On 18 June 2019, Facebook launched project Libra alongside 27 partners including e-commerce marketplace eBay, media services provider Spotify, transport network companies Uber and Lyft, and payment companies such as Mastercard, PayPal and Visa. According to the recent white paper from Libra Association members, Libra is designed to be a stable, low-volatility cryptocurrency with its own secure, scalable and reliable blockchain. Their mission? To enable a simple global currency and financial infrastructure that empowers billions of people.
The number of Libra Association founding members is expected to rise from the current 28 to 100 by the initiative’s target launch date in the first half of 2020. Members will consist of geographically distributed and diverse businesses, non-profit and multilateral organisations, and academic institutions – but the one thing that stands out from the group members, so far, is the absence of any traditional banks.
The Libra Association will form an independent non-profit body charged with running the platform and providing a framework for governance, with Facebook but one of the future members of this open-source Libra initiative.
Libra and its practical applications
Unlike most other cryptocurrencies, Libra appears to be fit for purpose. From initial observations, it looks to be:
- Stable – a unit of ‘Libra’ currency will initially be backed by a basket of financial assets denominated in four stable fiat currencies: USD, EUR, JPY and GBP. For every ‘Libra’ created there will be a ‘Libra Reserve’.
- Instantaneous – the Libra blockchain system is set up as a single data structure allowing high transaction throughput. The system adopts Byzantine Fault Tolerant (BFT) consensus protocols that are designed to allow the blockchain system to function correctly even if some validator ‘nodes’ (electronic devices connecting to the blockchain network that validate and record transaction data) are compromised or fail. In comparison, a bitcoin ‘block transaction’ can take up to 10 minutes to process, making it less suitable for widespread adoption. The Libra blockchain will initially be permissioned and private, and only Libra Association members will be able to create (mint) or destroy (burn) Libra.
- Able to tap into a mass-market – Facebook will use Libra currency in its proprietary ‘Calibra’ wallet that will allow individuals and businesses to make electronic transactions. It will be available to its ca 2 billion users of Facebook and its associated apps (and other interested users). A potential customer base that amounts to more than a quarter of the world’s estimated population. After a simple government-issued ID verification, users could pay each other through Whatsapp or Messenger. Facebook’s brand, together with Visa and Mastercard, could allow Calibra wallet adoption by consumers and acceptance at merchants at a scale never seen before for any other cryptocurrency. Over time, the open source Libra framework should enable integration of the technology into smartphones and browsers for easy access. Smaller merchants, for example, could accept payments in Libra using QR (quick response) barcodes on their smartphones. Convenience (or reduced friction) has so far proven to be the most important driver of technology adoption.
The most obvious applications for digital currency are peer-to-peer transfers, cross-border remittances, and commercial transactions. In certain cases, users pay around 5-10% in fees for transferring money back to their families domiciled in other countries. Facebook expects to bring these fees down by an order of magnitude.
While transaction services are the first use case, I believe Facebook (and Libra Association members) would eventually expand to offering other financial services to the bottom of the pyramid; lower income and ‘unbanked’ consumers. Just read the text from their whitepaper below:
“All over the world, people with less money pay more for financial services. Hard-earned income is eroded by fees, from remittances and wire costs to overdraft and ATM charges. Payday loans can charge annualized interest rates of 400 percent or more, and finance charges can be as high as $30 just to borrow $100. When people are asked why they remain on the fringe of the existing financial system, those who remain ’unbanked’ point to not having sufficient funds, high and unpredictable fees, banks being too far away, and lacking the necessary documentation.” – Libra Whitepaper
There is good reason to believe that Libra can deliver on the promise of bringing financial services to the under-banked through leveraging the low cost of a private blockchain, avoiding existing financial intermediaries, and harnessing insights from aggregated financial data (and social data, when explicitly permissioned by the user). Facebook’s WhatsApp user base likely has a large overlap with the population in the emerging markets.
Shifting power and profit pools
It didn’t escape my attention that there are, so far, no banks among Libra Association founding members. While that is likely to change over time as the number of members rises, it appears quite likely that the profit pool for banks will erode with the downward pressure on fees. Lower fees will result in value creation for consumers, while a share of the profit pool may be captured by the new participants including Tech companies and merchants. Given that anyone can create another wallet using the Libra framework, the upside for Facebook, or any single participant, is unclear today. However, the downside to the legacy financial system, which is currently enjoying high fees, is clearer.
The other stakeholders likely to be impacted are central banks in many developing countries, especially those with unstable currencies. Take a scenario where the local currency is rapidly losing value – the population may instead choose to deal in Libra. In this instance, how would a central bank react to suddenly having no control over its own currency? This is an unknown, but a likely, dilemma confronting institutions should the Libra Association be successful in their mission to encourage mass market adoption of Libra.
Central banks around the world have voiced concerns about Libra, not only doubting Facebook’s transparency and its trustworthiness with respect to handling data, but also by highlighting the potential risks from an unregulated system.
What does it mean for Facebook?
We don’t yet know what other new services Facebook intends to launch on top of Libra but, at this stage, it is not clear how much upside one can attribute. The company has suggested it will likely not make money from transaction fees, given that it plans to bring down fees by an order of magnitude – to a level needed only to cover fraud and charge backs. It also doesn’t plan to share social data with financial data without customer’s consent.
Libra doesn’t enhance the value of the core advertising business directly, as the company doesn’t plan to use Calibra data to improve ad targeting, but it does improve ad monetisation. Libra could help Facebook improve conversion of its existing ads to transactions on its own platform. Lower friction in executing transactions and better measurement of that improvement should boost ad monetisation. Essentially, introducing payments is an economic moat-enhancing and value-capturing feature for Facebook that could earn it a distinct advantage.
Assessing disruption potential and valuing ‘optionality’
Facebook’s foray into payments is a prime example of a ‘disruptor’ company that is influencing change and challenging industry norms. (We discussed this trend in a previous Investment insight paper on how technology is disrupting industries).
We appreciate that the adoption of blockchain-based Libra will take time – especially as it involves consumers who typically require a step-improvement before they change their established habits, and regulators who are already displeased with Facebook’s poor handling of customer data. However, bringing transaction and remittance fees down 10-fold creates true value for consumers and is a compelling argument for the adoption of Libra.
Our active approach to valuing and investing in tech companies means that we are regularly revisiting, and either confirming or evolving our investment theses. Where Facebook is concerned, valuing the Libra initiative on its own is challenging given the uncertainties surrounding it. As such, when analysing and valuing the company on the sum of its parts, prudence ensures that we do not attribute any speculative value to the Libra project. Consequently, the potential success of the initiative is simply a ‘free option’ from our perspective. In essence, this is the ‘option’ to potentially benefit from an add-on that does not constitute a part of a company’s core business, and for which any ‘unlocked’ value is not factored into the company’s valuation.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.