potential to fund illicit activities including money laundering, human trafficking, illegal drug trade, and even terrorism. A decentralized currency could theoretically allow criminals to entirely avoid the security protocols implemented by the US financial system, removing a ton of the roadblocks set in place to avoid financing such criminal activities.

Marcus responded that most criminal transactions today occur through cash anyways, because it’s incredibly hard to record the spread and history of hand-to-hand paper transactions. An online banking ecosystem would reduce the ability of criminal transactions to go wholly unnoticed by regulatory agencies. Moreover, he claims that Calibra is building identity protections designed to recognize and invalidate transactions tied to criminal behaviors. 

Nonetheless, many Congresspeople have doubts about Marcus’ vacuous claims about Facebook’s potential to properly manage the security of their financial ecosystem. Representative Brad Sherman from California went so far as to claim “the number of deaths that will occur in America, if this is successful in playing the role it's intended, will exceed what was lost on 9/11.”

3. Rapid, Economy-Threatening Growth

Much of Libra’s potential to truly disrupt the current financial ecosystem is tied to Facebook’s user base of 2.4 billion monthly active users. Though cryptocurrency has been booming in recent months, its scale has never reached anything like that of Facebook’s; if Facebook natively integrated Libra through Calibra into its products, Libra would almost inevitably see huge growth and adoption in its very few months when it goes permissionless.

Many in Congress hold concerns about what such rapid adoption would do the U.S.’s current financial ecosystem. The transition from the use of the US Dollar to a currency like Libra could drastically bring down the power of the US Dollar in international markets, threatening long-standing trade agreements and financial protocols that are not perfect, but still work.

Understanding the impact of what such rapid adoption of a decentralized currency is a nebulous task, but one that truly highlights the fundamental catch-22 of Libra. Libra’s potential is almost wholly rooted in its connection with Facebook––from its demonstrated engineering talent, scalability, and most importantly, huge user base. Still, many of the concerns with Libra, particularly its potential to hurt the US Financial Ecosystem and concerns surrounding data privacy (see the next section for more) are also fundamentally rooted with Facebook. Big tech may have the unique power to disrupt the status quo, but its anticipated impact is incredibly unclear.

4. Data Privacy 

Aside from Libra, Facebook’s also been in the news for one of the biggest tech scandals in recent history––poor and illicit use of user data. Just last year, Facebook was uncovered for improperly handling and using millions of its users’ data; just one political firm gained access to data for over 87 million users.

At its core, Facebook’s entire business model is principled on ad sales; it drives sales and growth in this sector by selling user data to the companies that want them, allowing for ads optimized to each user’s interests and internet activity. Uncovering just how far Facebook takes each user’s data has threatened much of the public sector’s and general public’s confidence in the social media network’s trustability. A poll once showed that less than 17% of users would feel comfortable letting Facebook handle their financial information, just because of Facebook’s poor use of arguably less critical data, like what Pages they like or who they message.

Facebook tried to sideline this problem by establishing an entirely new independent association, called the Libra Association that will supposedly completely handle the Libra blockchain without oversight from Facebook. David Marcus added that Libra will not share any user data with Facebook without explicit, enthusiastic consent from the user. Yet, Libra’s origins still press concerns for those worried about how Facebook gathers and capitalizes on information from its users everyday. No matter what claims Facebook and Libra make about data sharing and independence, it’s impossible to deny that they both originated from the same thought space and share similar incentives when it comes to making profit, and that can be even further optimized with collusion.

Final Thoughts

At the end of the day, the US Government is so concerned about Libra because of its genuine potential to disrupt the domestic and global financial ecosystem on a possibly irreversible scale. Regardless of the concerns they raise, the common understanding here is that the combination of Libra and Facebook reflects a huge step towards a supposedly-decentralized economy. Whether that financial system truly benefits all and protects security or descends into even worse data handling and crime financing is yet to be seen; but Libra has the ability to change the financial world for better or worse.

Fun Survey - Which companies should be part of the Libra Association?

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Hi, I’m Paul Veradittakit, a Partner at Pantera Capital, one of the oldest and largest institutional investors focused on investing into blockchain companies and cryptocurrencies. The firm invests in equity, pre-sales/IEO rounds, and cryptocurrencies on the secondary markets. I focus on early investments and want to share my thoughts and what’s going on in the industry in this weekly newsletter.

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