On June 18, 2019, Facebook announced its plan to create a global cryptocurrency named Libra. The social-networking giant wants to offer any person holding a smartphone with an internet connection a stable and secure way to transfer money and make payments all over the world. Libra will be built on a blockchain and backed by a basket of sovereign currencies to maintain its value stable—the Libra Reserve. No information, however, has been disclosed so far about who will be authorized to take part in the Libra blockchain or what assets will be used to form the Libra Reserve.[1]

Although framed as a cryptocurrency, Libra differs from Bitcoin, the most popular cryptocurrency until these days, in three meaningful ways.[2] First, Libra will have an identified issuer, the Libra Association, which will be based in Switzerland and manage the technical and financial operations of the Libra network. Second, Libra’s transactions will happen in a permissioned blockchain. Libra will circulate in a decentralized but closed system in which only authorized participants will be able to verify the transactions and update the related records in the distributed ledger. Finally, Libra will neither be issued at will by the Libra Association nor appear as a byproduct of the settlement work done by the participants in the Libra blockchain. Libra will be created at the initiative of persons and entities interested in exchanging some of their money for Libra.

The announcement of Libra has attracted wide attention and much concern, not least because of Facebook’s 2.4 billion user base and its recent history of privacy abuses. Journalists, academics, and legislators have spoken openly against Libra, underscoring the many perils and risks it would bring for monetary sovereignty, financial stability, and even the life of ordinary people.[3] But how exactly should we look at Libra, and what would the implications be? In this post, after examining Libra’s structural design, I argue that Libra should be seen not as a currency but as a security, a perception that may seal its fate as a short-lived project.

Libra is not a currency

Facebook advertises Libra as a “simple global currency and financial infrastructure.” But Libra is more like a security that has little to offer on financial infrastructure. How come Libra is not a currency? Because it will be created by conversion, not by issuance. Libra’s existence depends on people and corporations willing to convert some of their sovereign monies into Libra units. If no one wants to make the conversion, Libra does not come to life.

Unlike a currency, the creation of Libra is not under the control of its issuer but of its users.[4] Sure, the founding members of the Libra Association may decide to get the process started and fund the Libra Reserve to create an initial batch of Libra units. But then again, Libra will only come into existence because the founding members will have converted assets denominated in sovereign currencies into Libra units.

To consider Libra a currency would be similar to viewing a pre-paid debit card as such. Both may be used to make payments and transfer funds, characteristics that give them some degree of “moneyness,” meaning that they can be used as a means of payment. Neither of them, though, is an original and independent currency; they are mere representations of other currencies. Does that mean that Libra is electronic money then?

Not at all. Libra does not qualify as e-money either.[5] Libra, much like a pre-paid debit card, does satisfy the basic characteristics of e-money since it is issued on receipt of funds and stored electronically. But Libra is not a digital representation of a specific sovereign currency that can be used to make payments. Libra is instead a digital representation of value based on a basket of assets denominated in multiple sovereign currencies.

As Libra’s white paper clarifies, “one Libra will not always be able to convert into the same amount of a given local currency . . . . Rather, as the value of the underlying assets moves, the value of one Libra in any local currency may fluctuate.” Contrary to e-money, Libra is not “an electronic surrogate for coins and banknotes” that holds its nominal value stable relative to the sovereign currency used when funds were transferred.[6]

For example, $100 in cash transferred to a pre-paid debit card will become $100 of e-money, and the parity will remain unchanged no matter how long the holder of the card waits before making payments. On the other hand, $100 in cash transferred to a Libra account will become, say, 1000 Libra units, which, one week later, might be worth $96 and, after another week, $98—or perhaps $101.

Libra is a security

Libra is, after all, a transferable digital claim on the Libra Reserve. This reality pushes Libra away from the currency realm and into the securities territory. The “Howey test,” a framework developed by the U.S. Supreme Court to help identify when an investment is considered a security for regulatory purposes, confirms that perception. As the Supreme Court held in this precedent that influenced securities laws across the world,

“an investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise.”[7]

Libra is likely to meet all the prongs of the Howey test and, thus, to be considered a security.[8] First, the initial acquisition of Libra requires an investment of money since it can only be created in exchange for value, notably money denominated in a sovereign currency. The future circulation of Libra does not change this assessment, as its circulation will be similar to the trading of securities at the secondary market: no new security is created in either case.

Second, Libra is a common enterprise in which the fortune of the acquirers and users depends on the success of the Libra Association’s efforts. If the Libra Association does not manage Libra’s operations and reserve properly, acquirers of Libra may not be able to use it as expected or may even lose the money invested.

Third, Libra’s acquirers and users have a reasonable expectation of profits derived exclusively from the efforts of the Libra Association. Although Libra’s white paper makes clear that “[u]sers of Libra do not receive a return from the reserve,” “expectation of profits,” as courts have ruled, can carry other meanings.[9]

In Libra’s case, the financial return expected from acquirers and users may be that Libra continually holds a stable value relative to any sovereign currency they prefer to use when making the initial purchase or demanding redemption.[10] And this expectation will be closely connected to the belief that, regardless of individual actions or market forces (like inflation), the stability of Libra will derive from the managerial efforts and oversight of the Libra Association. More than that, Libra is supposed to be readily transferable and widely accepted at least among Facebook users, a group that represents a potentially vast market.

