Facebook’s consortium project, Libra, has the potential to disrupt traditional business models in retail banking, payments, and retail asset management (in addition to regulatory and monetary policy). While there are many variables that will impact how this will all play out and there are significant technology, privacy, regulatory, and security concerns that could stop this project in its tracks, a meaningful new front has opened up in the evolution of western financial services that warrants discussion.
There is an unmistakable brilliance to the Libra concept. This is true business model innovation, which we have stated as one of the foundational tenets of our investment theses at MGV. Even though the individual parts are nothing new (closed loop payment system, stablecoin, distributed ledger, a basket of currencies, a giant balance sheet, non-bank deposits, an identity graph, full AML/KYC compliance, etc.), none of these have been bundled to date at this scale and breadth as a platform strategy.
We offer some analysis and outline a range of implications in this post.
Business Model Innovation at Scale
It is important to note that much of what has been written about Libra in the week following its announcement, aside from Facebook’s PR-driven White Paper, is a focus on Libra as a cryptocurrency and/or a blockchain project. Meanwhile, technology investors collectively yawned, with FB stock mostly treading water in a rising market. We believe these short-term responses miss the mark in assessing the potential importance of the Libra project.
Libra is a complex yet elegant web of cryptocurrency, fiat currency, commercial partnerships, and governance that has the potential to create, for western markets and emerging markets, the equivalent of the massively successful Chinese platforms WeChat and AliPay. Combining communities and platforms with access to a broad array of financial services, these Chinese models have created pathways around traditional financial services vendors. Closed loop payment systems, credit card rails, retail banking services, and retail asset management products are all subsumed inside these platforms. Much like mobile phone services “leapfrogged” wire line services in emerging markets, platform strategies have leapfrogged traditional financial services in China (and increasingly in SEA).
We at MGV have speculated that a replica of the WeChat platform strategy would emerge in the west, with appropriate tailoring to markets (e.g., privacy in the EU). We had expected evolutionary moves like Amazon Prime’s ever growing financial service offerings, Apple Pay/Card, and eventually Google’s entry into the market. We have also speculated on a move by Facebook, SnapChat, or Telegram that would add increasing pressure to an already intense competitive market (hence we have avoided direct-to-consumer business models). However, Libra is not just evolutionary. It is revolutionary from a business model point of view and creates a very different value proposition, particularly when built on top of Facebook’s installed base of 2.4 billion active users.
One key variable to consider: What type of ecosystem is Libra trying to create? The WeChat and AliPay models do not always play well with incumbents or outside innovation. FB claims to want a transparent, competitive, ecosystem with many different developers and commercial enterprises. It will be interesting to see how inclusive and open Libra will ultimately become, and the role of FB relative to other members of Libra’s governing council. The emergence of multiple, competing wallets with an assortment of vendors would clearly present a different opportunity set for incumbents and fintechs alike versus a more closed FB-centric ecosystem.
Significant Hurdles and Uncertainty Complicate Road from Plan to Platform
Because of its massively disruptive potential, we fully expect market stakeholders to attempt to slow or stop Libra. Incumbents, startups, and regulators have too much to lose. Note that no bank has signed up as a Libra partner and that many of the “founding members” may apparently still be on the fence (e.g., nonbinding letter of intent with no upfront funding commitment). Politicians and regulators from various jurisdictions across the world are expressing varying levels of concern, or outright alarm. Current legal and regulatory rules do not provide a ready roadmap for the assortment of gray areas that Libra’s project inhabits (tax treatment, currency vs commodity, legal standing, monetary policy, privacy, systemic financial infrastructure implications, etc.). Consequently, Libra may not launch at all or may launch in a greatly diminished or altered state. There are of course also a host of potential demand side impediments, particularly in the developed world, where incremental cost savings and optionality may not be sufficient to drive uptake by retail customers, particularly if privacy concerns become a real issue for the platform. We will save an analysis of the myriad of obstacles for a later date, and for simplicity, this document assumes a full launch and success.
