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Libra and Financial Inclusion

posted by Adam Levitin

Facebook’s proposed Libra cryptocurrency project has truly stirred up a hornet’s nest of controversy.  Critics have generally focused on Libra as a currency and the power of Facebook in society and its appropriation of users’ privacy.  

I think that discussion misses a key point.  Libra will be, first and foremost, a payment system.  It will be a payment system that happens to operate using a currency index, rather than a single country’s currency, and clear using blockchain rather than other clearing software, but it’s still a payment system, that is a system for moving value between parties.  The payment system aspect is what both makes me incredibly skeptical about Libra’s financial inclusion claims and about Libra’s prospects for success. 

1. Libra Brings Nothing New to the Table for Financial Inclusion

The Libra white paper pitches the product as facilitating financial inclusion.  The little discussion it has, however, is completely confused and shows just how little the Libra team has thought about financial inclusion.  For starters, the Libra folks are conflating three very different problems:  developed countries under-banked, developed country unbanked, and developing country unbanked.  To wit, the white paper starts by talking defining the problem that Libra hopes to solve.  Thus, in the first paragraph, it cites some global figures for the unbanked, virtually all of whom are in the developing world, but then gives an example of the high cost of payday loans, a developed world product that is available only to people with bank accounts.  Not an auspicious start, although in fairness, there's a lot of confused discussion on the underbanked/unbanked even from academics.

Now Libra does explain some of the main reasons that people in the developed world are unbanked:  insufficient funds (which I think encompasses the volatile financial lives of low-income households), high and unpredictable fees, lack of convenient locations, and lack of necessary documentation.  So let’s ask how a blockchain-based cryptocurrency payment system addresses these problems. 

First, there’s the insufficient funds problem.  Low-income households have volatile financial lives and often maintain very small balances on deposit.  The interest spread on these low-balance deposits isn’t enough to cover the costs of maintaining these accounts in the banking system.  I don’t think Libra is going to be able to avoid these costs.  It won’t have the brick-and-mortar cost structure to support, and we don't’ know the precise entity forms that Libra will take, but it would seem that everyone who is taking Libra deposits would be a “bank” for US banking law purposes, irrespective of chartering. That means compliance with most US consumer financial laws—EFTA, TISA, GLBA.  That alone adds in costs because of the default setting of paper notices. 

Second, there’s problem of fees.  Banking services aren’t free.  Libra seems to be promising low-cost services.  It’s not clear what low-cost means.  A $20 fee in the US isn’t huge, but it would be in Bangladesh.  Is Libra going to have different fee schedules for different countries?  If Libra is priced to make a profit (and it certainly will be), it’s going to have trouble offering truly low-cost services.  I have trouble seeing Libra as a true game-changer for banking costs. 

Third, there’s the convenience problem.  Here Libra can help—a banking system that is accessible through smart phones can eliminate banking deserts.  The only problem is that this has already been done.  Pretty much every bank offers substantial on-line services:  balance checks, payments, deposits.  So what is Libra bringing to the party that’s new? 

Fourth, there’s the documentation issue. That’s an anti-money laundering regulation problem.  Banks and money services businesses are required to have customer identification programs:  there’s no anonymous movement of funds allowed generally.  Libra has nothing to offer to get around this problem.  If you don’t have documentation, there’s zero chance Libra’s going to let you into the system.  And a Facebook account alone isn’t sufficient documentation.  You’re going to have to have your identify verified with some sort of government-issued ID.  You won’t be able to open up an account in 30-seconds. 

Libra doesn’t come across as having anything new to offer to any of these problems.  The fact that it runs on blockchain for transaction clearing is pretty much irrelevant.  (News flash:  dropping the term “blockchain” ain’t gonna impress anyone anymore.)  Maybe the blockchain clearing enables faster clearing, but that’s not something most consumers care about.  (Let’s remember, however, the difficulties that Bitcoin faces in terms of transaction clearing speed—blockchain isn’t a good clearing method for trillions of transactions because the chain is going to get too long too fast.)  Faster clearing could reduce overdrafts and if it were real time clearing eliminate credit risk in payments (if the payments are not reversible).  But the savings from this just aren’t game-changing.  As it happens we already have close-to-real-time payments through Zelle (with banks subsidizing the daylight overdraft risk). 

