Noelle Acheson is a veteran of company analysis and a member of CoinDesk’s product team. The opinions expressed in this article are the author’s own.
The following article originally appeared in Institutional Crypto by CoinDesk, a free newsletter for institutional investors interested in cryptoassets, with news and views on crypto infrastructure delivered every Tuesday. Sign up here.
Coming from an organization so tied to the question of identity (whether real or not), it is surprising that Facebook’s Libra coin seems confused about its own.
The organization has chosen to brand Libra “a stable global cryptocurrency,” and the label “cryptocurrency” has been replicated by media around the world. Yet Libra is not a cryptocurrency.
Don’t get me wrong – those of us in the sector appreciate the global attention given to the concept since the announcement.
But in this case the definition matters beyond semantics: it will affect eventual use cases and regulatory treatment. It could also transform how investors view both stablecoins and blockchain-based securities going forward.
What’s in a name?
First, let’s look at why it’s not a cryptocurrency.
While definitions vary, one key characteristic of cryptocurrencies is their resistance to censorship. For this, they need to be “decentralized enough” to prevent any one group from deciding who gets to transact. Libra does not yet fulfill that criteria, and although the Foundation has said it plans to move towards a “more decentralized” system over time, doing so (or not) is entirely in its hands.
Furthermore, the value of a Libra coin is not created by the underlying technology, the market, math or however you choose to understand bitcoin and similar assets. It’s a digital representation of a basket of fiat currencies and other securities.
The only thing Libra coin has in common with cryptocurrencies is that they all move on a blockchain.
So, what is it? On the surface, it’s a “stablecoin,” a token that maintains a stable value via a peg to “real world” assets such as fiat currencies or a commodity (some stablecoins have an algorithmically-determined value mechanism, but they belong in a different discussion). The sector is currently awash with stablecoin projects building solutions for payments and settlements, most of which are not yet live. Of those that have launched, few outside of U.S.$-backed Tether have significant volume, although the market is young and still shifting.
Where Libra differs from its stablecoin peers is in the peg: according to the white paper, it will be backed by “a basket of bank deposits and short-term government securities” (my italics). Notice the use of the term “securities.” An asset backed by securities is, by definition, also a security. Libra is more like an ETF than a fiat-backed stablecoin.
We can try to argue that short-term government debt is more a currency than a security. But even without the telltale use of the word, the regulators’ approach to stablecoins is still up in the air. At the Crypto Evolved conference in New York last month, SEC Deputy Director Elizabeth Baird was asked for her take on stablecoins. Her response was blunt: “I think they’re securities.”
Others have posited that even relatively simple fiat-backed stablecoins could be characterized as swaps or “demand notes,” both of which would be treated as securities. And the SEC’s head of digital assets, Valerie Szczepanik, confirmed at a hearing last week that it does not matter that the stablecoin “does not have an expectation of profits” (with the usual caveat of “facts and circumstances”).
Note that this is Libra coin we’re talking about, not the Libra Investment Token which is obviously a security. We’re talking about the token that Facebook hopes will become the de facto payment mechanism for most of the world.
The white paper opens with: “Libra’s mission is to enable a simple global currency and financial infrastructure that empowers billions of people.” Glossing over the unrealistically aspirational qualification of “simple” (really??), can we use a security as a “currency”?
Asset-backed representations of value have been currencies before – think of the dollar and other national currencies back in the days of the gold standard. But they were backed by a commodity that was not controlled by any one entity and did not have an “issuer.” The Libra proposition is very different.
With this, we start to see why the definition is so important. If the Libra token is officially classified as a security, as is likely, then using it in a transaction will involve a “sale” of that security, and a capital gain or loss. Since we’re talking about a stablecoin, the taxable event is unlikely to be significant. But it will be greater than zero, since Libra’s basket value will fluctuate relative to the currency into which Libra coin has to be converted to complete the transaction (because Libra is unlikely to become a “unit of account” in which the value of local goods is denominated).
Sure, software will emerge to smooth the friction and helpfully calculate what we have to officially declare – but the need to do so at all will act as a significant barrier. It’s not only the hassle and cost involved; it’s also the understandable desire of most even law-abiding users to stay off the tax authorities’ radar.
What does this mean for crypto investors?
In terms of portfolio allocations, not much. Libra as it is currently structured will not provide competition-beating gains for funds looking for alpha. As its ecosystem matures, it could provide stable returns through lending or collateralization – many funds prize liquidity and stability over high risk and performance. But that’s not going to set the securities world on fire.
The main impact will come not so much from Libra itself, but in the glimpse it offers of where a new asset class could emerge.
The idea of securities as payment mechanisms is innovative and could open up a host of potential use cases. The requisite stable value need not necessarily mean limited upside, as new share issuance as a sort of value-linked dividend (for example) could maintain a peg while providing the holder with a return. Instead of the share price going up, an algorithm would issue you more of them, and destroy some if the value went down. Your wealth would fluctuate, while the price of the share remains stable.
The fiscal friction from using a security as payment would not be an issue for institutions, since they generally have back offices well versed in handling this.
Another intriguing thread to pull on is the idea of securities backed by a basket of currencies and government debt. We could see the emergence of custom-made securities that hedge the currency risk of the issuer. Currency hedges are a major concern for both corporates and investors – imagine a debt instrument that packages those complex equations into a stable yield, or into a pre-hedged token for use in either capital markets or supply chain transactions.
Expect the unexpected
Financial innovation did not start when blockchain technology got a new lease of life through connected networks and decentralized consensus. Markets have been furiously evolving since there were markets, often in unexpected ways with unintended consequences.
For all its features and faults, Libra represents a significant step forward in this process. Its stated aim of extending financial inclusion and reducing payment friction is one that has consumed entrepreneurial minds for decades, and while this may not be the solution the world is waiting for, it’s at least pushing the conversation forward in constructive ways.
However, when it comes to technology of any type, few inventions end up being used for their original intent. Libra is unlikely to be any different. In combining elements of distributed ledger technology, economic philosophy and savvy marketing, the initiative will end up boosting awareness, adoption and development of cryptocurrencies and security tokens more broadly. Just not in the way the designers originally anticipated.
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