With that said, the implications of a successful Libra project are immense. On the positive ledger, financial inclusion will increase, and transaction costs, payment fees, and friction will all decline. Unfortunately, the negatives are potentially far reaching. For consumers, trust and privacy will be vulnerable. For incumbents, retail banking, retail payments, direct to consumer financial services, and all of the associated providers of these services are potentially vulnerable. For regulators and public policy, Libra presents a stark new world that doesn’t align with current norms around customer protection, prudential oversight, and financial stability. A decade removed from a devastating financial crisis, global regulators are unlikely to look fondly on a de novo startup with over 2 billion users seeking to transform the payments and financial services landscape.
Implications (Assumes Successful Implementation Over Time)
We see meaningful disruption across multiple financial sector verticals, including the regulatory community, from a successful Libra venture.
For Retail Banks, Libra has profound implications. Branch traffic and transactions are already in steep decline across the developed world. Retail banks are becoming utilities whose main asset is stable deposits (with or without branches due to solid mobile offerings). However, deposit displacement is becoming an observable phenomenon (albeit in early stages) from various elements such as prepaid cards, Amazon Pay, Apple Pay, Starbucks cards, etc. If Libra gains traction, retail deposit base decline from deposit displacement will accelerate (as cash is linked to or moves outright to the Libra platform). This would have vast implications for retail banks and, by definition, the market structure in major economies (see regulatory below).
For Retail Lenders, Libra will offer a treasure trove of fresh and relevant targets to service – see data below. The SME banking angle should not be forgotten. Many businesses, some small, some not so small, conduct business on Facebook. Expect, at some point, lending or other products to be presented to small businesses. This has the potential to further dent a bank’s business.
For Payments, niche retail payment solutions and closed loop system business models could effectively be placed on life support. Interchange fees, particularly in the US where they average more than 200 bps, will shrink if Libra’s promise of “ultra low transaction fees” holds true. Closed loop payments systems like Venmo (and possibly PayPal) could be at risk. International remittance fees will plummet, which will impact banks and fintech startups in the space.
For Retail Asset Managers, we believe that Libra will aim to recreate the WeChat model which led to the world’s largest money market fund only a few years after launch. Savings, lending and investment programs will be a focus area for Libra over time as it seeks to add functionality and features for its 2.4 billion potential users. Startups in the savings, budgeting (PFM), P2P lending, and retail investing space would struggle in that new market paradigm. Mass market asset management firms (mutual funds/UCITs firms and discount brokers) would be under similar pressure.
For Data Players, the data flow is a crucial part of the Libra platform. All transactions taking place within Libra will generate data and meta-data, which means less data is available outside of the platform. Those that have access to that data (in compliant and legal ways) will benefit and be able to deliver the right financial products to the right customers.
For Regulators, shifts in the financial landscape through a revamped market structure is an obvious issue. Fewer banks, fewer branches, and fewer deposits would present acute challenges across the banking system. However, there are even larger issues at stake. If Libra and its stablecoin are effectively owned by ⅓ of the world’s population, it defacto becomes the world’s largest and most powerful central bank (admittedly this is the extreme scenario of Libra adoption). A single corporation and an assortment of partners in a Swiss foundation would hold significant sway over the world’s monetary policy and global financial stability. The implications are profound, breathtaking, and troublesome. In short, this vision obviously will not happen to the fullest extent but a bipolar world with Libra and the Chinese apps as dominant pseudo-financial institutions is worthy of consideration.
Post-Libra Playbook for Incumbents & Other Stakeholders
Prior to listing our preliminary thoughts we have two important caveats around potential engagement strategies:
- Technology and business choices will dictate privacy and consumer protection going forward. It is important for Libra not to repeat the same mistakes as Facebook, or be beholden to FB-centric technology development and privacy protocols that could frustrate broader acceptance. Otherwise, there exists a reputational risk for Libra and its partners.
- Were Libra not to launch for regulatory or legal reasons, we believe the type of business model it is trying to establish will be pursued by other firms. For example, if Libra fails due to privacy concerns but the overall platform/stablecoin concept is validated, Apple could conceivably create an Applecoin concept as an extension of its ecosystem/platform. It is therefore important to study and explore the ramifications of a Libra-like platform.
