Libra: What it means for community banks

Illustration: Benedetto Cristofani

When the social media titan announced that it is developing its own cryptocurrency, it shook the financial industry. But what is Facebook planning? How is Libra structured differently than the thousands of previous cryptos? And what are policymakers saying about Facebook’s plan to expand into currency?

By Colleen Morrison

With 2.41 billion monthly active users, no one questions Facebook’s influence, and when the company makes announcements, people listen. So, the world paid attention—and reacted—in June when Facebook and the Libra Association revealed a plan to build a new form of cryptocurrency.

Libra, as the new currency is called, is “a global, digitally native, reserve-backed cryptocurrency built on the foundation of blockchain technology.” But what makes it unique isn’t so much what it is, but how it’s structured.

First, some definitions. Blockchain describes the database that links various pieces of information using an open, distributed ledger format to record interactions or transactions in a decentralized network. As with any digital system, developers can leverage fundamental principles to make the blockchain network unique to their needs. Think of it as the system that allows the money to move.

Then there’s cryptocurrency, or, in simpler terms, the money itself. Cryptocurrency refers to a digital item of financial value that has no central issuing authority. Bitcoin is the most notable example. This currency relies on the decentralized blockchain network to record transactions and protect against counterfeit and fraud via a layer of cryptography baked into its digital form.

Blockchain and cryptocurrency work hand in hand to create a system of monetary exchange that flows outside the confines of the established financial system. And this is where Libra’s approach differs from many of the more than 2,700 existing cryptocurrencies. Libra will be backed by established, traditional currencies in a reserve, or “fully backed by a reserve of real assets.”

But what, exactly, does that mean?

Breaking down what Libra is

To answer that question, we need to delve more deeply into the foundation of Libra. Three key parts comprise the core structure of the back-end support for Libra: Libra Blockchain, Libra Reserve and the Libra Association. Each component plays a role in differentiating this cryptocurrency from others.

Libra Blockchain refers to the network that allows the cryptocurrency to be exchanged. It is an “open, interoperable ecosystem of financial services that developers and organizations will build to help people and businesses hold and transfer Libra for everyday use,” according to a white paper published by Libra. The currency itself is also called Libra.

The Libra Reserve makes the cryptocurrency unique. It assimilates a “basket of currencies” as a fungible pool of cash and short-term government securities held by a global network of secure custodial arrangements, as agreed upon with applicable regulators. Planned currencies in this reserve include the U.S. dollar, the British pound, the Singapore dollar, the euro and the Japanese yen. The apparent goal? To limit Libra’s volatility.

Finally, there is the Libra Association, an independent membership-based organization that acts as the governing body for the Libra Blockchain and the Libra Reserve. This association is headquartered in Geneva, Switzerland, and is pursuing a license as a payment system with lead supervisory authority under the Swiss Financial Market Supervisory Authority (FINMA). Its founding members as of mid-October were:

  • Payments, technology and marketplaces: PayU, Facebook/Calibra, Farfetch, Lyft, Spotify and Uber
  • Telecommunications: Iliad and Vodafone
  • Blockchain services: Anchorage, Bison Trails, Coinbase and Xapo
  • Venture capital: Andreessen Horowitz, Breakthrough Initiatives, Ribbit Capital, Thrive Capital and Union Square Ventures
  • Nonprofits, multilateral organizations and academic institutions: Creative Destruction Lab, Kiva, Mercy Corps and Women’s World Banking

Noticeably absent from this list? Some of the world’s biggest payments and online commerce companies: Mastercard, PayPal, Mercado Pago, Stripe (which stopped offering bitcoin in 2018), Visa, eBay and Booking Holdings, all of which left the Libra Association en masse in mid-October. Also absent from this list? A single financial institution or organization representing them.

Facebook currently plays a large role in the setup with the association and has publicly stated that it plans to continue to do so through 2019, but once the Libra Blockchain launches, Facebook will step back to assume an equal role with all other association members.

Yet, at the time Libra launched, Facebook was the only one of its founding members that debuted plans for its initial product offering. Calibra is Facebook’s “new digital wallet that [customers will] be able to use to save, send and spend Libra.” According to Facebook, Calibra is slated to launch in the social media giant’s Messenger and WhatsApp applications, as well as its own standalone app, in 2020. While there is only a short time between the announcement of Libra and this planned product launch, Facebook assures us that it will do its due diligence.

