Note that Facebook’s Libra has now changed its name to Diem and is expected to launch in January 2021 and will be linked to the US dollar. This post refers to both Libra as proposed in the original white paper from June 2019 as well as the Diem currency which is the current proposed concept satisfying regulator’s approval.

I was watching an old Milton Friedman special, Free to Choose, based off the book of the same name, where he mentioned that governments are always backward looking, never forward. All the talk about free markets and innovation got me to thinking about cryptocurrency. Specifically about the main problem with cryptocurrency as a store of value and the hostility of governments to the Libra proposal from Facebook which I wrote about last year.

The main argument against Libra was that it created a currency that was free from any government. This struck fear into governments around the world, especially the US government, which feared losing the sovereignty of its own currency.

But this isn’t a threat to the dollar anymore than gold is or the euro is. Even when central bankers were sounding the alarm that this would be different because it would almost immediately be systematic. A fiat currency is only as good as its backers and its perception. History has shown that since we left the gold standard, certain governments are simply the best and most trusted backers of money. Libra just attempted to synthesize the best and most stable government efforts at fiat money into one derivative currency.

The scaled down version of Libra, reportedly set to debut in 2021, is disappointing. Rather than a digital token backed by a basket of stable currencies, it will eventually have its backing per currency: the Libra dollar, the Libra euro etc. In other words, it has simply become the Facebook version of Tether. This is a little unfair to Facebook because it’s not actually a subsidiary of Facebook but Facebook made itself the face of Libra so they need to take responsibility for the marketing strategy gone awry.

The Issue With Independent Currencies

Tether is a crypto currency that was supposedly linked to the dollar. But when you have individuals at the helm of a currency with personal profit as their primary motivation, there is a strong incentive to cheat. The incentive is to produce more of the currency than they have of the underlying asset which it is linked to and then sell that currency for other hard assets (or legitimate dollars) before holders catch on that the currency they hold is losing value. This is exactly what happened with Tether and there are important lessons in that incident. The lessons that Libra tried to take away from this is that besides just linking a cryptocurrency to a sovereign currency by faith, you needed to demonstrate a transparent and independent structure behind it so people start to believe that you won’t cheat the currency by “printing” more. I argued in that previous post that Libra was essentially just a currency board similar to colonial governments had 100 years ago or Argentina attempted in the 90’s and early 2000’s.

Libra was envisioned as a currency that could break free of governments. Let’s be honest, this is the crypto currency advocate’s dream and the final peice of the puzzle. To be money, what is being used as money must be a medium of exchange and a unit of account as well as a stable store of value. It’s the last part that is eluding cryptocurrency enthusiasts and would complete their holy trinity of having an electronic currency free of government which has those 3 qualities.

Stable value has been elusive though. I don’t care what anyone tells you, no one knows what Bitcoin is worth. Some have attempted to link it to the marginal cost of electricity globally but it has departed wildly from this again and has been subject to wild swings of speculation.

We live in a bifurcated world of money. There is physically printed money, which can be anonymous yet is still accepted as a means of exchange and then there is electronic money, for which the burden falls on private institutions to document and regulate where the money is coming from. This is where Libra made its fatal error when it was originally envisioned. The backers thought they could create a currency that was free from governments, transmitted electronically and free from any oversight or regulation. This last part was the Achilles heel of the concept.

Physical money, let’s use dollars in this case, is free to be anonymous and used for illicit purposes. The government implicitly tolerates some amount of illicit activity with regards to physical money because the benefits of having a national means of exchange and control over monetary policy outweigh the costs of a little bit of illicit activity compared to the size of legitimate financial markets. It’s the electronic form of money where they seek to exert more control. This is to prevent fraud and illegal activities on a large scale. Large sums of physical money from illegal activities would be difficult to transfer and store which is why large scale criminal operations, like that of Pablo Escobar, sought access to the international banking system. Once illicit money finds a home there, it becomes more difficult to control as it can be whisked easily all over the world.

Libra’s fatal flaw was that it sought to flout these controls and remain available for illicit and illegal purposes. That wasn’t the spirit or the goal of what the consortium was thinking but rather a consequence of not being within the traditional banking framework. This gave the governments an easy excuse to shut it down. The vision and the dream of the original version of Libra was to provide a freely accessible, stable currency for those in the world world who are unbanked. This potential market globally is estimated at 1.7 billion people.

Although the idea had seemingly solved the problem of a stable “world” currency by fixing its value to a currency basket, it created a new problem in that it didn’t take into consideration the documentation and background of account holders that needs to be maintained in rich world bank accounts. The cost of this may seem insignificant to most people with a job in the rich world where we have access to low cost or even free online banking in a stable currency (the dollar, euro or yen) but this isn’t the case in a place like Mozambique or Ethiopia. There, if a local bank even offers dollar or euro accounts (which they may do, but usually only for the rich) they have requirements that are prohibitive for someone making the equivalent of $500 a month. The billions of people in the developing world that are low wage earners are locked out of a stable currency and are beholden to the whims of their own government and the money they print.

This is one reason why governments that consistently have gotten it wrong and screwed up their currency through bad policies have given up on their own currency and dollarized. Dollarization just replaces the local currency with another but since the US dollar is internationally trusted as a stable store of value, other parts of the economy can begin to function more normally again.

The Real Challenges Lie Ahead

So if banking the poor and their low balance accounts is the true goal of the anarcho-crypto crowd, then the challenge in addition to a stable value is keeping illicit funds out rather than the utopian dream of having a widely available currency free from government control. To date, this has been done through slow and thorough documentation of individuals and their companies before allowing their funds to enter the global financial system. This is known in the banking world as Know Your Customer (KYC) protocol, a consequence of the US Patriot Act which was enacted as a result of the attacks of September 11.

Innovation in how to identify honest people and companies, while keeping out the criminal and terrorist elements, is going to be the key for more wide scale acceptance and usability of cryptocurrency and blockchain tokens in everyday life. There are bits and pieces of the puzzle being developed currently in an area known as reg-tech but until there is a company that can quickly and cheaply document or solve the issue of security of access to the global financial system, crypto currencies will remain in a regulatory grey area.

The initial proposal for Libra, even though it turned out to be a failure, was an important step in the right direction. Many of today’s most successful companies stand on the shoulders of failures that came before them: AOL, MySpace, Groceries.com etc. Don’t think the idea of a stable, digital token for the developing world is dead, it’s merely going through another innovation iteration until that transparency and safety can be achieved.

In addition, the stated aim of banking the unbanked is a worthy one. It’s a shame that the World Bank, the IMF and the BIS, institutions that are supposed to promote increased standards of living in the developing world, aren’t taking this aim more seriously. Rather, many of them as well as the central banks are preoccupied with creating their own central bank token blockchains to be able to stimulate their own monetary systems with the press of a button.

There is massive entrepreneurial talent and labor that could be tapped even further in the developing world if more everyday people had access to a bank account or digital wallet that held a stable currency. Don’t think that this will be the final form of Libra or other asset based cryptocurrencies that we will see in the near future.

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