Facebook's Libra will force a reckoning on crypto, privacy law
In the eyes of regulators, Facebook and bitcoin have a lot in common. Both challenge citizens' relationship to privacy, and both use technology in ways that current laws were unprepared for.
By bringing both of those issues together in its Libra cryptocurrency, Facebook is forcing multiple governments to finally declare how they want to address privacy, digital currencies and the global reach of tech giants.
There are scheduled hearings in the U.S. that will likely result in bipartisan calls for Facebook to alter or halt its project. The U.S. Senate’s Banking Committee has scheduled a hearing for July 16 and it’s likely the House Banking Committee will hold a hearing shortly after. These events are coming unusually fast for D.C.’s incremental culture, demonstrating U.S. lawmakers are eager to pressure Facebook.
Regulators outside the U.S. are also targeting Facebook. In Europe, France is forming a G-7 group to study how Libra and other cryptocurrencies can be governed, including money laundering and consumer protections. And in Japan, a group of cryptocurrency exchanges will meet with global regulators at an event called the V20 summit, running concurrent with the G20 summit in Osaka on June 28 and 29.
What will come of these hearings? There are already some clues, as U.S. Sen. Sherrod Brown (D, Ohio) has said Facebook is “too powerful” and contends Facebook is running a risky unregulated cryptocurrency out of a “Swiss bank account” (likely a reference to Libra’s corporate location) — and said he’s skeptical of Facebook’s promise to serve underbanked consumers. U.S. Rep. Maxine Waters said Facebook cannot be allowed to compete with the dollar.
These comments hit on the different fronts where Facebook will face pressure. If Libra is seen as a counter to government money, which is Waters’ contention, or a shadow “central bank,” regulators in the U.S. and elsewhere will see it as an outside and in some cases illegal threat to government's role in stabilizing currency. Libra’s white paper refers to Libra as a “unit of currency,” a designation that could raise the ire of governments if viewed as a direct competitive threat to government-backed money.
"If there’s any kind of anxiety or concern about crypto around the world, [Libra] will bring it to head. "
Governments in general view cryptocurrency as undermining their ability to set monetary policy. There is some history here, though not on Facebook's scale. Bernard von NotHaus was prosecuted and convicted on charges of counterfeiting in 2011 over his “Liberty Dollar,” or coins, virtual currency and paper bills that were designed to be an “inflation proof” alternative to U.S. dollars, which NotHaus contended had been devalued by the Federal Reserve. In many governments, there are restrictions against issuing alternative currency to compete directly with government-backed money, said Eric Grover, a principal at Intrepid Ventures.
But if there’s a sense Facebook is operating in a regulatory vacuum, as Senator Brown contends, it gives lawmakers space to build new restrictions to govern an already disparate cryptocurrency industry.
"If there’s any kind of anxiety or concern about crypto around the world, [Libra] will bring it to head. It may be the biggest thing ever in terms of volume or actual usage," said Patrick Burke, a partner at Phillips Nizer and former deputy superintendent at the New York State Department of Financial Services, which administered New York’s BitLicense, an early attempt to regulate bitcoin and other cryptocurrency.
Facebook is likely to face even more pressure in emerging markets, where it’s selling financial inclusion as a major goal of Libra, Grover said. Facebook and cryptocurrencies are legally restricted in the nations where most of the world’s underbanked reside, making Libra’s success a longshot in markets such as China and India unless there’s substantial deregulation.
In an email, Facebook's public relations office said Libra will be backed 100% through the Libra Reserve, a collection of low-volatility assets like bank deposits and government securities in currencies from "reputable central banks." In an earlier interview, Jorn Lambert, an executive vice president for Mastercard, one of Libra’s investors, conceded some markets may never welcome Libra.
“Governments of deep emerging markets are [not likely] to look kindly on an attempt to displace their weak currencies,” Grover said. The lack of adoption from large markets like India and China could hurt the scale Libra needs to build international scale."
“If — and I think it’s a big if — Libra gets off the ground, it’s potentially a global money transfer network and therefore subject to a host of national and state-level money-transfer licensing and anti-money-laundering and ‘know-your-customer’ compliance requirements,” Grover said.
Facebook already faces pressure from governments over privacy issues, and that pressure will likely roll into forcing Facebook to account for how it will combat criminal activity on a payments network as it works on its existing security challenges.
“Regulators are going to want to know what happens if Kim Jong-Un gets a Libra wallet.”
AML is a major focus of all international banking regulators, and given cryptocurrency’s reputation as a means for criminal financing — and Facebook’s reputation for privacy glitches — laundering and privacy will be the dominant themes of any regulations created for Facebook and Libra.
“Regulators are going to want to know what happens if Kim Jong-Un gets a Libra wallet,” Burke said. “They may have protections for that sort of thing, but Facebook will have to show that.”
It’s here where Libra’s partners such as Mastercard and Visa could be helpful, Burke said, adding the large international payment networks have scalable AML and fraud tools. If Libra can build a critical mass of payment transactions it will also have the volume of data and a network of respected stakeholders that could satisfy regulators, according to Burke.
“The problem with cryptocurrency is it’s not built to scale. Bitcoin cannot do enough transactions per minute the way Visa and Mastercard can," Burke said. "So you have Visa and Mastercard and PayPal and the others together where they’ve all dedicated themselves to making an alternative currency for the world that processes billions of payments per day. They are probably sharing their best ideas on how to do that.”
Although hotly debated, the lack of robust and consistent controls with respect to KYC and AML is a major barrier to institutional embrace of blockchain, according to Rachel Woolley, global AML manager for Fenergo, an onboarding company. Woolley has worked on AML and KYC issues for about 12 years.
A number of current regulatory initiatives may shine a light on what future KYC/AML checks could look like in the cryptocurrency environment, Woolley said, adding the U.S. Financial Crimes Enforcement Network has been working to add language to aid in coordinating efforts and exchange information with other enforcement agencies around the world.
Since most of these AML/KYC regulatory issues involve address verification for onboarding, Facebook may run into trouble in markets such as the Middle East and Africa, where there often aren't address registries and networks that are similar to the U.S. and Europe, Woolley said.
“It’s hard to prove an address in these countries,” Woolley said, adding there are market differences in reforming these discrepancies. “Last year Hong Kong removed verification of address requirements, for example, but if regulators can’t find a way to agree on address requirements, I don’t know what a crypto payment system would do in that case.”
Facebook’s white paper does not say much about how it will work with regulatory bodies to boost financial inclusion, Woolley contends.
“There’s a lot of mention of future participants in the future currency, but very little mention of engaging with regulators,” she said. “That won’t allay the fears of those regulators.”
Additionally, Facebook’s language around Calibra, the subsidiary Facebook launched to build financial services for Libra and create a corporate separation, likely isn’t clear enough to escape regulatory pressure, Woolley said. “It uses the word ‘regulated,’ but there’s not a lot of language about how they are engaged with these regulators,” she said.