BUY Facebook’s Libra and you are literally giving the social media giant a licence to print money, in the form of its new cryptocurrency.
A bunch of big companies have agreed to pony up $10 million each to take part, and it is easy to see why: On some reasonable-sounding assumptions about its takeup, it could be insanely profitable in real money, too.
Yet, delve into the plans and Libra looks a lot less appealing to users than Facebook’s hype suggests.
The profits would come from interest on the reserve backing Libra, designed to keep Libra’s value stable.
All interest is diverted to the companies backing Libra’s governing body, while holders of Libra itself earn nothing—giving the founders profits akin to the seigniorage
Assume one in 10 of the world’s 1.7 billion unbanked each hold $10 of Libra plus half of Facebook’s 2.4 billion other users sign up, putting in $50 each. The backers would get the interest on $61 billion of reserves.
They’ve pledged to hold a very boring safe portfolio of global bonds and bank accounts, which might earn 1% tops. Still, that is $600 million or so a year.
Take out $100 million as a wild guess of what it costs to run the system, and assume the 24 initial founders were joined by another 100 helping finance the expansion, and it would generate 40% returns on their initial investment every year.
If interest rates ever go up, those returns would be much higher.
It is easy to get carried away. In China the rapid expansion of Ant Financial, Baidu and Tencent pushed mobile payments above 16% of GDP in 2017, according to research by the Bank for International Settlements, without even counting payments between accounts.
If Libra takes 16% of Visa’s transactions, it would be processing a cool $1 trillion a year; match the velocity of money of the U.S. and Libra would need a $200 billion reserve, making $2 billion of profits, about a third of Visa’s net income in 2017. (Visa is among Libra’s backers.)
On less optimistic assumptions things don’t look so good. If Facebook users put in only $10 each, returns would be just 3%.
And if only a quarter of Facebook users adopt Libra, the income wouldn’t cover the (assumed! These are all assumptions!) costs.
If regulators get in on the act—as the Bank of England Gov. Mark Carney has suggested he would—the costs would be much higher, too; Visa’s costs are more than $5 billion a year.
Even if Libra only breaks even, Facebook and other backers might hope to profit from services built using Libra, or from the (probably fat) fees charged by brokerages, such as Facebook’s new Calibra, to convert money in and out of Libra.
Still, if Libra follows the pattern of virtually every bank in history, it would recognize that it can be more profitable by taking more risk with the reserve or minting new coins without reserve backing. It says it won’t do either, and has a voting structure that would require a supermajority to change the rules. But the voters have a strong incentive to change the rules once (if!) Libra becomes established.
Facebook’s reach ought to help Libra get big quickly. But its success isn’t obvious. The problem is the cost of getting money in and out via the “authorized resellers,” or exchanges. San Francisco-based Coinbase charges a minimum of 1.49% plus another 0.5% as a spread on the rate it offers to convert money into bitcoin and other cryptocurrencies. There is no reason to think Libra pricing would be much different.
Those costs make it hard to justify using Libra for domestic payments, which will be cheaper via the banking system, unless you want to hold Libra anyway. Even inefficient and expensive international transfers will still be cheaper in many traditional currencies than via Libra, if you have to pay 2% crypto exchange fees at either end.
If Libra offers a cheap way to transact in small sizes, it might be worth holding some, though, to allow tiny payments for things online such as articles, music or virtual items in games.
Libra might have appeal in countries with dodgy currencies, much as bitcoin does. It is designed to hold its value by promising to hold only the safest assets, just like a money-market fund, so it should move roughly in line with this basket of bonds and deposits spread across multiple currencies.
The reserve isn’t quite as great as it seems, though. Like a money-market fund Libra has no capital and no deposit insurance, so any drop in the value of the reserves should mean the value of Libra falls. Losses from fraud, mismanagement or default within the reserve fall on Libra holders, unlike with a normal bank account or bank note.
Worse still, the founders of Libra have a terrible incentive structure. If the reserve can be run to have capital losses but a high cash yield, the losses lie with the Libra holders while the profits go to the founders. Buy an old bond issued when yields were higher, and the price will be above face value. That generates a capital loss at maturity offset by coupons well above more recent issues.
Do you trust Facebook and the big corporations and venture capitalists on the governing board not to misuse a license to print money? If so, no problem. - WSJ
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