What the Libra discussion totally misses is how consumers are going to get value into the Libra system in the first place.  If I have cash, how do I put funds on Libra?  I’m going to need to go through a bank or other financial institution, and it’s not going to be free.  Same if I want to take money out of Libra.  (This is the same problem as with Bitcoin wallets.)  So, consumers are going to need to be banked or rely on money transmitters and the like to move funds in and out of Libra, which will be necessary as long as Libra is not legal tender. 

2. Libra is a Payment System and that Is Why It Will Likely Fail

Now let’s remember that Libra is a payment system.  Starting a new payment system is really hard.  That’s because of network effects (something Facebook understands very well).  The value of a payment system depends on the number of users; the more users the more valuable it is to be part of the system.  But payment systems are two-sided networks:  they need payors and payees to both participate.  It doesn’t do any good to have lots of people who want to pay with Libra if you don’t have a lots of people who want to be paid in Libra or vice-versa.  This creates a chicken-and-egg problem.  You need to get both payors and payees on board simultaneously for a system to work.  That’s incredibly hard to do.  Just ask Discover or look at the fate of the defunct Revolution Card and Wal-Mart-sponsored-MCX.  

So what will get people signed up both as payors and payees?  You’ve got to offer them something worthwhile.  Here’s what Libra seems to be offering:  (1) payment and safekeeping in alternative currency, (2) faster clearing, (3) greater convenience relative to brick-and-mortar, and (4) possibly lower fees.  I see little attraction to that for most Americans, or indeed for most folks in the Western world.   Unless Libra is made legal tender (so you can pay the government taxes and fees in it), you’re going to have to operate in two currencies, and who needs that hassle, plus the exchange rate risk?   The faster clearing just isn’t that important to most people, Libra’s going to be competing against banks on-line, and there’s really no evidence that Libra’s fees are going to be so much lower as to matter.  I just don’t see the value proposition for consumers or merchants in the western world. 

The situation might be different in developing countries, where there is a lack of financial institution infrastructure and unstable currencies.  In that regard, Libra could be making a play similar to what M-Pesa did in Kenya—providing a payment system through the Internet.  But here’s the thing—it’s going to be very hard for Libra to comply with US AML expectations if it is serving developing country populations—how is it going to verify customer identity, for example?  And Libra will have to price much lower in developing countries.  Moreover, electronic payment systems are traceable, which is not something everyone likes, as they limit tax evasion and facilitate government surveillance.  I’m just not seeing what Libra brings to the table.  

Now part of Libra might be a data play.  Some of the most valuable consumer data is data on what consumer's actually buy and at what price.  That's even more valuable than knowing what sort of ads I look at or what terms I search for.  Currently payment systems like Visa and MC can only tell the name of the merchant and the merchant category and the purchase amount.  They don't know the specific items purchased.  Google gets some of this data by reading emails--if you make an on-line purchase, Google knows what items you bought.  So much for privacy.  I suspect that Libra will attempt to get this sort of Level-3 SKU data from merchants.  If it's required to get paid in Libra, the larger and smarter merchants aren't going to accept Libra. 

Notice that this whole discussion has been without any reference to Libra’s political risk, which is huge.  If there’s enormous skepticism in the US (is Libra a potential SIFI or FMU?), what about in countries that are even more protective of entry into their financial systems, such as India and China?  Even if Libra has a value proposition for the developing world, it might not be able to access much of the developing world’s population legally.   

Maybe I’m just too much of an old-school Gen-X’er to get it, but the scale just don’t seem to balance for Libra.   


Very informative article. I will include a link in my research to this article. Thanks

Author missed or did not emphasize KYC rules. Western Union takes 10-20% for routine US-to-non-US intl transfers, so there's room for Libra just on cost alone, but KYC rules might sink it.

Ray--you clearly didn't read the post.

"Fourth, there’s the documentation issue. That’s an anti-money laundering regulation problem. Banks and money services businesses are required to have customer identification programs: there’s no anonymous movement of funds allowed generally. Libra has nothing to offer to get around this problem. If you don’t have documentation, there’s zero chance Libra’s going to let you into the system. And a Facebook account alone isn’t sufficient documentation. You’re going to have to have your identify verified with some sort of government-issued ID. You won’t be able to open up an account in 30-seconds."

KYC is AML. Banks and MSBs have to have CIPs. That means that they have to be able to identify the sender, and they have to be satisfied that the receiving institution can identify the recipient. It's not cheap. Part of the WU rates are because of costs, not just profits.

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