Do regulators have anything to fear from Libra?

9 July, 2019

Facebook's Libra seems to be all over the cryptocurrency news these days. Hardly a day goes by without at least one or two Libra stories popping up. That is to be expected, given the nature of Facebook's ambitious cryptocurrency project and the fact that regulators now find themselves in the position of having to educate themselves about cryptocurrency so they can fully understand Libra's implications.

As regulators learn, they appear to be growing more concerned. From the U.S. to South Korea to the EU, regulators are slowly coming to the conclusion that Libra could be detrimental to global economics if it catches on as much as Facebook predicts it will. But are those regulators correct? Do they really have anything to fear from Libra?

Let us be clear about one thing: regulators and politicians generally fear anything that threatens their hold on power. But by the same token, they are tasked with protecting the public good. One can understand the inclination to regulate in a world where global corporations like Facebook have so much control over what people think, do, and say. But it is still hard to believe that Libra represents the existential threat that so many regulators now think it is.

Fears of financial instability

South Korea's Financial Services Commission (FSC) has demonstrated a rather tepid response to cryptocurrency over the years. While the country is generally welcoming to crypto and blockchain based businesses, and they have no problem with citizens owning cryptocurrency, government officials have been quick to crack down on any entities they believe are engaged unscrupulous activities.

Government regulators take their responsibility to protect citizens seriously. With that in mind, the FSC worries that widespread adoption of Libra could bring instability to global financial markets by taking too much fiat out of circulation. In the recent report, the FSC poses the question of what might happen if the more than two billion current Facebook users transferred just 10% of their financial resources to Libra.

South Korean regulators believe one possibility could be a series of bank runs that would threaten bank solvency around the world. So much money being taken out of the traditional banking system would also mean less money to loan, lower reserves, and higher debt loads for the banks themselves.

If a global run on banks did occur, it could make the late '20s and early '30s Depression look mild by comparison. And yet, there is no reason to believe that such a dire scenario would actually occur. Even if the majority of Facebook's users did move 10% of their income into Libra, they wouldn't all do so simultaneously. It would be a more gradual transition and barely a blip on the banking industry's radar screen.

Lost business for banks

Even if widespread Libra adoption doesn't cause a run on banks, FSC regulators still fear the traditional banking sector will suffer. They cited one example of Facebook purchasing a bond with funds deposited by Libra users, rather than making a bank deposit. Regulators say that losing such a sizable deposit would be damaging to the banking system.

In addition, there are fears that Facebook will implement Libra transactions with no fees attached. Regulators are concerned that such transactions will encourage people to stop using traditional payments in favor Libra. That would mean fewer revenues for both retail and commercial banks, institutions that rely on transaction fees for quite a bit of their income.

Fears of money laundering

South Korea's FSC is also concerned about large-scale money-laundering it believes might coincide with Libra's growth. Regulators say that preventing money laundering requires a strong regulatory framework similar to what banks are already subjected to. Without such a framework, Libra's unconstrained development could create problems that eventually grow too big to solve with regulation.

Money-laundering has long been a concern of cryptocurrency in general. Why it is more concerning for crypto than fiat is unclear. Government regulators may say that they have done a good job controlling money-laundering in the traditional banking sector, but it's just talk. Money-laundering has been going on for as long as humans have been banking; it was going on long before crypto and continues to happen in the banking sector today.

Regulation is too slow

All of the concerns outlined in the FSC report are not unique to South Korea. Regulators the world over share their opinions. More importantly, some of those regulators are beginning to sound the alarm that regulation is moving too slowly. Will they speed things up now that Libra is on the table? Not only is it possible, it is probable.

In the U.S., a number of lawmakers have already started talking about issuing some sort of moratorium that would temporarily freeze development of cryptocurrency in that country. Others are more specific in calling for a freeze on Libra. U.S. politicians will begin holding hearings soon in an attempt to figure out what to do about Facebook's decision to get into financial services.

Across the Pond, the European Central Bank (ECB) is pressing regulators to get more aggressive. They want regulators to develop tough rules that will tightly control big tech's entry into financial services. ECB Executive Board member Benoit Coeure was quoted by Coin Desk as saying "we have to move more quickly" in the regulatory arena.

"It's out of the question to allow them to develop in a regulatory void for their financial service activities, because it's just too dangerous," Coeure said. "We have to move more quickly than we've been able to do up until now."

Bruno Le Maire, the French finance minister, has gone on record as saying he believes regulators should not allow Facebook to "become a sovereign currency." His statement clearly shows just how nervous world regulators are. Perhaps Facebook does hope Libra will one day replace fiat entirely, but they have given no indication that any such plans are in the works. Still, government regulators see that as the endgame.

Libra is not a passing fad

It is both interesting and amusing to pay attention to what regulators are saying about Libra. Up until a few years ago, when rumors of Facebook's cryptocurrency first began circulating, government regulators gave very little thought to the whole concept of digital money. Any talk of Bitcoin and its many competitors was limited to speculation that cryptocurrency was a passing fad.

What is so different today? Facebook's entry into the cryptocurrency arena cannot be explained away as a passing fad. Facebook is the world's number one social media provider with more than 2.3 billion users worldwide. Like it or not, the portfolio of Facebook social media properties is very influential in the worldwide discussion on any topic. So when Facebook speaks, people listen.

It is not a stretch to suggest that people will start using Libra as soon as it is available. The only question is how much they will use it. A worst-case scenario for regulators is that people pump so much money into Libra that fiat collapses. But that is unlikely to happen based on the simple fact that Libra is a stablecoin rather than a pure cryptocurrency.

The big stable coin difference

A pure cryptocurrency is a standalone monetary system that rises or falls on the investments of people who buy coins. A stablecoin is decidedly different because it is backed by some other trusted asset. A stablecoin might be backed by a respected fiat, a commodity (like gold or silver), securities, and the like.

Libra will be backed by a combination of fiat currencies and government securities. As such, its price will be tied very closely to the fiat currencies behind it. As global economics go, so will Libra. Here's why this matters: stablecoins are not investments on this same scale as something like Bitcoin or Bitcoin Cash. There are not massive amounts of money to be made on equally huge price swings. Suffice it to say there are not going to be any Libra whales.

That means that most Libra users are going to be average citizens just looking to transact business online. As long as world governments do not recognize Libra as legal tender, there is nothing to worry about. Libra becomes just another electronic payment system no different than mobile payments or online services.

As for Facebook, they are going to have to link their cryptocurrency activities to traditional banking in some way, shape, or form. They will have to be able to convert fiat to crypto and back again. And once the traditional banking sector gets involved, Libra no longer poses a threat to their existence.

So what is really going on here? It is probably a combination of two things. First is fear. Human beings typically fear what they do not understand, and neither politicians nor regulators have much of a clue when it comes to cryptocurrency. Second is the need for control. Regulators, by their very nature, believe that government has to control everything. Seeing the possibility of Libra being developed in a regulatory void does not comport with the way they see the world.

No, regulators have nothing to fear from Libra. It will be what it will be based on the best possible regulator in the world: the free and open market. That is, if regulators leave it alone.