We will paraphrase Bill Gates: Humans chronically overestimate what will happen over the next two years but underestimate what will happen over the next ten. For our purposes here, we fully expect a slow Libra roll out as incumbents, regulators, and the broader ecosystem engage in hand-to-hand combat over the sticky issues created by the Libra vision and implementation. Notwithstanding commercial and technological obstacles, it is likely that the vision outlined in the Libra White Paper is but an opening bid by Facebook that will be dramatically altered to appease regulatory and incumbent financial services providers. However, over the next decade, Libra could become a significant force. Incumbents in particular should consider playing both offense (e.g., engaging with Libra for key learnings at a minimum) and defense (e.g., customer retention through technology differentiation, exploring alternative platforms) as the Libra initiative moves forward (or doesn’t).
- BigTech will respond eventually. What will Apple and Amazon do? Most likely they will attempt to derail Libra privately. Publicly, they will attempt to segment the market. Amazon will focus on its Prime community by offering superior pricing and lower friction. Apple will focus on its 1 billion customers (volume of email addresses) by offering far superior product design, cryptography, and privacy. As mentioned above, BigTech may attempt to replicate many aspects of the Libra platform, modified for their own platform strategies.
- Traditional Fintech Startups with a direct to consumer focus, if later stage like Robinhood, may thrive if they partner with the Libra platform. Newer, more traditional consumer offerings may have a harder time competing with or partnering with a dominant Libra (again, assuming broad success of the platform). New platforms always create new opportunities. This could be true of Libra and its open source structure, but is too soon to tell what Libra’s appetite will be for partnerships and engagement.
- Regulators will respond quickly. US politicians and regulators are not exactly happy. France has already announced investigations. EU regulators will certainly follow. Likely areas for regulators to examine: Is Libra a currency or a commodity (bitcoin is a commodity under US regulations, for example). How is a basket of currencies regulated vs a single currency issued by a sovereign? What are the data privacy protocols? How are the segregated account deposits handled and by whom? What is the governance and how much influence does Facebook (and Zuckerberg’s voting control) have over the Foundation? Finally, is Libra “Too Big To Fail”?
Investment Implications for MGV
We have published investment themes that, even if we assume Libra’s outright success (which we do not), thankfully do not need to be adjusted significantly for the Libra news. We have long anticipated something similar (if not this consequential), and have previously stated in our blog that platforms will become the dominant financial services model of the future. We will continue to avoid investing in traditional B2C startups, P2P payments, and most retail offerings (B2B2C will be minimal), seeking instead B2B startups aimed at incumbents and startups with new business models that take advantage of platforms (Libra, Amazon Prime, Apple, etc.).
Additional Information: Libra Explained
Technical, commercial, and structuring details are bound to change as the Libra project matures. The Libra White Paper needs to be taken as what it is, a work in progress (and an initial branding exercise). We outline the most important aspects below as is and without editorializing or endorsement.
Per the White Paper, the goal of Libra is to “serve as a solid foundation for financial services, including a new global currency, which could meet the daily financial needs of billions of people.” The four key components of Libra are: 1) a foundational technology platform on the blockchain; 2) a digital currency backed by a reserve of assets to support its intrinsic value; 3) a reserve token, Libra Investment Token (LIT); and 4) governance and oversight by an independent Libra Association.
The platform will initially launch as a “permissioned” blockchain in order to better navigate the complexities of establishing and scaling this endeavor before transitioning to a “permissionless” structure. While this transition may not be easy to effectuate, Libra promises that in either state, the platform and technology will be open to anyone, allowing users, developers and businesses to access and provide services on Libra. (How Libra evolves on this front will be telling, in terms of building a truly open ecosystem versus a Facebook-centric vehicle for financial services.)
The value of each Libra will be tied to a basket of deposits and short-term government securities to promote a stable base of value for the currency. This stablecoin structure is designed to minimize volatility and promote valuation stability, in turn helping facilitate global acceptance, and fungibility for the new currency. Interest on these reserve assets will underwrite the costs of the platform, with excess profits slated to be dividended out to the members.
The Libra Association will be based out of Geneva Switzerland and will provide a governing mechanism for the network and the reserve. Facebook expects the initial list of 28 “Founding Members” across the payments, technology, telecommunications, blockchain, venture capital, and non-profit sectors to grow to approximately 100 ahead of the launch of the currency in 1H 2020. These members will operate the validator nodes for the platform.
Finally, in conjunction with this effort, Facebook created Calibra to build and operate financial services for the social network (e.g., Facebook’s digital wallet).