“The time between now and launch is designed to be an open, collaborative process,” says Facebook spokesman Josh Gunter. “We will take the time to get this right.”

Milestones in cryptocurrency

2008 is registered, and the Bitcoin: A Peer-to-Peer Electronic Cash System white paper is released by Satoshi Nakamoto, a pseudonym of its creator(s). Most experts agree that this marks the foundation of cryptocurrency.

The first bitcoin transaction takes place. Nakamoto successfully sends 10 bitcoins to crypto expert Hal Finney.

The first mainstream cryptocurrency transaction occurs, and it’s met with the first signs of trouble. Someone uses 10,000 bitcoins to buy two pizzas, and in August, the first hack occurs.

Illicit use of bitcoin on the dark web grows, while competition emerges. The fervor over cryptocurrency causes value to rise.

The first bitcoin ATM launches in Vancouver, Canada. Globally, countries begin debates on how to incorporate cryptocurrencies.

Microsoft tests the waters and allows users to buy games with bitcoin.

2015 – 2017
Cryptocurrency continues to climb in popularity. New cryptocurrencies emerge, bitcoin ATMs grow, countries formalize cryptocurrency as a form of payment and the number of businesses accepting crypto payments climbs. In 2017, one bitcoin becomes more valuable than one ounce of gold.

2018 – Today
Work on cryptocurrency regulation continues, and more mainstream partnerships—like that of Ripple with Santander for international money transfers—emerge. At the same time, the volatility of the currency remains center stage, and purveyors begin to show signs of discontent. Stripe drops bitcoin from its offerings in 2018.

Security concerns with Libra

Yet, while Facebook has a strong history of ingenuity, its inability to mitigate fraud and protect customer data creates concerns about its readiness for a launch of this magnitude (see sidebar below). In a letter to the Senate Committee on Banking, Housing and Urban Affairs before a July 16 preliminary hearing on Libra, ICBA pointed out that Facebook security weaknesses have exposed as many as 50 million users to hackers and that the company is in the business of selling user information to marketers and other third parties.

“Libra is concerning for many reasons, not least Facebook’s demonstrable willingness to peddle personal data for profit [and its] denials to the contrary,” declares Preston Kennedy, ICBA’s chairman and the president and CEO of Zachary Bancshares Inc. in Zachary, La. “This is unthinkable in the financial services world, especially for community banks.”

“Libra is concerning for many reasons, not least Facebook’s demonstrable willingness to peddle personal data for profit [and its] denials to the contrary.”
—Preston Kennedy, ICBA chairman

Yet, the Libra Association does involve payments players that have a history of protecting financial data, and cryptocurrency allows for a layer of embedded security by the nature of its construction. To that point, the Libra Blockchain was set up with advanced programming, such as the Move programming language, to address security concerns. According to a white paper published by Libra, this is designed to “take insights from security incidents that have happened … and create a language that makes it inherently easier to write code that fulfills the author’s intent, thereby lessening the risk of unintended bugs or security incidents.”

The white paper also discusses how transactions are securely stored on the Libra Blockchain. But the very nature of the Libra Blockchain as a single data structure that records transaction history raises data protection issues.

Significant concerns arise around the Bank Secrecy Act (BSA) and anti-money laundering (AML). Without the same level of regulatory scrutiny as traditional financial institutions, there is the potential for illicit activities to make their way onto Libra, as we witnessed with the dark web activity that became prominent with other cryptocurrencies.

“I hope that regulators and legislators are wary of the claim that cryptocurrency somehow will be a boon for the ‘unbanked,’” Kennedy says. “In truth, despite whatever benefit there may be to society, crypto is an ideal medium for the type of illegal activity that community banks currently expend an ever-increasing amount of resources tracking for law enforcement.”

According to an emailed response from Dante Disparte, the head of policy and communications for the Libra Association, the Libra team is working through these issues. “Regarding anti-fraud and AML, the association is committed to working to address privacy and security issues,” he says. “While we cannot share specific meeting details, we have already met with policymakers and regulators and will continue to engage with these groups and solicit feedback as we prepare to launch Libra.”

