Facebook (FB) - Get Report made a big splash Tuesday, unveiling its long-awaited move into cryptocurrency with a novel product called Libra, as well as a set of technologies to establish a market for it.
While the details are ambitious and have unique aspects, the effort is likely to amount to little, for three reasons:
1. Libra won't eliminate the speculation and volatility that have afflicted other cryptocurrencies.
Speculation has been a hallmark of Bitcoin and other currencies, and it has led to wild price swings. In the past year, Bitcoin dropped from a high of over $17,000 for each Bitcoin to under $4,000, and has only worked its way back to about half its prior high. Because there is little but speculation to cement the value of Bitcoin, its price fluctuates wildly based on supply and demand, and it is open to manipulation by malicious parties.
Facebook's system aims to fix that by basing the value of Libra on a basket of securities, short-term holdings of assets in fiat currencies kept in trust by an association that manages the currency, including Facebook and a range of partners, including Visa (V) - Get Report and MasterCard (MA) - Get Report . The assets, called a "reserve," mean there will always be a buyer of last resort for anyone's Libra holdings, which is a good thing for promoting stability.
But some people are mis-interpreting the reserve as a "peg," a fixing of the value of the currency in terms of dollars and euros and pounds sterling. That's not true. A monetary peg is the result of an active exchange rate regime that buys and sells reserves to force the currency to maintain a certain level of value. Facebook explicitly noted that the reserve is not actively managed. It sits there in a bank ready to cash out Libra holdings when anyone wants. In the meantime, the virtual currency is free to float in value as traders speculate on future exchange rates.
As it states in one of the accompanying materials, "Because the reserve will not be actively managed, any appreciation or depreciation in the value of the Libra will come solely as a result of FX market movements."
No one, not even Facebook, knows what that degree of variability will be in the price. While real-world currencies float in value against one another, each currency is to an extent anchored by being embedded in a vast network of trade in goods and services, both domestic and foreign. Until Libra establishes itself, it doesn't have that anchor.
2. Libra won't address the biggest problem facing the "unbanked."
Facebook claims that reducing friction in the funding process will loosen up money for people without access to banks and other financial institutions. But even with a friction-free currency, someone still has to lend these parties money. That means someone has to put capital at risk. That's a challenge that's irrespective of currency movement. Libra will expose just how much the world is willing to lend to the unbanked. It may turn out to be less than hoped for.
3. Technology is too unreliable to form a foundation for a virtual store of value.
Libra's biggest challenge is that technology is not sufficiently robust to secure assets. Under the best of circumstances, software is unreliable. It is prone to failure that can lead to lost data. That's because computer technology is generally built for performance, first and foremost, to deliver speed of compute. Software in general is not built to be robust and to emphasize reliability above all else.
The world of crypto has hardly been the best of circumstances. Bad actors constantly seek to corrupt and compromise computer systems. They break into the software "wallets" that store virtual currencies. Tens of millions of dollars have been stolen from the crypto exchanges that hold traders' currency in escrow. The latest trick is stealing people's smartphone SIM to intercept credentials to break into wallets. Those vulnerable points constitute the weakest links that compromise any virtual currency.
It would be nice to think that a big company such as Facebook can bring sanity to all that. But Facebook and other big techs have shown themselves to be poor stewards of safety and security and trust. Their software and services are "best-effort" Internet offerings where consumers tread at their own risk. Putting one's hard-earned money into crypto systems from Facebook or any other big tech company is probably no better than hoping one's email account won't be hacked, though for many of us, it ultimately will.
While all this plays out, starting next year, there may still be upside for Facebook and its partners. While participants in Libra find out just how big the risk is, the parties controlling the system can perhaps enjoy a decent profit in the spread between Libra and fiat currencies that will be exchanged for it.
Facebook stands to make money in the near term, but perhaps not surprisingly, the payoff for society is likely to be much less.
Tiernan Ray neither trades nor owns any shares of any companies mentioned in this article.