Libra, therefore, closely resembles shares in an open-end money market mutual fund, which reflect the value of a portfolio of assets selected by the fund manager and are expected to be freely redeemable at no significant price loss.[11] Libra seems to go beyond typical mutual fund’s shares since they can be transferred to other participants in the Libra network.^[12] But the difference is only apparent.

Unless resale restrictions apply (e.g., because of holding period requirements), securities are also transferable, either on an exchange or through a contractual agreement.[13] From this perspective, the Libra infrastructure will be just a platform to facilitate the trade of securities, the Libra units, between Libra’s users. Even so, the exchange of Libra units through the Libra infrastructure will only be straightforward when the Libra’s users taking part in the transaction are operating in the same jurisdiction.

Libra and its foreign-exchange component

If, however, the transaction involves Libra’s users operating in different jurisdictions, a foreign-exchange, or forex, transaction will also be in play. Because the offering and distribution of Libra units will be conducted locally by national entities—and not internationally by the Libra Association[14]—every cross-border transfer or payment will trigger a forex transaction.

As with any other international transaction involving money, a Libra unit could not simply disappear from a user’s account in one jurisdiction and appear on another user’s account in a different jurisdiction. Except for small amounts, forex regulations require the international flow of sovereign currencies to happen with the actual exchange of the corresponding currencies. The ultimate goal is to ensure that a sovereign currency remains under the exclusive control of the governmental authorities entitled to issue this currency.

Take, for instance, a transfer of funds from a Brazilian person to a Japanese entity that goes through a bank in the United States. This transaction must start with the conversion of Brazilian reais to U.S. dollars. The U.S. dollars will then be converted into Japanese yens and the transaction, settled.

Even if the American bank had subsidiaries in Brazil and Japan, these forex transactions would have to exist. The bank could not simply keep the reais in its Brazilian subsidiary and use its Japanese subsidiary to credit the account of the Japanese entity with an equivalent amount in yens—with no actual exchange or flow of money. In this case, the bank’s Japanese subsidiary would be creating yens without any support, a process that, in aggregate, could end up affecting the monetary stability sought by the Bank of Japan.

The problem for Libra is that it will not be a privately-issued currency denominated in its own unit of account and detached from any jurisdiction, like Bitcoin. Libra units will be based on a basket of sovereign currencies and separately distributed by jurisdiction. International transactions with Libra will, therefore, inevitably require the exchange of the underlining sovereign currencies for the trade to be legal.

In practice, thus, for a person in the United Kingdom to transfer Libra to a relative in South Korea, Libra units will have first to be converted into the sovereign currency of the sender’s jurisdiction—here, pounds. These pounds will then be converted into the sovereign currency of the recipient’s jurisdiction, wons, through the forex market. Only then the wons will be used to purchase the Libra units that will appear in the Libra account of the relative in South Korea. All these transactions will have to be performed, at a cost, by the exchanges and other financial-services providers operating in the Libra network.

Libra and its regulatory costs

The choice to design Libra as a “stablecoin” backed by assets denominated in different sovereign currencies may render Libra’s costs too high to handle. Libra proposes to create a slick and efficient global financial infrastructure. For it to function, however, Libra will require a complex web of multinational transactions and operators that are already subject to strict regulation.

If governmental authorities find Libra to be a security, any local entity offering or distributing Libra units will have to comply with securities regulations in full since Libra will be sold not to sophisticated investors but to the general public. Moreover, local entities dealing with the circulation of Libra will have to observe a myriad of legal rules, from securities and anti-money laundering regulations to forex regulations, if they also engage in international transfers. Finally, these entities and Libra’s users will be subject to the applicable tax laws.

This regulatory burden will bring operational and transactional costs that may not be met by the return the Libra Association and its partners will get from the Libra Reserve.[15] As the Libra Reserve will comprise a “basket of bank deposits and short-term government securities,”[16] which are assets with tiny if not negative returns, the Libra Association will face countless managerial challenges to build a profitable business.

Conclusion

Despite the fuss, Libra, if ever launched, may well be a short-lived project. As Libra is more likely to be considered a security rather than a currency, Libra will be heavily regulated from the start in every jurisdiction where it is offered, distributed, or put in circulation—no matter where the Libra Association is headquartered or where Libra units are initially created. Libra will thus have to clear too many regulatory hurdles to become the “simple global currency and financial infrastructure” it purports to be.

Marcelo M. Prates is a lawyer at the Central Bank of Brazil and a double graduate of Duke University School of Law (LL.M. 2015, S.J.D. 2018). The views and opinions expressed here are his and do not reflect the position or policy of any of the institutions with which he is affiliated. For comments, please contact marcelo.prates@bcb.gov.br.

[1] Information about Libra is available on its website and in the accompanying white paper.

