Licence to print money or a farfetched fantasy?

Buy Facebook’s Libra and you are literally giving the social media giant a licence to print money.

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 $US10 million each to take part, and it is easy to see why: On some reasonable-sounding assumptions about its take-up, 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 made by central banks.

Assume one in 10 of the world’s 1.7 billion unbanked each hold $US10 of Libra plus half of Facebook’s 2.4 billion other users sign up, putting in $US50 each. The backers would get the interest on $US61 billion of reserves. They’ve pledged to hold a very boring safe portfolio of global bonds and bank accounts, which might earn 1 per cent tops. Still, that is $US600m or so a year. Take out $US100m 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 per cent 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 per cent of GDP in 2017 without even counting payments between accounts. If Libra takes 16 per cent of Visa’s transactions, it would be processing a cool $US1 trillion a year; match the velocity of money of the US and Libra would need a $US200bn reserve, making $US2bn 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 $US10 each, returns would be just 3 per cent. And if only a quarter of Facebook users adopt Libra, the income wouldn’t cover the (assumed) costs. If regulators get in on the act — as the Bank of England governor Mark Carney has suggested he would — the costs would be much higher, too; Visa’s costs are more than $US5bn 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 recognise 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.

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.

The Wall Street Journal