Buy Facebook’s Libra and you are literally giving the social media giant a license to print money, in the form of its new cryptocurrency.
A bunch of big companies have agreed to pay up $10 million each to take part, and it is easy to see why: On some reasonable-sounding assumptions about its takeup, 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.
Facebook’s reach ought to help Libra get big quickly. But its success isn’t obvious. The problem is the cost of getting money in and out via the “authorized resellers,” or exchanges.
Those costs make it hard to justify using Libra for domestic payments, which will be cheaper via the banking system, unless you want to hold Libra anyway. Even inefficient and expensive international transfers will still be cheaper in many traditional currencies than via Libra, if you have to pay 2% crypto exchange fees at either end.
Libra might have appeal in countries with dodgy currencies, much as bitcoin does. It is designed to hold its value by promising to hold only the safest assets, just like a money-market fund, so it should move roughly in line with this basket of bonds and deposits spread across multiple currencies.
The reserve isn’t quite as great as it seems, though. 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. Buy an old bond issued when yields were higher, and the price will be above face value. That generates a capital loss at maturity offset by coupons well above more recent issues.