In his prepared testimony to the Senate Committee on Banking, Housing, and Urban Affairs at July’s Libra hearing, David Marcus, Facebook’s head of Calibra, reiterated that sentiment. “Protecting consumers and ensuring people’s privacy is one of the Libra Association’s top priorities,” Marcus said, but he provided little detail on how they plan to accomplish that goal.

David Marcus, Facebook’s head of blockchain, testified at the Senate Banking Committee hearing on Libra in July.

Facebook’s history of paying fines

Facebook has a history of data privacy issue payouts, but with profits of nearly $17 billion in revenue in the second quarter of 2019, do these fines make enough of a dent to change behavior? Here are some of the social media giant’s biggest punitive hits:

$9.5 million: Back in 2007, Facebook paid this sum as a result of a class-action lawsuit on Beacon, a service that aggregated user information from online activities and automatically added them to user profiles—the company’s first attempt at monetizing customer data.

$5 billion: Facebook owes an unprecedented $5 billion penalty to the Federal Trade Commission over user data practices. As reported with its second quarter 2019 financial results, this settlement with the FTC requires the company not only to pay this penalty but also to “significantly enhance practices and processes for privacy compliance and oversight, including a comprehensive expansion of their privacy program.”

$100 million: In a related settlement this past July, Facebook agreed to pay another $100 million to the U.S. Securities and Exchange Commission (SEC) over data misuse charges.

Regulators and legislators react

While the Libra Association has touted its commitment to working with regulators and legislators, all signs from those audiences point to this process being a longer-term effort. Federal Reserve chairman Jerome Powell responded immediately to the Libra announcement, saying that it “raises many serious concerns regarding privacy, money laundering, consumer protection and financial stability.”

“These are concerns that should be thoroughly and publicly addressed before proceeding,” he added.

Legislators resoundingly concurred, finding a topic on which both parties agreed. Rep. Maxine Waters (D-Calif.), chairwoman of the House Financial Services Committee, called on Facebook for a “moratorium on any movement forward on developing a cryptocurrency until Congress and regulators have the opportunity to examine these issues and take action.” And Sen. Mike Crapo (R-Idaho), chairman of the Senate Committee on Banking, Housing and Urban Affairs noted, “The Libra announcement has heightened the need for policymakers and regulators to establish clear rules of the road.”

This level of regulatory scrutiny is rumored to have been behind October’s mass exodus of Mastercard, Visa, PayPal and other former Libra Association members. The rumors were swirling as far back as August, when the Financial Times reported that at least three of the original 28 founding members were considering backing out of the group out of an unwillingness to risk additional compliance hurdles with their existing businesses.

Facebook, for its part, has been consistent in its openness to collaborating with regulators and legislators to address any concerns before launch. The company has also testified that the Libra Association plans to register with FinCEN as a money services business.

“From the Calibra side, we know that the journey to launching Libra will be a long one and that we cannot do this alone,” Gunter says. “Engaging with regulators, policymakers and experts is critical to Libra’s success. This was the whole reason that Facebook, along with other members of the Libra Association, shared our plans early. As David Marcus mentioned in his testimony, Facebook will not offer the Libra digital currency until we have fully addressed regulatory concerns and received appropriate approvals.”

The Libra Association reiterated that assurance. “The Libra Association and its members are committed to working with regulatory authorities to achieve a safe, transparent and consumer-friendly implementation of Libra,” Disparte said in a statement. But when questioned about other Libra Association members’ plans for product launches and if they, too, will wait for approvals like Facebook, he declined to comment.

Keep Libra on your radar

Libra is certain to remain a central regulatory and legislative topic for the foreseeable future. But in the meantime, what does it mean for community banks?
“Community banks need to be aware of how our customers will be impacted by the issuance of any cryptocurrency, including Libra,” says Jack Hartings, the president and CEO of $550 million-asset Peoples Bank Co. in Coldwater, Ohio. “The risk may be greater than they understand.”
If nothing else, Facebook’s efforts with Libra’s launch have raised cryptocurrency to a must-tackle topic on a global scale. As Powell pointed out, with a network of more than two billion, anything Facebook does rises to a level of systemic importance. And as community bankers know, “systemic importance” signals there’s more to come.

“Community banks need to be aware of how our customers will be impacted by the issuance of any cryptocurrency, including Libra.”
—Jack Hartings, Peoples Bank Co.

Colleen Morrison is a writer in Maryland.