[2] Bitcoin was launched in 2009 and remains the most popular cryptocurrency by market capitalization. See https://coinmarketcap.com/.

[3] See, for instance, Weighing Libra in the balance: Facebook wants to create a global currency (2019, Jun. 22), The Economist; Pistor, K. (2019, June 20). Facebook’s Libra must be stopped, Project Syndicate; Posner, E. (2019, Jun. 25). The trouble starts if Facebook’s new currency succeeds, The Atlantic; Duffy, C. (2019, Jul. 15). Maxine Waters has a plan to ban Libra and other Big Tech cryptocurrencies, CNN Business. On a more neutral note, laying out “initial recommendations for both private sector stablecoin developers and public sector authorities to address the challenges and risks,” see the G7 report on global stablecoins issued on October 18, 2019. A positive perspective, although also highlighting many regulatory concerns, can be found in Zetzsche, D., Buckley, R. & Arner, D. (2019). Regulating Libra: The transformative potential of Facebook’s cryptocurrency and possible regulatory responses (European Banking Institute Working Paper Series, No. 44).

[4] As Libra’s white paper points out, “[t]he [Libra] association is the only party able to create (mint) and destroy (burn) Libra. Coins are only minted when authorized resellers have purchased those coins from the association with fiat assets to fully back the new coins.”

[5] E-money is defined in the European Union law as “electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions as defined in point 5 of Article 4 of Directive 2007/64/EC, and which is accepted by a natural or legal person other than the electronic money issuer” (Directive 2009/110/EC of the European Parliament and of the Council of 16 September 2009 with subsequent modifications). A similar definition appears, for example, in the British and Brazilian rules and regulations on payment institutions. E-money remains relatively unregulated in the United States, although “stored-value” cards are widely used: see Haim, L. & Mann, R. (2014). Putting stored-value cards in their place. Lewis & Clark Law Review, 18(4), 989-1018.

[6] See Recital (13) of the EU Electronic Money Directive (Directive 2009/110/EC of the European Parliament and of the Council of 16 September 2009).

[7] S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946).

[8] For a detailed assessment of how to determine whether a digital asset may be considered a “security” based on the relevant legislation and the evolution of the case law, see “Framework for ‘investment contract’ analysis of digital assets” prepared by the Strategic Hub for Innovation and Financial Technology (FinHub) of the U.S. Securities and Exchange Commission (SEC). Based on this assessment and Bitcoin’s characteristics, the SEC recently stated that it does not see Bitcoin as a security. See the SEC staff letter to Cipher Technology Bitcoin Fund, from October 1, 2019.

[9] See, for example, S.E.C. v. Edwards, 540 U.S. 389 (2004). The Supreme Court held in Edwards that “[w]e used ‘profits’ [in Howey] in the sense of income or return, to include, for example, dividends, other periodic payments, or the increased value of the investment. There is no reason to distinguish between promises of fixed returns and promises of variable returns for purposes of the test, so understood. In both cases, the investing public is attracted by representations of investment income.”

[10] As stated on Libra’s website: “By fully backing each coin with a set of stable and liquid assets (described later) and by working with a competitive group of exchanges and other liquidity providers, users can have confidence that they will be able to sell any Libra coin at or close to the value of the reserve at any time.”

[11] Also likening Libra to shares in a money market mutual fund, see Kapadia, A. (2019, Aug. 22). Facebook’s Libra is an attempt to mask a promise as a token, LiveMint; and Hockett, R. (2019, Jun. 20). Facebook’s Proposed Crypto-Currency: More Pisces Than Libra For Now, Forbes.

[12] In the United States, investors have been able to use “checkable” money-market mutual fund (MMMF) accounts to make payments. But the terminology is misleading. An MMMF account “check” does not represent a direct drawing on balances kept in the MMMF account that can be immediately transferred to another account—as the traditional check drawn on a current account does. Instead, a check from an MMMF account involves “a dual order to the fund’s manager to sell a specified portion of the shareowner’s asset holdings and then to transfer the monetary proceeds to a third party named on the check” (Salerno, J. T. (2010). Money, sound and unsound. Auburn, AL: Ludwig von Mises Institute, p. 124). And this transfer is made with the use of bank deposits, credited by the fund’s manager to the current account of the third party. So, a “checkable” MMMF account is not a separate means of payment but a platform that eventually leads to the use of bank deposits as means of payment.

[13] About resale of securities in the United States, see, for instance, Campbell, Jr., R. B. (1995). Resales of securities under the Securities Act of 1933. Washington and Lee Law Review, 52, 1333-1384; Choi, S.J. (2000). Resales of offshore securities into the United States: Evaluating the overvaluation risk to U.S. investors, Washington University Law Review, 78, 519-565.

[14] As Libra’s white paper underscores, “Libra is designed to be a stable digital cryptocurrency that will be fully backed by a reserve of real assets—the Libra Reserve—and supported by a competitive network of exchanges buying and selling Libra.”

[15] From Libra’s white paper: “Interest on the reserve assets will be used to cover the costs of the system, ensure low transaction fees, and support further growth and adoption.”

[16] Libra’s white paper.